John Maynard Keynes Is Very Much Alive

Paul Krugman cites Greg Mankiw:

The Keynesian moment: Greg has this exactly right:

IF you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than a half-century ago, his diagnosis of recessions and depressions remains the foundation of modern macroeconomics. His insights go a long way toward explaining the challenges we now confront.

I think it’s worth saying a bit more about why, exactly, we’re in such a Keynesian moment. If Keynes receded in our consciousness over the past few decades, it wasn’t mainly because of uninformed criticisms from the right; it was because central bankers seemed to have everything under control. Uncle Alan and his counterparts, by controlling the money supply, could do the job of stabilizing the economy, and Keynesian fiscal policy seemed irrelevant. Now, Keynes understood the role of monetary policy quite well, and believed that it had been effective in the past. What he argued, however, was that there were situations in which monetary policy could do no more — and that the world economy he lived in was facing such a situation:

To-day and presumably for the future the schedule of the marginal efficiency of capital is, for a variety of reasons, much lower than it was in the nineteenth century. The acuteness and the peculiarity of our contemporary problem arises, therefore, out of the possibility that the average rate of interest which will allow a reasonable average level of employment is one so unacceptable to wealth-owners that it cannot be readily established merely by manipulating the quantity of money. So long as a tolerable level of employment could be attained on the average of one or two or three decades merely by assuring an adequate supply of money in terms of wage-units, even the nineteenth century could find a way. If this was our only problem now—if a sufficient degree of devaluation is all we need—we, to-day, would certainly find a way.

Archaic language, but he was describing a situation very much like the one we face now. To be sure, Keynes failed to foresee the postwar rise of the “marginal efficiency of capital” — the way that economic growth combined with inflation would create an environment in which interest rates were high enough in normal times that monetary policy was effective at fighting slumps. Hence the long era in which Keynes didn’t seem all that relevant. But his analysis remained as valid as ever, under the right conditions. Those conditions reappeared first in Japan during the 90s; now they’re everywhere.

And in the long run, it turns out, Keynes is anything but dead.

Comments

[Ken Houghton]

"the way that economic growth combined with inflation would create an environment in which interest rates were high enough in normal times that monetary policy was effective at fighting slumps."

Come on, Dr. Krugman, take this the next step: the war on inflation ("Conquest of American Inflation," to coin a phrase from my book shelf) left us in a situation when interest rates (real, nominal, all of the above) were too low to be able to fight a "slump."

Good thing Mankiw arranged his textbook so innovatively, eh? (http://www.nationalreview.com/nrof_bartlett/bartlett030503.asp; And, no, I don't mean to pick on Bruce Bartlett):

"For example, economist Mark Skousen, former president of the Foundation for Economic Education, praised Mankiw in his book, _The Making of Modern Economics_ (M.E. Sharpe, 2001). Mankiw, Skousen said, put classical economics at the front of his text and relegated Keynesian economics to a secondary position. Said Skousen, “In essence, under Mankiw, the classical model becomes the ‘general’ theory and the Keynesian model becomes the ‘special’ case — the very opposite of Keynes’s thesis.”"

Waiting on the next edition from Neo-Keynesian Mankiw.

[Peter Principle]

"in the long run, it turns out, Keynes is anything but dead."

We can only hope that rational expectations critique of Keynes -- specifically, the theory that economic actors tend to adjust for changes in fiscal policy in ways that quickly negate the effectiveness of fiscal policy -- isn't alive, too.

[MattYoung]

Whatever happened has reached government. Normally it is a transportation bottleneck. Americans have generally expected government and solve transportation bottlenecks.

But, not necessarily by infrastructure expenditures of any great amount. If the bottleneck is a result of government policy, or the bottleneck simply requires an adjustemnt to existing infrastructure, then we can get by with minimal expense.

Remember, what we are avoiding is $150/barrel oil. Burning a lot more oil is not going to help avoid that problem.

[MrM]

I posted the same question on Krugman's NYT blog:
Keynes analyzed recessions caused by demand shocks.
What we are going through now seems to be a different kind of recession - the one driven by the Minsky-type deleveraging. It is not obvious that the post-recession aggregate demand will or should come back to the pre-recession level.
Why should one believe that the Keynesian recipe will work in this kind recession too?

[Rakesh Bhandari]

But in (rightly) calling for government control of private entities, isn't Professor DeLong going beyond Keynes? Keynes underlined that a socialization of investment
'need not exclude all manner of comporomises and of devices by which public authority will cooperate with private initiative.' Moreover, only investment
planning was involved : 'Beyond this no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community.' After all, argued Keynes, 'It is not the ownership of the means of production which is important for the State to assume. If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those own them, it will have accomplished all that is necessary.' Brad can clarify but I think his proposals go beyond what Keynes would have recommended.

[Laura Harrison]

In the love/hate blogathon of Paul Krugman and Greg Mankiw...

It is significant that Greg Mankiw, an economist with links to Bush and Romney, should in his excellent article encourage us to approach the current economic crisis through the eyes of John Maynard Keynes.

However, his answer to the question "what would Keynes have done?" ignores an element that would clearly have been uppermost in Keynes's mind - how to get international action to solve the crisis.

Keynes would clearly have wanted international coordination of economic policies (monetary and fiscal) between the major economies, and would have wanted international economic institutions (the World Bank and the IMF, both of which he helped to found) to act in ways to free individual countries to take action (e.g. fiscal stiumulus) to overcome the crisis.

Anyone wanting background to this integral part of Keynes' thinking should read Donald Markwell's path-breaking study of "John Maynard Keynes and International Relations, Economic Paths to War and Peace", published in 2006 by Oxford University Press.

Mankiw's argument that it is hard to see how to get effective stimulus to consumption, investment, net exports and even government purchases makes it even more important that the United States provide leadership and encouragement to international action to overcome the crisis - and all the more surprising that in this otherwise compelling article he neglects to say anything about US leadership to get international stimulatory action.

Unfortunately, Krugman's response does not make this point about the need for international cooperation on economic policy. He does make it, in effect, in his excellent article in the NY Review of Books, where he talks of a "global rescue",etc.

It is a shame Krugman does not (as Keynes would have done!) argue the case for international action in his blog and NY Times articles.

[MattYoung]

I haven't read General Theory, but I hazard a guess at Keynes' central point. As we move from one set of operating conditions to another, we go through a period of change which is very inefficient. The new equilibrium will be, necessarily, unexpected. So we don't have the reserves to get us through the change, and we have to restructure using the non-monetary authority of government.

That is why everyone asks how we got it wrong, because if we expected the change, the the new eqilibrium investment would be funded.

This brings us back to Arnold Kling, who argues that bankruptcy should step in and sort out the failed institutions after the economy determines the new equilibrium(s).

Mankiw's point, via interpretation, is the the federal government, in stimulus activity, is not a fair representative of the aggregate, and stimulus activity should be shunted down to the state level. (I say shunt it down to the congressional level).

Krugman's national level stimulus would force the components of our economy to adapt to a federal defined term structure, which would (IMHO) yield more opportunities for derivatives, hedging and gaming. My position states that a government as large as the US federal is not a stable representation of the term structure of the components.

I we can't have Kling on this, then go with Mankiw.

[Phillip Huggan]

Regarding bank bailouts, I'm starting to see this whole hiccup as a function of the just-in-time economy. One sector of a bank's business is short-term loans. When these cease, so does the whole machine. The goal of bank bailouts is to target that specific bank customer (even if other bank business lines are toxic), in the hope banks are only temporarily irrationally panicked into not lending.
In the future, this could be made easier by planning such nationalizations ahead of time. You don't want banks to game the bailout by increasing risk so the G.Brown nationalization model is prudent. You could incorporate lenders specifically targeting nothing but short-term supply chain customers, and have just these banks be gradually eaten if scared to lend (to prevent government having to write off poisonous bank assets). If, if you know the bankers are suffering from PTSD and are just afraid to lend, you could lend them depreciating assets instead of cash. But if the bankers have reason to be afraid to lend...
The modern supply chain saves warehousing costs and increases churn, but it also means the machine can be shut down just as fast, potentially. I just got that. I'm sure there are plans to ensure essential infrastructures continue through a civil defense situation. Perhaps a lesser plan should be scripted for globalized infrastructures such as short term lending. A problem: sometimes there can be a plain glut of financial services, even for short-term lending.

[Michael Turner]

Laura Harrison writes: "[Mankiw's] answer to the question "what would Keynes have done?" ignores an element that would clearly have been uppermost in Keynes's mind - how to get international action to solve the crisis."

What Mankiw wrote there seemed to go limp about halfway through. Mankiw is, in fact, a New Keynesian. If you're an economist, that's no secret. However, one can be in that school -- use it as a framework for diagnosis -- and still be damned near Libertarian about policy. So it's like this really straight-seeming guy you know announces one day, "I'm gay." You wait for the other shoe to drop, knowing that it will be about his membership in the Log Cabin Club.

With what seemed to me an uncharacteristic impishness, Mankiw followed up with a cluster-bomb of arguably out-of-context quotes:

http://gregmankiw.blogspot.com/2008/11/next-team.html

And he has followed *that* up with a number of posts suggesting that Keynesianism has some holes that really matter here (and allusively deriding Krugman, I think, as hubristic about comprehensively understanding macro well enough to call policy shots).

One solution he seems to favor could be called "Christmas Comes Early, and Maybe Often": the most efficient stimulus might be a surprise (and deficit-financed) tax cut. He also suggests (as MattYoung notes above) pushing spending decisions further down than the national level. Good luck with the idea of a coordinated global effort if we go that way. Mankiw also seems to have major doubts about massive stimulus, pointing to a price to pay down the road. This seems like the usual GOP talking point about Social Security.

Mankiw might be about as Keynesian as you can be and still be a Republican. Or about as Republican as you can be and still be a Keynesian.

Sometimes I wish I had a highly informed source on economics that was also reliably non-partisan, who would say, "If you want this kind of society, you can get much of it by going this way; if you want that kind of society, you can get much of it by going that way; but there is no policy architecture that gets either side all of what they want."

I make do with Krugman and the like, since they wear their partisan sympathies on their sleeves, and seem at least able to resolve the outlines the GOP social vision, through a glass darkly. That might be as much honesty as we can reasonably expect.

[rcthweatt]

ISTM the historical record proves Keynes right, as conclusively as it can reasonably be expected to. The '70s? Mightn't the relentless rise in the price of the most basic commodity in the economy have caused stagflation? The commodity which later tanked just in time to save Reagan? Yes, oil.

Which brings us to- beyond our "magneto trouble", we have the problem(which they didn't have in 1930) of 'What goes in the tank?' If we get demand back up, won't $147bbl be back too, and spoil things? Isn't the crisis in confidence based on more than depleted capital? So, we need Big Gov't to, most of all, set the agenda for a new energy economy- massive expansion of wind and solar, plug-in hybrids, cap and trade with auction proceeds rebated as tax cuts- and, once that is done, the liquid will once again feel the tug of greed, and we've got our new bubble, which just may leave us with an economy that's not facing a dead end.

[Michael Turner]

"Mightn't the relentless rise in the price of the most basic commodity in the economy have caused stagflation?"

It's still debated. I've seen analyses that conclude, in effect, that the cause was basically monetary, that Nixon prevailed upon Alfred Kahn to expand the money supply sharply so as to help him win re-election by putting a temporary flush of apparent health on the economy. (So much for the independence of the Fed, eh? But that one cuts both ways: if Marriner Eccles had tried to be "independent" of New Deal policies, he might have ended up subverting them to a great extent. As it was, he was an ardent convert to Keynesianism, much more so than FDR, because Eccles actually grasped the ideas and it's not clear that FDR ever did.)

You have to be careful about cause and effect. Oil price shocks aren't necessarily inflationary -- only if the increases continue indefinitely, and/or are sharp enough to ignite a wage-price spiral. Otherwise, you might see only an across-the-board increase in prices that eventually levels off to ordinary price growth after the shock has been absorbed. Krugman is actually pretty careful on this point. We recently had dramatic oil price increases, but wage stagnation continued. It's like he's always said: the real monster to fear is deflation.

Oil prices can go up almost asymptotically on demand from an overheating economy, then drop very dramatically when the bubble bursts. Sure, one can observe that oil price spikes tend to precede recessions, but that's correlation, not cause. Bubbly economies ALSO tend to precede recessions, and bubbly economies can create unsustainably rapid increases in commodity demand.

It looks like that's what happened this time, and it looks like yet another data point supporting the case for stripping energy costs out of core inflation numbers. When wingnut pundits were castigating us as Chicken Littles for ignoring that wonderful recent drop in gasoline prices, they don't seem to realize they were pointing out an indicator of recession, not something that would save us from recession. They seem to have shut up about that, finally. I think they were more invested than certain leftwing pundits in the theory that the oil price increases owed to some kind of commodity futures bubble. Nobody ever proved that, and plenty of people pointed out how ridiculously unlikely a bubble was, unless you could find evidence of hoarding the commodity itself. There wasn't any speculative storage to speak of -- the oil was getting sopped up by a global economy growing faster than it could. And now we know: the global economy was roaring ahead because harrowing risks were being ignored.

[rcthweatt]

I remember the latter part of the '70s as a series of oil price increases, followed by inflation, followed by price increases, followed by....(i.e., OPEC countering silly Fed tricks). This didn't hurt me at the time, in fact the reverse, as I had moved from the Phila. area, where the economy was dead, to New Orleans, where an oil boom was on(so was a real estate boom). Things were just fine until oil prices began to drop, culminating in the steep plunge at the end of 1986, which in percentage terms was almost as large as the current one, and far more sudden- we're talking a week; Sheikh Yemani, the Saudi oil minister, had lost patience with the quota cheating by other OPEC countries, and had sharply increased production. The effects on oil exploration were immediate and dramatic- crash is the only appropriate term. The effects of this decline, culminating in the plunge, on the economy of the region as a whole were very severe, and the cause was not in dispute. In the rest of the USA, I hear tell, things improved quite a bit, and Reagan didn't have to go out and get himself shot again after all(he joked about doing so when his approval was at low ebb). So, from my vantage point(I worked in the offshore oil industry), I tend to rank the price of oil pretty high as an economic factor- Occam's razor and all.

If memory serves, the oil crisis didn't really hit until after Nixon left us- Ford caught the brunt of the anger(paranoia was rife), I'm pretty sure it cost him Pa. in 1976.