Posts Tagged ‘Keynes’

beyond Keynesians vs free-marketers

Tuesday, May 8th, 2012

Columbia University economist Jeffrey Sachs has a very interesting, informative column in today’s Financial Times.

Macroeconomic debates are mostly ideological rather than empirical.  This is a shame.  The diverse experiences across the OECD economies can clarify a lot about the various schools of thought.  Of all the high-income countries, it is the northern European countries, including social democratic Scandinavia and the Netherlands, and social-market Germany, that have the most favorable combination of low budget deficits, high employment, and global competitiveness.  Of course the specific challenges and current conditions differ by country, and so too will the best packages.

Northern Europe, including Germany itself, rejects the swingeing budget cuts that Chancellor Merkel has advocated for the rest of Europe. The northern European countries balance their budgets through high taxation, not low government spending.  They use ample public outlays to ensure universal access to education, job training, and modern infrastructure.  They insist on environmental standards, not environmental deregulation. ….

Northern Europe shows that social democratic (or social market) structuralism – an active government that is socially oriented, environmentally friendly, and skill promoting — works best. Scandinavia was also exemplary a generation ago when it decisively cleaned up its bank sector after an ill-fated cycle of liberalisation, boom and bust.  Today’s tired debates between Keynesians and free-marketers greatly oversimplify the real options, especially now that banking reform, job training, and inequality are the key issues.  Perhaps Francois Hollande will facilitate a new growth orientation based on structural changes rather than a doomed flirtation with fiscal profligacy.

Jeffrey Sachs, “We must move beyond growth versus austerity“, The A-List, Financial Times, 8 May 2012.

There is much more in the full column.

the Treasury View of 1929

Saturday, April 14th, 2012

What most depresses me, as I read myriad comments on our current financial crisis, is to see that the Treasury View that Keynes fought against in the 1930s is still alive and well. This is the view that public spending displaces private investment, so cannot stimulate the economy. Via Brad DeLong, here is Joan Robinson’s recollection of the 1930s debate, which eerily resembles the debate we are witnessing now.

What was the state of orthodox opinion when the world was struck by the great slump? First of all, there was the famous Treasury View of 1929…. Lloyd George was campaigning for a policy of public works; Keynes with Hubert Henderson produced the pamphlet Can Lloyd George Do It?, which first adumbrated the theory of the multiplier and of the relation of saving to investment. To answer Lloyd George, the Conservative government produced a White Paper in which various ministers stated the case against spending money in their respective departments on housing, schools, roads, etc. The Chancellor of the Exchequer was Churchill; he could not bring himself a second time to defend deflation and sound finance. It was left to the officials to produce the argument for the Treasury. Their case was very simple. It was based on the idea that investment is governed by saving. If the government borrowed £100 million to spend on public works, there would be £100 million less for foreign investment. The surplus of exports would fall by a corresponding amount. There would be a transfer of employment but no change in the total. It is not fair to put much weight on this. The Treasury, after all, was required to say something and this was what they thought of to say. The fact that it appeared to be a respectable argument, however, certainly was a symptom of the state of opinion at that time….

The main orthodox reaction to the slump was the argument that wages were too high. This could be backed up by statistical argument. In those old days, prices used to fall when there was a decline in demand, so that prices were lower relatively to money-wage rates than when employment was higher. In a style of argument nowadays familiar in another context, a correlation was exhibited as a cause. The theory that unemployment could be due only to wages being too high received solid support from the evidence….

While the controversy about public works was developing, Professor Robbins sent to Vienna for a member of the Austrian school to provide a counter attraction to Keynes. I very well remember Hayek’s visit to Cambridge on his way to the London School. He expounded his theory and covered a black board with his triangles. The whole argument, as we could see later, consisted in confusing the current rate of investment with the total stock of capital goods, but we could not make it out at the time. The general tendency seemed to be to show that the slump was caused by [excessive] consumption. R. F. Kahn, who was at that time involved in explaining that the multiplier guaranteed that saving equals investment, asked in a puzzled tone, “Is it your view that if I went out tomorrow and bought a new overcoat, that would increase unemployment?”‘ “Yes,” said Hayek, “but,” pointing to his triangles on the board, “it would take a very long mathematical argument to explain why.”

This pitiful state of confusion was the first crisis of economic theory that I referred to…

Joan Robinson, “The Second Crisis of Economic Theory” (Richard T. Ely Lecture), American Economic Review 62:1/2 (March 1972), pp. 1-10.

Cambridge economist Joan Robinson (1903-1983) was a brilliant, original thinker, yet never received a Nobel Prize. Many, if not most, economists believe that the Swedish Royal Academy was biased against her. According to an anonymous biographer in The Concise Encyclopedia of Economics, this bias was not because she was a woman. “Rather, her political views became more left wing as she aged, to the point where she admired Mao Zedong’s China and Kim Il Sung’s North Korea. These extreme views should not have affected her chances of getting an award for her intellectual contributions, but they probably did.”

Joan Robinson previously appeared on TdJ here, as the second entry in the “economics as faith” series.

defining ‘Keynesian’

Tuesday, February 7th, 2012

Jonathan Portes argues that the label ‘Keynesian’ has become politicised, resulting in sterile political debate and needlessly high levels of unemployment. He describes three definitions of ‘Keynesian’.

Definition 1 is ‘anyone who doesn’t believe the Treasury View’, the doctrine that it is impossible for fiscal policy to affect aggregate demand “because the government needs to get the extra money from somewhere, whether through taxes or borrowing”. Mr Portes used to believe this, but no longer does. Nor does anyone else, so everyone is a Keynesian by this definition.

Definition 2 is “someone who believes that as an empirical matter, fiscal policy does have a substantial impact on aggregate demand; in contrast to those who believe that ‘Ricardian equivalence’ means that changes to government spending and borrowing will be substantially or wholly offset by changes to private sector spending and saving”.

Definition 3

So under Definitions 1 and 2 I’m a Keynesian, but then so is pretty much everyone else whom one would take seriously. The final definition, then, of a Keynesian, appears to be a much more ‘political’ one – someone who thinks that slowing fiscal consolidation would be a sensible policy decision in the current UK (or US) economic context. But this definition seems to me to be misconceived ….

[T]he main argument between those of us who favour slowing fiscal consolidation in the UK and those who think that this would be a dangerous mistake is not about whether the direct impact would be positive. It is whether the price of this direct positive impact would be ‘credibility’ with financial markets, and hence a damaging rise in long-term interest rates that would more than offset the gains.

I think this risk is hugely exaggerated, … but … this debate really has nothing to do with Keynes at all. It’s about a lot of things – how policymakers should deal with potential market irrationality, the role of the credit rating agencies, multiple equilibria, etc. But I don’t see that taking one side or the other of these arguments makes you a Keynesian (or not).

Jonathan Portes, “Fiscal policy: What does ‘Keynesian’ mean?“, Vox EU, 7 February 2012.

Jonathan Portes (born 1966) is director of the National Institute of Economic and Social Research, a London-based, independent research institute.

Hayek and Keynes

Thursday, December 22nd, 2011

If you are thinking of giving an economist-nerd friend a book for Christmas, you might be attracted to a new publication that ranks #38 on’s “best sellers” list of economics books, with an average customer review of 4 stars. Popularity, however, is not everything. After reading the reviews, it becomes clear that Keynes Hayek: The Clash that Defined Modern Economics (Norton, 2011), by Nicholas Wapshott, would probably not be a good choice for a nerdy economist friend.

Economist Herbert Gintis wrote a scathing review of the book at (see the link above), and gives it three stars only because of its entertainment value.

The problem with the book is that the two figures [Keynes and Hayek] really did not much interact, either in words or in real life, and each was preoccupied with a major battle that did not involve the other. Keynes’ polemic was against the received wisdom in British and American economics, which held that economic downturns are self-correcting, provided the monetary authority maintained the value of the currency and did not run exorbitant deficits. Of course the Austrian school believed this too, but this school was practically unknown in Anglo-American circles. Hayek was concerned with business cycle theory, but his contributions were exceeding arcane and unpersuasive. Rather, Hayek was the dedicated enemy of central planning of the state socialist variety. ….

I think the world of both Keynes and Hayek, the former as a wise practitioner whose economic theory is completely ridiculous (it took Hicks, Samuelson, and other serious economists to “make sense” of Keynes’ impenetrable prose—“make sense” not by clarification of Keynes’ ideas, but rather by offering an alternative analytical framework in which underemployment equilibrium is possible), and the latter as brilliant intellectual who was almost destroyed (despite his Nobel prize) by his adherence to the bizarre and irrelevant doctrines of the Austrian school, whose economic theory was dogmatically dictated by its paranoid fear of state intervention.

Read this for fun, dear reader, the same way you read People magazine. Don’t think you will get some deep insights in the the nature of modern political economy. You won’t.

Herbert Gintis (born 1940), now Professor Emeritus at the University of Massachusetts, in 1968 co-founded the Union for Radical Political Economics. He also co-authored, with Samuel Bowles, Schooling in Capitalist America: Educational Reform and the Contradictions of Economic Life (Basic Books, 1976), which at the time had a large influence on me.

At the other end of the political spectrum, Greg Ransom titles his Amazon review “This is a fantasy not history, constructed via cut & paste”, and gives the book two stars (from a maximum of five – no star at all is not an option).

I’ll give the book two stars rather than one, in part for this — Wapshott digs out quotations of British newspapers which haven’t been republished before, and he digs out a few original quotations from British archive materials which are new to the book literature.

Ransom blogs at Taking Hayek Seriously and is an expert on Hayek.

2012 politics and dead economists

Tuesday, September 13th, 2011

In a fusillade of debates and speeches President Barack Obama and his Republican challengers have firmly established the economic policy combat lines for next year. ….

Providing intellectual underpinnings to each side – while lurking mostly out of sight – is the work of long-dead economists. The White House continues to lean heavily on the playbook of economist John Maynard Keynes – without uttering his name. ….

Republicans have been less coy about their favourite school: Ludwig von Mises and Friedrich Hayek. The quasi-libertarian, anti-statist sensibilities of these philosophers appeal to a public that has soured on government. “I love von Mises,” Michele Bachmann told one interviewer. “When I go on vacation and I lay on the beach, I bring von Mises.” ….

The Republicans’ rhetoric may work well at the ballot box but their policies lack efficacy. However compelling the merits of long-term deficit reduction, the Keynesian notion of counter-cyclical fiscal policy remains valid. As economists Alan Blinder and Mark Zandi (a former adviser to Republican John McCain) found, the first Obama stimulus saved about 8.5m jobs and may have prevented a depression. Now Mr Zandi calculates the new Obama plan would create 1.9m jobs in the next year and add two percentage points to gross domestic product. The Republican alternative – slamming on the brakes – would have the opposite result.

Steven Rattner, “The 2012 rivals can be named: Hayek v Keynes“, Financial Times, 13 September 2011.

the myth of ‘job-killing’ spending

Tuesday, June 21st, 2011

Princeton economist Alan Blinder is worried about a “wrong-headed” idea that is popular with US Republicans. Blinder refers to British economist John Maynard Keynes, who ended his famous 1936 book, The General Theory of Employment, Interest and Money, pointing out that ideas “both when they are right and when they are wrong, are more powerful than is commonly believed. Indeed, the world is ruled by little else. …. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Soon or late, it is ideas, not vested interests, which are dangerous for good or evil.”

Right now, I’m worried about the damage that might be done by one particularly wrong-headed idea: the notion that, in stark contrast to Keynes’s teaching, government spending destroys jobs.

No, that’s not a typo. House Speaker John Boehner and other Republicans regularly rail against “job-killing government spending.” Think about that for a minute. The claim is that employment actually declines when federal spending rises. Using the same illogic, employment should soar if we made massive cuts in public spending—as some are advocating right now. ….

It is easy, but irrelevant, to understand how someone might object to any particular item in the federal budget—whether it is the war in Afghanistan, ethanol subsidies, Social Security benefits, or building bridges to nowhere. But even building bridges to nowhere would create jobs, not destroy them, as the congressman from nowhere knows. To be sure, that is not a valid argument for building them. Dumb public spending deserves to be rejected—but not because it kills jobs. ….

Despite … evidence and logic, some people still claim that fiscal stimulus won’t create jobs. Spending cuts, they insist, are the route to higher employment. And ideas have consequences. One possibly frightening consequence is that our limping economy might have one of its two crutches—fiscal policy—kicked out from under it in an orgy of premature expenditure cutting. Given the current jobs emergency, that would be tragic.

Alan S. Blinder, “The GOP Myth of ‘Job-Killing’ Spending“, Wall Street Journal, 21 June 2011.

Thanks to Mark Thoma for the pointer.

Alan Blinder (born 1945) was vice chairman of the US Federal Reserve from 1994 to 1996.

fiscal consolidation is not stimulus

Friday, June 3rd, 2011

Martin Wolf responds to monetarist criticism of his position that fiscal contraction is unlikely to be expansionary when the economy is in deep recession. Martin explains that he is a fiscal conservative. His disagreement with monetarists is on the timing of fiscal consolidation, not the necessity.

I supported the [UK] fiscal consolidation in the early 1980s and 1990s. In both cases, it seemed manageable and necessary. I also support fiscal consolidation now. The doubts are simply over timing, speed and flexibility, because today private indebtedness is high, banks fragile and interest rates as low as possible. ….

Yes, in the very long run, the combination of a large expansion of broad money with a fiscal contraction would probably return the economy to something close to full employment, but nobody can know over what time period or even at what price level. The celebrated remark of Keynes – “The long run is a misleading guide to current affairs. In the long run we are all dead” – is applicable.

Martin Wolf, “Arguing over the ABC and D of the crisis“, Financial Times, 3 June 2011.

Martin selected an appropriate quote from chapter 3 of Keynes’ A Tract on Monetary Reform (1923). I would add the sentence that follows: “Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.”

Keynesian economics and the economics of Keynes

Friday, March 18th, 2011

Below is the beginning and end of a post by Carleton University economist Nick Rowe. It is a long and wonkish post, but Nick writes with exceptional clarity and (compared to other economists!) with minimum jargon. Read the entire post by clicking on the link.

If we lived in a world of barter exchange, or in a world where people could use barter exchange at minimal cost, Keynesian macroeconomics would make no sense whatsoever.

That is not, of course, a criticism of Keynesian macroeconomics. We do live in a world where people use monetary exchange, not barter. And people (usually) use monetary exchange because barter is (usually) very costly.

But do Keynesians understand this?

[Not fully ….]

The trouble with Keynesians is that they aren’t radical enough. They need to look at their own models and see the root of the problem, and recommend policies to get at the root of the problem. The root of all Keynesian recessions is monetary.

Just like Milton Friedman said.

Nick Rowe, “Do Keynesians understand their own models?”, Worthwhile Canadian Initiative, 18 March 2011.

Friedman actually said that inflation is a monetary phenomenon. Nick shows that this insight applies also to recessions.

fiscal multipliers

Tuesday, February 8th, 2011

Unemployment in the US continues to be high despite the stimulus program enacted by the federal government in March of 2009. Some argue that this proves that the stimulus was too small; more is needed. Others question the validity of a key implication of Keynesian economics, that when demand is low, government spending can bridge the gap and have a multiplier effect on demand. The multiplier is defined as change in real GDP divided by change in government spending, so a multiplier greater than unity is essentially a ‘free lunch’: GDP goes up by more than the amount of government spending. A multiplier smaller than unity indicates that government spending is crowding out some private spending. A multiplier of zero means that all government spending crowds out private spending, and has no stimulus effect at all.

Sceptics of high Keynesian multipliers frequently cite the work of Harvard’s Robert Barro, a New Classical economist who has estimated government spending multipliers for the United States that are smaller than unity during periods of war, and close to zero in peacetime.

I have estimated … that World War II raised U.S. real defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943–44, amounting to 44% of trend real GDP. I also estimated that the war raised real GDP above trend by $430 billion per year in 1943–44. Thus, the multiplier was 0.8 (430/540). ….

We can consider similarly three other U.S. wartime experiences—World War I, the Korean War, and the Vietnam War—although the added defense expenditures were much smaller in comparison to GDP than that for WWII. When I combined the evidence for all four wars, I got an overall estimate of the multiplier of 0.8, the same value as before. ….

When I attempted to estimate directly the multiplier associated with peacetime government purchases [from 1942 to 1978], I got a number that was statistically insignificantly different from zero.

Robert J. Barro, “Voodoo Multipliers“, Economists’ Voice (February, 2009).

High multipliers are only plausible when demand is low and there are no constraints on supply. During wartime supply constraints are the norm, and are often so severe that governments ration consumer goods. Nor would Keynesian multipliers be high during all periods of peacetime – rather, only when demand is low. Keynesian multipliers are relevant at the present time only if the US economy is in a severe recession and is not supply-constrained.

A new paper from the prestigious NBER (National Bureau of Economic Research) examines the period 1939-1941, the recessionary period just before World War II, to shed light on this debate. The authors show that the US fiscal multiplier was 1.9 through mid-1941, but falls to 0.9 if data are included from the second half of 1941, when capacity constraints began to appear.

Co-authors Robert Gordon and Robert Krenn conclude that nearly 90 percent of the economic recovery that took place between the first quarter of 1939 and the last quarter of 1941 can be attributed to fiscal policy innovations. ….

This paper highlights a paradox in the study of fiscal multipliers: even though proponents of fiscal policy stimulus to cure a weak economy operate in an environment of low capacity utilization, most of the actual episodes of rapid fiscal expansion have taken place either prior to or during wartime episodes in which capacity constraints were operative (including World War II, the Korean war, and the Vietnam war). An ideal test case for measuring the fiscal multiplier occurred in the six quarters between mid-1940 and late-1941, prior to the Pearl Harbor attack. Previous analysts assumed that this period represented a fair test of the multiplier effect, because the unemployment rate was 9.9 percent on average during 1941. However, this paper shows that capacity constraints did exist in 1941, particularly in the second half of the year. The fiscal stimulus in 1940-41 was partly crowded out not by any increase in interest rates, but rather by capacity constraints in critical area s of manufacturing that became increasingly binding in the second half of 1941. Therefore, estimates of fiscal multipliers for 1940-41 are only relevant to low-utilization situations like 2008-10 if they are based on the evolution of the U. S. economy through mid-1941 and exclude the effect of the capacity-constrained last half of 1941.

After reviewing evidence from the 1940-41 editions of Business Week, Fortune, and The New York Times, Gordon and Krenn document that the American economy went to war starting in June 1940, fully 18 months before Pearl Harbor. In February 1941 fully one percent of the American labor force was at work building army training camps for 1.4 million new draftees. Employment in ship-building to expand the U. S. Navy and to supply Lend-Lease aid to Britain accounted for another one percent of the labor force in 1941. As early as June 1941, capacity utilization had reached 100 percent in the production of iron and steel and durable goods of all types.

… Gordon and Krenn … show that private consumption and investment actually declined in the last half of 1941, as shortages of steel prevented auto companies from satisfying demand, and shortages of aluminum needed for aircraft production suppressed civilian production of everyday pots and pans. As a result, the government spending multiplier is 1.9 when estimated through mid-1941 but only 0.9 when measured through the end of 1941.

Robert J. Gordon and Robert Krenn “The End of the Great Depression“, NBER Working Paper No. 16380 (September 2010).

The summary above was compiled by Matt Nesvisky for The NBER Digest, February 2011.

Robert J. Gordon teaches economics at Northwestern University and is author of the popular text Macroeconomics, now in its 10th edition. His co-author Robert Krenn is employed by a proprietary trading firm in Chicago’s financial district. Their paper should satisfy Keynesian sceptics, but probably won’t, because empirical evidence seldom has any effect on economics as faith.

“Animal Spirits” explained

Sunday, October 10th, 2010

One week ago, I promised a full explanation of what economists mean by the term “animal spirits”. I am now fulfilling that promise by posting relevant passages from the delightful book written by economists George Akerlof and Robert Shiller.

John Maynard Keynes [in  The General Theory (1936)] sought to explain departures from full employment, and he emphasized the importance of animal spirits. He stressed their fundamental role in businessmen’s calculations. “Our basis of knowledge for estimating the yield ten years hence of a  railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing,” he wrote. If people are so uncertain, how are decisions made? They “can only be taken as a result of animal spirits.” They are the result of “a spontaneous urge to action.” They are not as rational economic theory would dictate, “the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”

In the original use of the term, in its ancient and medieval Latin form spiritus animalis, the word animal means “of the mind” or “animating.” It refers to a basic mental energy and life force. But in modern economics animal spirits has acquired a somewhat different meaning; it is now an economic term, referring to a restless and inconsistent element in the economy. It refers to our peculiar relationship with ambiguity and uncertainty. Sometimes we are paralyzed by it. Yet at other times it refreshes and energizes us, overcoming our fears and indecisions.


The term animal spirits originated in ancient times, and the works of the ancient physician Galen (ca. 130-ca. 200) have been widely quoted ever since as a source for it. The term was commonly used in medicine through medieval times and up until Robert Burton’s The Anatomy of Melancholy (1632) and Rene Descartes’ Traité de l’Homme (1664). There were said to be three spirits: the spiritus vitalis that originated in the heart, the spiritus naturalis that originated in the liver, and the spiritus animalis that originated in the brain. The philosopher George Santayana (1923) built a system of philosophy around the  centrality of “animal faith,” which he defined as “a pure and absolute spirit, an imperceptible cognitive energy, whose essence is intuition.”

George Akerlof and Robert Shiller, Animal Spirits: How human psychology drives the economy and why it matters for global capitalism (Princeton University Press, 2009), pp. 3-4, 177-178.