Tag Archives: john maynard keynes

Economic theory as a guiding light for government action in this crisis

Economic theory as a guiding light for government action in this crisis. But which theory? The dominant Keynesian economic theory, or that of the Austrian School?  (see the links at the end for background information about each).

Here is an excerpt from the Drobny Global Monitor of 5 March 2009, by Andres Drobny (see his bio at the end).   It not only provides a major expert’s perspective on our situation, but also illustrates the complexity and limitations of today’s economic theory — factors often lost in the politicized discussion about the appropriate public policy response to this recession (or depression).


One of the debates out there is whether the governments should keep ‘bailing out’ institutions to prevent a cascade of defaults. Or, just let them go bust, let the ‘haircuts’ fall where they fall, get it over with and then allow firms to restructure and start again. Avoid the Japanese mistake of prolonging the misery.

It is sometimes suggested that the former idea is somehow ‘Keynesian’. And, the latter is often described as ‘Austrian’.

Now, it is true that some Keynesians argue in favor of ‘bailouts’. And, Governments generally seem to be following both a bailout strategy and the more traditional Keynesian idea of fiscal stimulus during a slump. It is also true that some famous Austrians have been known to favor the default strategy.  Yet, this discussion misses the point. None of this is actually what the various theories suggest. There’s a profound difference between policy prescriptions associated with a theoretical perspective, and the underlying theories themselves.

And, looking back at the simple principles of Austrian and Keynesian theories provides some clarity of what we are currently living through, how the policy debates fit in, and what is evolving in financial markets. It also helps us assess the increasingly popular ‘bond bubble’ concept that has been circulating this year.

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A situation report about the global economy, as the flames break thru the firewalls

Summary:  The global economy continues to fall towards debt deflation (see here), rare and never cured (WWII was not a “cure”.)   This is a brief look at current dynamics, and the short and medium term futures.    At over 2000 words, it is already too long; supporting logic and evidence must await later posts.

This is all speculation.  I say this up front, to avoid having to fill the text with “perhaps” and “maybe” in every sentence.  I hope I these guesses are wrong.


  1. Global summary
  2. Asia
  3. What about the US?
  4. Looking ahead, what can we expect for America?
  5. Looking beyond the downturn, what can we expect?
  6. The big unknown
  7. Do you believe this forecast?
  8. Conclusions

1.  Global summary

Metrics of economic activity are almost all falling.  Many are falling rapidly; some are in free fall.

The world moves from a financial crisis — in which governments bail out banks — to a larger crisis in which entire nations must need bailouts.  Iceland was the first.  A long sick list is growing:  the UK, Ireland, Spain, Italy, and many emerging nations (esp in Eastern Europe).

2.  Asia

Asia, so dependent on exports, falls into a depression (often defined as 4 quarters with real GDP down 10%).

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Economics is not a morality tale

Western civilization can be seen as the liberation of technical theory (science, in the broadest sense) from moral values.  This battle continues to this day.  It is so much easier and enjoyable to be a witch-doctor than a scientist  (again, in the broad sense as devoted to rational thought).

  1. Machiavelli divorced poltical theory from the personal morality of the ruler — a ruler must do the right thing for his people, even at the cost of going to Hell (Shakespear sketches this out pleasantly in Measure for Measure). 
  2. Modern medicine broke the connection (so evident in the Gospels) that sickness is not the consequence of sin (with a few possible exceptions). 
  3. Keynes broke the connection between economic cycles and sin. 

The current reminder of this dearly learned insight

Keynes offers us the best way to think about the financial crisis“, Martin Wolf, Financial Times, 23 December 2008 — Exp note #3.  Excerpt:

I see three broad lessons.

The first, which was taken forward by Minsky, is that we should not take the pretensions of financiers seriously. “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.” Not for him, then, was the notion of “efficient markets”.

The second lesson is that the economy cannot be analysed in the same way as an individual business. For an individual company, it makes sense to cut costs. If the world tries to do so, it will merely shrink demand. An individual may not spend all his income. But the world must do so.

The third and most important lesson is that one should not treat the economy as a morality tale. In the 1930s, two opposing ideological visions were on offer: the Austrian; and the socialist. The Austrians – Ludwig von Mises and Friedrich von Hayek – argued that a purging of the excesses of the 1920s was required. Socialists argued that socialism needed to replace failed capitalism, outright. These views were grounded in alternative secular religions: the former in the view that individual self-seeking behaviour guaranteed a stable economic order; the latter in the idea that the identical motivation could lead only to exploitation, instability and crisis.

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Some thoughts about the economy of mid-21st century America

Our lesson for today is an excerpt from “Economic possibilities for our grandchildren” by John Maynard Keynes, originally published in The Nation and Athenœum, 11 and 18 October 1930:

We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the nineteenth cen­ tury is over; that the rapid improvement in the standard of life is now going to slow down — at any rate in Great Britain; that a decline in prosperity is more likely than an improve­ ment in the decade which lies ahead of us.

I believe that this is a wildly mistaken inter­pretation of what is happening to us. We are suffering, not from the rheumatics of old age, but from the growing-pains of over-rapid changes, from the painfulness of readjustment between one economic period and another.

The increase of technical efficiency has been taking place faster than we can deal with the problem of labour absorption; the improve­ ment in the standard of life has been a little too quick; the banking and monetary system of the world has been preventing the rate of interest from falling as fast as equilibrium re­ quires. And even so, the waste and confusion which ensue relate to not more than 7½ per cent of the national income; we are muddling away one and sixpence in the £, and have only 18s. 6d., when we might, if we were more sensible, have £1; yet, nevertheless, the 18s. 6d. mounts up to as much as the £1 would have been five or six years ago.

… The prevailing world depression, the enormous anomaly of unemployment in a world full of wants, the disastrous mistakes we have made, blind us to what is going on under the surface-to the true interpretation of the trend of things. For I predict that both of the two opposed errors of pessimism which now make so much noise in the world will be proved wrong in our own time — the pessimism of the revolutionaries who think that things are so bad that nothing can save us but violent change, and the pessimism of the reactionaries who consider the balance of our economic and social life so precarious that we must risk no experiments.

My purpose in this essay, however, is not to examine the present or the near future, but to disembarrass myself of short views and take wings into the future. What can we reasonably expect the level of our economic life to be a hundred years hence? What are the economic possibilities for our grandchildren?

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Words of wisdom about the global recession, from the greatest economist of our era

These are words that deserve attention as we begin a new year, entering into what looks like the worst economic crisis since the Great Depression.  The author is a foreigner, hence his stilted language.

Excerpt from “The Great Slump of 2009”

The world has been slow to realise that we are living this year in the shadow of one of the greatest economic catastrophes of modern history. But now that the man in the street has become aware of what is happening, he, not knowing the why and wherefore, is as full to-day of what may prove excessive fears as, previously, when the trouble was first coming on, he was lacking in what would have been a reasonable anxiety. He begins to doubt the future. Is he now awakening from a pleasant dream to face the darkness of facts? Or dropping off into a nightmare which will pass away?

He need not be doubtful. The other was not a dream. This is a nightmare, which will pass away with the morning. For the resources of Nature and men’s devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for every one a high standard of life — high, I mean, compared with, say, twenty years ago–  and will soon learn to afford a standard higher still. We were not previously deceived. But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time — perhaps for a long time.

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About the state of economic science, and advice from a famous economist

Summary:  an economist explains the current state of the science of economics, and then Bruce Bartlett repeats to us the most-famous modern economist’s advice about a similar situation.

Excerpt from a post by Prof Brad DeLong (Economics, Berekeley) at his blog Grasping Reality with Both Hands.  It is so perfect that it needs no elaboration:

The problem is that economic theory is not rocket science. It is not like theoretical physics — conducting a relatively few crucial experiments to decide on basic theories and then working out the consequences of those theories from first principles. Economic theory is, instead, crystalized history. We take a bunch of historical episodes that seem relevant to the problems of interest of today. We boil down what seem to be their salient features. And then from the resulting soup and bones we construct simple stylized models that we think help us understand present and future episodes that fall into the same class.

The problem is that right now we have a financial crisis big enough and strange enough that there is only one past historical episode in the same class: the early stages of the Great Depression. And when there is only one, the value of skill at deriving theoretical lessons from the class is at a steep discount and the value of knowing the history is at a premium: better to take the history raw.

What would Keynes advise us to do?

His post discusses an article I recommend reading:  “What Would Keynes Do?“, Bruce Bartlett, Forbes, 5 December 2008 — “The government should spend on stuff, not on bad assets.”   Excerpt:

Every day that goes by makes clearer the parallels between the current financial crisis and the one that led to the Great Depression. Then, as now, the core problem was one of deflation, or falling prices. But fixing it will require more than just low interest rates. This was the key insight of British economist John Maynard Keynes, whose theories finally explained how to end the Great Depression. They may be the key to solving today’s crisis as well.

The Great Depression was so deep and prolonged for many reasons. Herbert Hoover stupidly signed the Smoot-Hawley Tariff, which crippled international trade and finance, and imposed one of the largest tax increases in American history in 1932, which was exactly the wrong medicine at the wrong time. Franklin D. Roosevelt at least understood that deflation was at the root of the problem, but he thought artificially raising the price of gold and preventing businesses from cutting prices and wages by law was the solution. In fact, it prevented the economy from adjusting, which made the situation worse.

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The greatness of John Maynard Keynes, our only guide in this crisis

Judging from the comments on the FM site, most readers should carefully review these articles.  I believe this crisis results from a paradigm crisis in Keynesian economics, as we reach the boundaries of his vision — specifically, the point at which aggregate private sector debt becomes a limiting factor for the economy’s growth.  But however inadequate, Keynesian theory is all we have until another such genius comes along.

It does not matter how inadequate Keynesian theory might be, it is all we have today.  Thomas Kuhn explained in his great work, The Structure of Scientific Revolutions (chapter 8) that paradigms can only be replaced, not disproven:

The decision to reject one paradigm is always simultaneously the decision to accept another, and the judgment leading to that decision involves the comparison of both paradigms with nature and with each other. (p. 79)

A scientist, and even more strongly a public official, can no more make economic decisions without a paradigm than a computer work without software.  Unfortunately, today Keynesian theory is all we have.  Competitors, such as Austrian and Marxist economics, provide neither the precision or scope of vision necessary to manipulate fiscal and monetary policy.  Hence I recommend reading this brief essays on the application of Keynes’ work (developed by his successors) to our crisis.

  1. What Would Keynes Have Done?“, Greg Mankiw, New York Times, 28 November 2008
  2. The Keynesian moment“, Paul Krugman, op-ed in the New York Times, 29 November 2008
  3. The greatness of Keynes“, Paul Krugman, op-ed in the New York Times, 30 November 2008


What Would Keynes Have Done?“, Greg Mankiw, New York Times, 28 November 2008 — Excerpt:

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