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

Excerpts

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

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.

According to Keynes, the root cause of economic downturns is insufficient aggregate demand. When the total demand for goods and services declines, businesses throughout the economy see their sales fall off. Lower sales induce firms to cut back production and to lay off workers. Rising unemployment and declining profits further depress demand, leading to a feedback loop with a very unhappy ending.

The situation reverses, Keynesian theory says, only when some event or policy increases aggregate demand. The problem right now is that it is hard to see where that demand might come from.

The Keynesian moment“, Paul Krugman, op-ed in the New York Times, 29 November 2008 — Excerpt:

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

The greatness of Keynes“, Paul Krugman, op-ed in the New York Times, 30 November 2008 — Keynes understood things that remain a mystery to non-economist policy gurus even today.  This brief essay is well worth reading in full.  Excerpt:

The greatness of Keynes is illustrated by the trouble people who consider themselves well informed have, to this day, in understanding the basic principles of how a depressed economy works.

Afterword

If you are new to this site, please glance at the archives below.  You may find answers to your questions in these.

Please share your comments by posting below.  Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

For more information from the FM site

To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp relevance to this topic:

Forecasts on the FM site about causes of the crisis:

  1. The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  2. Diagnosing the eagle, chapter I — the housing bust, 6 December 2007
  3. Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
  4. Let us light a candle while we walk, lest we fear what lies ahead, 10 February 2008 – Putting the end of the post-WWII regime in a larger historical context.
  5. A vital but widely misunderstood aspect of our financial crisis, 18 September 2008 — Too many homes.
  6. A picture of the post-WWII debt supercycle, 26 September 2008
  7. Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
  8. Causes of the financial crisis (no, its not the usual list), 29 October 2008
  9. Government policy errors and the Great Depession, 1 November 2008

51 thoughts on “The greatness of John Maynard Keynes, our only guide in this crisis”

  1. For 34.-

    How inelegant to omit Greenspan in this private debt “zarzuela”. Coming from the “quoation blog plug-in”, this one resulted very very suspicious. Are you being paid at least?

    In summary:
    A typical bias from the trained tongue of an anonym media polititian (Fabius Maximus on this post). Is it possible to avoid specifics and then run away like a “donna mobile”. Of course this is your right, of course!

    You don’t remotely showed stature in the argument…since it was from the begining biased and poorly researched.

  2. Most of the recent writings about Keynes, including some but not all of what Greg Mankiw and Paul Krugman have written, neglects the important international dimension of what he was about. He advocated the international coordination of economic policies, and international economic institutions like those he helped to create at Bretton Woods (the World Bank and IMF), and for most of his life advocated free trade, including to promote peace between countries. Wht is this neglected so much, when it is so important to finding a way out of our current global mess? Anyone reading Markwell’s book on Keynes and international relations will see how central this was to Keynes’s thinking.
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    Fabius Maximus replies: This is an this important — even critical point! See my reply to comment #10 above, which says something similar.

  3. A good article at Forbes: “What Would Keynes Do?“, Bruce Bartlett, 5 December 2008 — “The government should spend on stuff, not on bad assets.” It’s seems to be a pretty good description.
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    Fabuis Maximus replies: Yes in one sense. Horrifying in another.
    * Economics has been one of the most common undergraduate majors for several generations.
    * This is Econ 101, the primary lesson from the major ecnoomic events in 20th century American and global history.
    * One of the top experts on the depression era has been Fed Chairman throughout the entire crisis.

    Why should this article need to be written? This message should be as necessary to say as “don’t pee upriver of your water source.”

  4. Obama is out with his stimulus plan; about 500 billion. Not nearly big enough IMO. If WWII got us going with 44% of GDP, that’s seven or so trillion today. It’s hard to spend that kind of money quickly. A war mobilization could do it, but what else? Predictably, govt. is still reactive, and in a too little too late mode.
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    Fabius Maximus replies: Agreed, but then the MO of our government’s response has been “too little, too late.” Why change now, esp with the “Obama no-change administration”.

  5. Perhaps, before we continue with trying to bail things out, we should require them to retake econ 101! We might then have a remote chance! Better late then never and all that.

  6. FM: A bit long, but as an amateur Keynes student I hope very relevent.

    Don’t copy Keynes, learn how to think like him.

    Some very important things about Keynes were, for example:

    (1) When challenged when he had changed his view about a point: “Of course I changed my mind when I had new information, what would you do?”

    (2) His work on money, interest rates and especially the role of profits (totally neglected in nearly all economics up that point .. and sadly very much so since then).

    (3) The role of peoples actual behaviour under uncertainty (rather than the “perfect economic man” assumption normally used), predating all the recent work on behavioural economics, a dominant thread in recent (pseudo) Noble prizes in economics.

    (4) His suspicion of complex mathematical models of economies. This was a ‘gut feel’ from him, but, again, he predated the work on Chaos theory (ie non-linear dynamics), which makes it very difficult (not impossible now with modern maths and computer systems, but still very, very difficult) to build models of complex systems.

    (5) His love of Liberal (capital L to differentiate it from the US idea of liberals), democratic society. One, valid criticism of some extreme economic models (ie Austrian or Communism) is that it is impossible to maintain a democratic and free society if you apply those theories. We all know about Communism, but the Austrian school requires a brutal totalitarian society to be applied (with the attendant starvation, health collapse, etc). The ‘economy’ might work, trouble is you are so up to you eyeballs in a 4GW that you just end up switching ‘bad’ social spending to ‘good’ military spending to keep your people from cutting off the elite’s heads.

    (6) His love of a good quality of life. Though he made quite a fair bit of money in his time, he spent huge amounts of his money and even more of his precious time on education, arts, music and literature. His idea was that as we all got wealthier than, once the immediate needs of good housing, transport, health, etc were met then a good society should invest in the quality of life. He would be horrified by the ‘lowest common denominator’ consumer society we now exist in. He could have made far, far more money than he did, but he saw it as his duty to contribute to society (he didn’t have an actual paid position in the UK Govt, despite the fact he led all the idea development and the delegations during the war and for the post WW2 design and basicaly worked himself to death doing it .. a real $1 a year man).

    (7) His warnings about the effects of speculation. He personally made and lost a lot of money, so he had practical as well as theoretical knowledge of what happens when booms and busts happen.

    Is he a role model of what to do about getting out of this mess .. yes. But not as a prescription, rather as a role model on how to understand the issues and how to develop solutions. In other words do not follow what he prescribed in the past blindly, rather understand how he got to those answers and follow that way of problem solving.

    As he would say: “do not follow any formula blindly (including mine), but understand the broad and real principles of people and markets. Examine the current situation, work out a valid future to aim for, then work out the the steps necessary to achieve it. Ignore those who got us into this mess, listen only to those with real ideas about how to build that better future”.

  7. Richard in London

    This appears to me a classical debt deflation bust and in the world of fiat money this , as Bernanke said in 2002 , can be avoided by a series of measures which involve the printing press.He is now following the policies he set out in that speech. This should not surprise us . Will it work ? Insofar at is clearly now the policy to create inflation and the armoury exists , it seems to me that in that narrow sense it will. Financial assets will lose real value , nominal demand will be stimulated , the consequences of any other course of action are hideous to contemplate and scary for anglo – saxon democracy.Treasuries will not yield 0% for long .Let the presses roll , there is no other way.

  8. “The greatness of John Maynard Keynes, our only guide in this crisis”

    You’re sh*tting me, right? It is the idiotic theory of fractional reserve banking, fiat currency and unbridled government spending that got us into this mess in the first place.

    Meanwhile our liberties suffer, our “widows and orphans” suffer, our economy suffers and Paulson, Reich and their cronies at Goldman and Morgan buy up assets at fire sale prices and get richer.

    I have unsubscribed from this worthless site. Adios.
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    Fabius Maximus replies: Here we see a danger of the internet. Ritter finds this site — with its broadly mainstream economics content — disturbing. Probably he retreats to fringe sites where everyone agrees that fractional reserve banking (used around the world) is “idiotic”. How pleasant but intellectually stupefying it must be to read nothing but material that agrees with one’s ideas.

    Also interesting that he apparently associates Keynes with fractional reserve banking. Keynes wrote about it, as he did many other aspects of the economic system, but its hardly his idea in any meaningful sense.

  9. “What would Keynes have done”

    A Keynesian solution

    The economy does demand a Keynesian solution; but not the tax and spend solution of the Great Depression. If John Maynard Keynes had lived a little longer (did not outlive his parents) he would have structured the institution he wrote was missing from economic society at the time. Keynes would not use bail outs or tax cuts imposed on the free market by our government managed economy.

    The free market economy works because it is based on profit incentives. The bail out will not work for the same reason that tax cut did not work—it created a 10 trillion dollar debt because the government gave away the taxes without positive incentives. Business invests these taxes on growth only if they expect profits; otherwise they spend it in other ways. For these tax programs to work the taxes must be given as incentives if invested in a program that will create economic growth.

    An optional “Private Mutual Welfare Trust” (Trust) to our Social Welfare System” can be used as a program to create economic growth. Tax & interest incentives are given to employees that invest 10% of their disposable income and employers that match their employees’ investments in the PMWT’s Wages Fund (Fund). The Fund is fine-tuned into welfare savings (health, education, etc) and investments (hospitals, schools, etc) to achieve effective demand and sustained growth too allow full employment and prosperity without inflation and recessions.

    This will work by creating a self-regulated free market economy that does not need government to manage the economy with its supply side or monetary policies. It will substantially reduce taxes and government waste and business will not have to finance employees’ fringe benefit plans, etc. The gross national income will increase by more than ten percent. Government must rethink their economic policies before giving our taxes to corporations. Reverse the Bail Out before it’s too late or it will create inflation followed by a depression.

    Respectfully,

    Daniel J. Roque and Richard C. Barnum

  10. FM note: At 490 words this comment was almost 2x the 250 word max length of the FM site’s Comment Policy — which appears at the end of every post and on the Comment Policy page. I edited it down to 320 words. Perhaps there is more about this at the author’s website.

    Yes, by all means act swiftly and boldly; but not recklessly in exacerbating the downfall. We propose implementing the real Keynesian solution being the biggest problem is unemployment and sustained growth to prevent the coming Great Depression II; however this does not mean the tax and spend solution of the Great Depression of 1929. We should not confuse the difference in Keynes’ approach to fight off these two depressions. There are similarities, for instance Keynes’ approach of a government managed economy which we have learned can be abused with fiscal policy (Bush-Reagan tax cuts) and monetary policy (Greenspan-Bernanke’s natural unemployment) that Keynes had warned would not work during recessions is out; however Keynes’ achieving effective demand & sustained growth through the missing institution he wrote about is in.

    Large-scale spending is needed to fight mass unemployment; but not from deficit spending by the government; instead from the Keynesian institution he wrote was needed. Meanwhile, do not despair over the checks and balance over stimulus legislation with careful Congressional deliberation—it’s what has ended the excesses of our current administration’s government managed economy. A conservative friend, Richard C. Barnum and I, a liberal can show proof through an Excel Performa model that the benefits of the Keynesian missing institution’s spending justify its costs. Our proposal gives back all welfare taxes as incentives for employees and employers to invest in a welfare program that employs labor and capital to create economic growth without inflation & recessions.

    We propose an optional “Private Mutual Welfare Trust” (PMWT or Trust) to our Social Welfare System”. Tax & interest incentives are given to employees that invest 10% of their disposable income and employers that match their employees’ investments in the PMWT’s Wages Fund (Fund). The Fund having an aggregate substitution effect in the welfare sector over the private sector is fine-tuned into welfare savings (health, education, etc) and welfare investments (hospitals, schools, etc). {remainder snipped}

  11. Pingback: An important and politically significant guide to the Great Depression « Fabius Maximus

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