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September 20, 2009
David Warsh, Proprietor

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Keynes In Context

The current wave of interest in the life, times and ideas of John Maynard Keynes is not hard to understand. You don’t need to be an economist to know that the last ten years or so in some deep way resembled the Roaring Twenties. Last autumn, the possibility of world depression seemed frighteningly real for a time. So was there something Keynes understood about the aftermath of the 1920s and the failure of the policies of the 1930s that had been forgotten? Does the apparent escape from financial meltdown today owe something to his insights then?

But it is not easy to find agreement on these matters.

This much is clear: the Keynesian Revolution was real. When the first glimpses of what soon came to be called “macroeconomics” were described in the 1930s, by Keynes and others, the discovery invigorated young economists who were struggling to understand a world then mired in persistent depression. It was as if the entire generation “were taken by a spell,” recalled James Meade. The contagion of enthusiasm among economists under the age of 35 had “the unexpected virulence of a disease,” wrote Paul Samuelson. No wonder, then, that when Lawrence Klein laid out the standard interpretation (at book length) as The Keynesian Revolution in 1949, not even dissenters such as Milton Friedman demurred publicly. Instead they mastered the consensus view.

Nor can there be much doubt that the reception of the new economic ideas was affected by the mood of the times, particularly by a pair of developments that had occurred in physics during the early years of the twentieth century – Einstein’s theories of special and general relativity, and the piecing-together by Niels Bohr and many others of quantum mechanics to describe the peculiar behavior of sub-atomic matter. Just as the new physics was understood to have altered profoundly the understanding of very large and very small phenomena, and to have left substantially unchanged the common-sense Newtonian understanding of the world between, so Keynes invited comparisons of himself to Einstein when he called his book The General Theory of Employment, Interest and Money, and labeled what he called “classical” economics “a special case.”

He explained (in the preface to the French edition) what made his theory general. “I mean by this I am chiefly concerned with the behavior of the system as a whole, with aggregate income, aggregate profits, aggregate output, aggregate employment, aggregate investment and aggregate savings, rather than with the incomes, profits, output, employment investment and saving of particular industries firm or individuals.” Thus did macro take over what had been studied previously under the heading of money and the business cycle; all the rest was microeconomics.

But 75 years later, despite the efforts of a luminous string of interpreters (John Hicks, Franco Modigliani, Don Patinkin), counter-interpreters (Joan Robinson, Axel Leijonhufvud, Nicholas Kaldor, Luigi Pasinetti), biographers (Roy Harrod, Robert Skidelsky, D.E. Moggridge), historians (Peter Clarke, David Laidler) and various re-interpreters (Lorenzo Pecchi and Gustavo Piga’s conference volume, Revisiting Keynes: Economic Possibilities for Our Grandchildren, is especially interesting, and Keynes is a major figure in Liaquat Ahamed’s best-selling Lords of Finance: The Bankers who Broke the World as well), it’s hard to say what it all means.

The standard story is easy to grasp: theoretical breakthrough, professional recognition, World War II, political influence, and, thanks to the adroit management of aggregate demand, a 25-year post-war boom in the industrial democracies (Time magazine put Keynes on its cover in December 1965, nearly twenty years after his death, at 63, in 1946). Then came a second act, not so triumphant: inflation and unemployment, the end of the gold standard and system of fixed exchange rates that Keynes had engineered at Bretton Woods, the counterattack by the Chicago school aimed mainly at various naïve psychological underpinnings of Keynesian dogma; and, after 1982, a second 25-year boom, this one said to rest on successful monetary policy.

The trouble is, as co-editor Bradley W. Bateman writes in the Cambridge Companion to Keynes, virtually every strut of both arguments of this stylized drama has been challenged by serious scholarship.

Certainly the historical figure of Keynes is as fabulous as ever: philosopher, economist, statistician, author, speculator, patron, collector, journalist, politician, friend, sexual adventurer, husband. He dominates the British financial scene in a glamorous time as completely as ever. With Keynes: The Return of the Master and Keynes: The Rise, Fall and Return of the 20th Century’s Most Influential Economist, biographer Skidelsky and historian Clarke have published reprises of their work with a view to demonstrating the relevance of the subject to the crisis of the present day. If it’s an introduction to Keynes himself you want, though, better to pony up the outrageous $45 for the paperback edition of Keynes and His Battles, by Gilles Dostaler, a charming book positioned neatly between the Skidelsky and Moggridge biographies.)

I have been following this controversy, on and off, for more that thirty years as a journalist, and for the last fifteen of those, the book that has seemed to me to situate Keynes in the context of the history of economics better than any other has been A History of Economic Theory: Classic Contributions, 1720-1980. After a long career as a monetary theorist, most of it spent at the Johns Hopkins University in Baltimore, Jürg Niehans returned to his native Switzerland and the University of Bern to write a history of thought.

He created what he described as a pantheon, a temple full of niches depicting the for greater and lesser deities, chapters on the life and work of the twenty authors of the last three hundred years he deemed to have been most significant, with another fifteen chapters on various topics and schools required to stitch together their stories to produce coherent narrative. Pitched at the level of an advanced undergraduate, the book appeared in 1990. Though 1980 (the book’s endpoint) was a long time ago, A History of Economic Theory is still the best history of thought I know.

Niehans, as noted, was a professional theorist. With Keynes, his irritation is plain. His argument, the one you often hear from those who make war on ambiguity, is that Keynes wrote better than he thought. Indeed, he sometimes borders on snide. One of Keynes’s grandfathers had been a brushmaker and florist, he observes, the other a clergyman; his father a university administrator who never made professor, despite his widely-known book on the methods of political economy. Nevertheless, “Maynard’s genealogical researches later showed that the Keyneses had belonged to the aristocracy and that one of his forebears was a Norman knight who had fought at Hastings. Maynard Keynes always managed to end up at the top.”

Niehans argues that Keynes rode roughshod over the rest of the economics profession in order to make his point; that, contrary to the doctrines of orthodox economics, the economy could regularly become trapped in a series of high unemployment equilibria. It was a point never nailed down to other economists’ satisfaction, says Niehans. Instead the outsider created various straw men to knock over in order to become a Great Economist.

True, he grudgingly admits, Keynes was an effective critic of the optimistic dogma of the 1920s, which held that monetary policy might eliminate the business cycle through the use of open-market operations. There were two reasons monetary policy might fail to work in a panic, Keynes said: either because the money supply, caught in a liquidity trap, would have little influence on the interest rate, or because the interest rate, undermined by a swift decline in the marginal efficiency of capital, would have little effect on investment demand.

Keynes’s most durable contribution, according to Niehans, was to place the failure of wages to fall in a recession at the center of the debate – in a model. Keynes was by no means the first economist rely on a mathematical model to bolster his argument, and he certainly wasn’t the best, but he was undoubtedly the most personally influential. And after John Hicks summarized the key ideas of the General Theory in a handful of simultaneous equations, with a simple diagram to depict the relationship of investment, saving, liquidity and money, the tight chains of formal reasoning, whose properties could be measured and tested against the real world, became the standard form of economic argument.

In the end, then, Niehans writes, “Keynes added a solid and useful brick to the building of economic theory. A brilliant writer, he offered this brick packed in glittering gift-wrap, sparking with hints, allusions, suggestions and quotable obiter dicta. Half a century later, The General Theory still glitters, but economic science has learned to distinguish the wrapping from the brick.” Unlike the scientific contributions and policies of that other genius of persuasion, Adam Smith, Niehans asserted that the insights of Keynes had tended to fade away. But what about the continuing debate about “what Keynes really meant?” — imperfect competition, transactions costs, multiple budget constraints? Niehans: “For a competent scientist, endowed with Keynes’s command over words, fifty years should have been long enough to make himself understood.”

A harsh judgment, but consistent with the rest of what I observed to be going on in the rest of mainstream economics – theorists building a more secure foundation, block by block, on the lot next door to the increasingly quaint but unapproachable edifice that was the General Theory. From a distance of fifty years, Keynes seemed to have been a charismatic figure, a literary master, the author of a series of suggestive metaphors, but with no more durable claim to have advanced that part of economics considered by its adepts to be “scientific” than was possessed by his rough contemporary Sigmund Freud as a psychologist. They were a couple of great writers. Wasn’t that enough?

Has that appraisal changed as the result of the experiences of the last year? It is, I think, too early to say. It is possible that, even as his name looms large again in newspaper columns and bookstalls, the great man recedes further into the distant past. But recently I have been spending more time reading the work of professional historians of economic thought, and at one point, I came across an assessment of Keynes that struck me as being more deeply knowledgeable and on the mark than that of Niehans. It belonged, interestingly enough, to Robert Lucas, of the University of Chicago, the man who, after Milton Friedman, did more to undermine the underpinnings of the Keynesian analysis than any other (and, among economists, more than Friedman himself). His comments came in the course of an address to a conference organized a few years ago at Duke University by the editors of the journal History of Political Economy, designed to sift a portion of the legacy of Keynesian thought. Lucas’s talk described some of the circumstances in which he and a handful of colleagues fell away from Keynesian ideas and created the rival New Classical or freshwater tradition. Its title: “My Keynesian Education.” (It appears in The IS-LM Model: Its Rise, Fall, and Strange Persistence, a supplement to the journal, for those readers with access to a good library).

The Einstein business, said Lucas, the revolutionary interpretation of Keynes’s contribution to the tapestry of economic thought, “that’s just so much hot air.” In writing the General Theory, he said, the larger role Keynes had assigned himself was as a spokesman for “a discredited profession.”

He’s writing in a situation where people are ready to throw in the towel on capitalism and liberal democracy and go with fascism, or corporatism, protectionism, socialist planning. Keynes’s first objective is to say “Look, there’s got to be a way to respond to depressions that’s consistent with capitalist democracy.” What he hits on is that the government should take on some new responsibilities, but the responsibilities are for stabilizing overall spending flows. You don’t have to plan the economy in detail in order to meet this objective. And in that sense, I think everybody in the post-war period – I’m talking about Keynesians and monetarists both — that’s the agreed-on view: We should stabilize spending flows, and the question is really one of the details about how best to do it. Friedman’s approach involved slightly less government involvement than a Keynesian approach, but I say slightly.

So I think that was a great political achievement. It gave us a lasting image of what we need economists for. I’ve been talking about the internal mainstream of economics, that’s what we researchers live on, but as a group we have to earn our living by helping people diagnose situations that arise and helping them understand what is going on and what we can do about it. That was Keynes’s whole life. He was a political activist from beginning to end. What he was concerned about when he wrote the General Theory was convincing people that there was a way of dealing with the Depression that was forceful and effective but didn’t involve scrapping the capitalist system. Maybe we could have done it without him, but I’m glad we didn’t have to try.

A generous estimate, I thought – an understanding of Keynes that seems likely to stand the test of time.

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