Keynes and the Birth of Macroeconomics
Although it is important to remember that economists before Keynes discussed
what we now call macroeconomic issues such as business cycles, inflation,
unemployment and growth, as we have already noted, the birth of modern
macroeconomics as a coherent and systematic approach to aggregate economic
phenomena can be traced back to the publication in February 1936 of Keynes’s
book The General Theory of Employment, Interest and Money. In a letter
written on 1 January 1935 to a friend, the writer George Bernard Shaw, Keynes
speculated that ‘I believe myself to be writing a book on economic theory
which will largely revolutionise – not, I suppose, at once but in the course of
the next ten years – the way the world thinks about economic problems’. That
Keynes’s bold prediction should be so accurately borne out is both a comment
on his own self-confidence and a reflection of the inadequacy of classical
economic analysis to provide an acceptable and convincing explanation of the
prevailing economic situation in the early 1930s. Keynes recognized that the
drastic economic situation confronting the capitalist system in the 1930s threatened
its very survival and was symptomatic of a fundamental flaw in the
operation of the price mechanism as a coordinating device.
To confront this problem Keynes needed to challenge the classical economists
from within their citadel. The flaw, as he saw it, lay in the existing
classical theory whose teaching Keynes regarded as not only ‘misleading’ but
‘disastrous’ if applied to the real-world problems facing the capitalist economies
during the interwar period. For Keynes, capitalism was not terminally ill
but unstable. His objective was to modify the rules of the game within the
capitalist system in order to preserve and strengthen it. He wanted full employment
to be the norm rather than the exception and his would be a
conservative revolution. As Galbraith (1977) has noted, Keynes never sought
to change the world out of personal dissatisfaction: ‘for him the world was
excellent’. Although the republic of Keynes’s political imagination lay on the
‘extreme left of celestial space’, he was no socialist. Despite the prompting of
George Bernard Shaw, Keynes remained notoriously blind to Marx. In his
opinion, Das Kapital contained nothing but ‘dreary out of date academic
controversialising’ which added up to nothing more than complicated hocus
pocus. At one of Keynes’s Political Economy Club meetings he admitted to
having read Marx in the same spirit as reading a detective story. He had
hoped to find some clue to an idea but had never succeeded in doing so (see
Skidelsky, 1992, pp. 514–23). But Keynes’s contempt for Marxist analysis
did not stop those on the right of the political spectrum from regarding his
message as dangerously radical. For Keynes the ultimate political problem
was how to combine economic efficiency, social justice and individual freedom.
But questions of equity were always secondary to questions of efficiency,
stability and growth. His solution to the economic malaise that was sweeping
the capitalist economies in the early 1930s was to accept ‘a large extension of
the traditional functions of government’. But as Keynes (1926) argued in The
End of Laissez-Faire, if the government is to be effective it should not
concern itself with ‘those activities which private individuals are already
fulfilling’ but attend to ‘those functions which fall outside the private sphere
of the individual, to those decisions which are made by no one if the state
does not make them’ (Keynes, 1972, Vol. IX, p. 291).
The most plausible explanation of the Great Depression is one involving a
massive decline in aggregate demand. Both Patinkin (1982) and Tobin (1997)
have argued forcefully that Keynes’s major discovery in the General Theory
was the ‘Principle of Effective Demand’ (see also Chapter 8). According to
the classical macroeconomic system, a downward shift of aggregate (effective)
demand will bring into play corrective forces involving falling prices so
that the final impact of a reduction in aggregate demand will be a lower price
level with real output and employment quickly returning to their full employment
levels. In the classical world self-correcting market forces, operating
via the price mechanism, restore equilibrium without the help of government
intervention. While it could be argued that the US economy behaved in a way
consistent with the classical model during the 1920s, it certainly did not in
the decade after 1929. The classical model could not adequately account for
Understanding modern macroeconomics 15
either the length or depth of the economic decline experienced by the major
economies of the world. Indeed those economists belonging to the Mises–
Hayek–Robbins–Schumpeter Austrian school of thought (see Chapter 9)
believed that the depression should be allowed to run its course, since such an
occurrence was the inevitable result of overinvestment during the artificially
created boom. In their view the Great Depression was not a problem which
policy makers should concern themselves with and intervention in the form
of a stimulus to aggregate demand would only make things worse. The choice
was between depression now or, if governments intervened inappropriately,
even worse depression in the future.
The current consensus views the behaviour of economies during this period
as consistent with an explanation which focuses on aggregate demand
deficiency. However, this deficient aggregate demand explanation is one that
a well-trained classical economist, brought up on Say’s Law of markets and
slogans of equilibrium, would find hard to either understand or accept. Indeed,
explanations of the Great Depression that downplay the role of aggregate
demand and instead emphasize the importance of supply-side factors have
recently made a comeback (see Cole and Ohanian, 1999, 2002a). For those
economists determined to find an explanation for the economic catastrophe
which had befallen the economic systems of the Western world, the Great
Depression had a depressing impact on their enthusiasm for laissez-faire
capitalism.
Although it is important to remember that economists before Keynes discussed
what we now call macroeconomic issues such as business cycles, inflation,
unemployment and growth, as we have already noted, the birth of modern
macroeconomics as a coherent and systematic approach to aggregate economic
phenomena can be traced back to the publication in February 1936 of Keynes’s
book The General Theory of Employment, Interest and Money. In a letter
written on 1 January 1935 to a friend, the writer George Bernard Shaw, Keynes
speculated that ‘I believe myself to be writing a book on economic theory
which will largely revolutionise – not, I suppose, at once but in the course of
the next ten years – the way the world thinks about economic problems’. That
Keynes’s bold prediction should be so accurately borne out is both a comment
on his own self-confidence and a reflection of the inadequacy of classical
economic analysis to provide an acceptable and convincing explanation of the
prevailing economic situation in the early 1930s. Keynes recognized that the
drastic economic situation confronting the capitalist system in the 1930s threatened
its very survival and was symptomatic of a fundamental flaw in the
operation of the price mechanism as a coordinating device.
To confront this problem Keynes needed to challenge the classical economists
from within their citadel. The flaw, as he saw it, lay in the existing
classical theory whose teaching Keynes regarded as not only ‘misleading’ but
‘disastrous’ if applied to the real-world problems facing the capitalist economies
during the interwar period. For Keynes, capitalism was not terminally ill
but unstable. His objective was to modify the rules of the game within the
capitalist system in order to preserve and strengthen it. He wanted full employment
to be the norm rather than the exception and his would be a
conservative revolution. As Galbraith (1977) has noted, Keynes never sought
to change the world out of personal dissatisfaction: ‘for him the world was
excellent’. Although the republic of Keynes’s political imagination lay on the
‘extreme left of celestial space’, he was no socialist. Despite the prompting of
George Bernard Shaw, Keynes remained notoriously blind to Marx. In his
opinion, Das Kapital contained nothing but ‘dreary out of date academic
controversialising’ which added up to nothing more than complicated hocus
pocus. At one of Keynes’s Political Economy Club meetings he admitted to
having read Marx in the same spirit as reading a detective story. He had
hoped to find some clue to an idea but had never succeeded in doing so (see
Skidelsky, 1992, pp. 514–23). But Keynes’s contempt for Marxist analysis
did not stop those on the right of the political spectrum from regarding his
message as dangerously radical. For Keynes the ultimate political problem
was how to combine economic efficiency, social justice and individual freedom.
But questions of equity were always secondary to questions of efficiency,
stability and growth. His solution to the economic malaise that was sweeping
the capitalist economies in the early 1930s was to accept ‘a large extension of
the traditional functions of government’. But as Keynes (1926) argued in The
End of Laissez-Faire, if the government is to be effective it should not
concern itself with ‘those activities which private individuals are already
fulfilling’ but attend to ‘those functions which fall outside the private sphere
of the individual, to those decisions which are made by no one if the state
does not make them’ (Keynes, 1972, Vol. IX, p. 291).
The most plausible explanation of the Great Depression is one involving a
massive decline in aggregate demand. Both Patinkin (1982) and Tobin (1997)
have argued forcefully that Keynes’s major discovery in the General Theory
was the ‘Principle of Effective Demand’ (see also Chapter 8). According to
the classical macroeconomic system, a downward shift of aggregate (effective)
demand will bring into play corrective forces involving falling prices so
that the final impact of a reduction in aggregate demand will be a lower price
level with real output and employment quickly returning to their full employment
levels. In the classical world self-correcting market forces, operating
via the price mechanism, restore equilibrium without the help of government
intervention. While it could be argued that the US economy behaved in a way
consistent with the classical model during the 1920s, it certainly did not in
the decade after 1929. The classical model could not adequately account for
Understanding modern macroeconomics 15
either the length or depth of the economic decline experienced by the major
economies of the world. Indeed those economists belonging to the Mises–
Hayek–Robbins–Schumpeter Austrian school of thought (see Chapter 9)
believed that the depression should be allowed to run its course, since such an
occurrence was the inevitable result of overinvestment during the artificially
created boom. In their view the Great Depression was not a problem which
policy makers should concern themselves with and intervention in the form
of a stimulus to aggregate demand would only make things worse. The choice
was between depression now or, if governments intervened inappropriately,
even worse depression in the future.
The current consensus views the behaviour of economies during this period
as consistent with an explanation which focuses on aggregate demand
deficiency. However, this deficient aggregate demand explanation is one that
a well-trained classical economist, brought up on Say’s Law of markets and
slogans of equilibrium, would find hard to either understand or accept. Indeed,
explanations of the Great Depression that downplay the role of aggregate
demand and instead emphasize the importance of supply-side factors have
recently made a comeback (see Cole and Ohanian, 1999, 2002a). For those
economists determined to find an explanation for the economic catastrophe
which had befallen the economic systems of the Western world, the Great
Depression had a depressing impact on their enthusiasm for laissez-faire
capitalism.
No comments:
Post a Comment