Robert Skidelsky: An impossible crash brought Keynes back to life
[Lord Skidelsky is author of John Maynard Keynes: Economist, Philosopher, Statesman.]
When Alistair Darling said that “much of what Keynes wrote still makes sense”, anyone under 40 might well have asked: “And who on earth is Keynes”?
When I first started writing about him in the early 1970s, John Maynard Keynes was a name to conjure with - not in the league of Led Zeppelin, to be sure, but certainly familiar to the mythical educated layman. Economic policy was “Keynesian” - that is, governments aimed to keep unemployment below the “magic” figure of one million, as they had for the previous 30 years, by expanding public spending or cutting taxes.
Then Keynesian policy suddenly became obsolete and the theory that backed it was consigned to history's dustbin. He might have been a great economist, right for his times - the Great Depression of the 1930s - but he had nothing to offer the modern world, and moreoever was responsible for the “stagflation” of the 1970s. In her assault on inflation, Margaret Thatcher put the Keynesian engines into reverse and created three million unemployed. Keynes seemed as dead as the dodo.
In fact, while dead to the public, Keynes lived a ghostly half-life in the corridors of the Bank of England and the Treasury. In setting interest rates, the Bank continued to pay attention to what was happening to output, the amount of economic activity, as well as inflation - although the inflation rate was its only “target”. Gordon Brown's fiscal rules allowed for the influence of the “automatic stabilisers”: the movement of the budget into deficit or surplus as the economy slowed or speeded up.
But basically the authorities relied on “managing expectations”, by the gentlest adjustments to interest rates, to keep us in perpetual non-inflationary boom; we lived in a world from which inflations and depressions had been banished, and for which Keynes was no longer needed.
For ten years the new formula worked. We were blessed with what Mervyn King, the Governor of the Bank of England, called a “nice” environment - a combination of strong growth in the US and Far East and the downward pressure on prices of a competitive globalising economy. More fundamentally, Keynesian economics was rejected by most of the economic profession as having caused inflation in the 1970s.
The main prescription of the “new” classical economics was to minimise the role of government and let markets do their job. It rested on an assumption that if economic agents are rational - the key assumption on which the claim of economics to be a science is based - the market system accurately prices all trades at each moment in time. If this is so, boom-bust cycles must be caused by outside “shocks” - wars, revolutions, above all political interference with the delicate adjustment mechanisms of the “invisible hand” of the market.
But this view has been blown sky- high by the present crisis. For this crisis was generated by the market system itself, not some outside “shock”; moreover, within a system that had been extensively deregulated in line with mainstream teaching. The automatically self-correcting market system to which the economics profession has mostly paid homage has been shown to be violently unstable. And this is exactly how Keynes expected it to behave.
What was left out of the mainstream economics of his day, and its “post-Keynes” successor, was the acknowledgement of radical uncertainty. “The outstanding fact,” he wrote in his magnum opus, The General Theory of Employment, Interest and Money (1936) “is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made”. We disguise this uncertainty by resorting to a variety of “pretty, polite techniques”, of which economics is one, “which try to deal with the present by abstracting from the fact that we know very little about the future”.
But any view of the future based on “so flimsy a foundation” is liable to alternating waves of irrational exuberance and blind panic. When panic sets in there is a flight into cash. But while this may be rational for the individual, it is disastrous for the economy. If everyone wants cash, no one will lend. As Keynes tellingly reminded us “there is no such thing as liquidity... for the community as a whole”. And that means that there may be no automatic barrier to the slide into depression, unless a government intervenes to offset extreme reluctance to lend by huge injections of cash into the economy...
Read entire article at Times (UK)
When Alistair Darling said that “much of what Keynes wrote still makes sense”, anyone under 40 might well have asked: “And who on earth is Keynes”?
When I first started writing about him in the early 1970s, John Maynard Keynes was a name to conjure with - not in the league of Led Zeppelin, to be sure, but certainly familiar to the mythical educated layman. Economic policy was “Keynesian” - that is, governments aimed to keep unemployment below the “magic” figure of one million, as they had for the previous 30 years, by expanding public spending or cutting taxes.
Then Keynesian policy suddenly became obsolete and the theory that backed it was consigned to history's dustbin. He might have been a great economist, right for his times - the Great Depression of the 1930s - but he had nothing to offer the modern world, and moreoever was responsible for the “stagflation” of the 1970s. In her assault on inflation, Margaret Thatcher put the Keynesian engines into reverse and created three million unemployed. Keynes seemed as dead as the dodo.
In fact, while dead to the public, Keynes lived a ghostly half-life in the corridors of the Bank of England and the Treasury. In setting interest rates, the Bank continued to pay attention to what was happening to output, the amount of economic activity, as well as inflation - although the inflation rate was its only “target”. Gordon Brown's fiscal rules allowed for the influence of the “automatic stabilisers”: the movement of the budget into deficit or surplus as the economy slowed or speeded up.
But basically the authorities relied on “managing expectations”, by the gentlest adjustments to interest rates, to keep us in perpetual non-inflationary boom; we lived in a world from which inflations and depressions had been banished, and for which Keynes was no longer needed.
For ten years the new formula worked. We were blessed with what Mervyn King, the Governor of the Bank of England, called a “nice” environment - a combination of strong growth in the US and Far East and the downward pressure on prices of a competitive globalising economy. More fundamentally, Keynesian economics was rejected by most of the economic profession as having caused inflation in the 1970s.
The main prescription of the “new” classical economics was to minimise the role of government and let markets do their job. It rested on an assumption that if economic agents are rational - the key assumption on which the claim of economics to be a science is based - the market system accurately prices all trades at each moment in time. If this is so, boom-bust cycles must be caused by outside “shocks” - wars, revolutions, above all political interference with the delicate adjustment mechanisms of the “invisible hand” of the market.
But this view has been blown sky- high by the present crisis. For this crisis was generated by the market system itself, not some outside “shock”; moreover, within a system that had been extensively deregulated in line with mainstream teaching. The automatically self-correcting market system to which the economics profession has mostly paid homage has been shown to be violently unstable. And this is exactly how Keynes expected it to behave.
What was left out of the mainstream economics of his day, and its “post-Keynes” successor, was the acknowledgement of radical uncertainty. “The outstanding fact,” he wrote in his magnum opus, The General Theory of Employment, Interest and Money (1936) “is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made”. We disguise this uncertainty by resorting to a variety of “pretty, polite techniques”, of which economics is one, “which try to deal with the present by abstracting from the fact that we know very little about the future”.
But any view of the future based on “so flimsy a foundation” is liable to alternating waves of irrational exuberance and blind panic. When panic sets in there is a flight into cash. But while this may be rational for the individual, it is disastrous for the economy. If everyone wants cash, no one will lend. As Keynes tellingly reminded us “there is no such thing as liquidity... for the community as a whole”. And that means that there may be no automatic barrier to the slide into depression, unless a government intervenes to offset extreme reluctance to lend by huge injections of cash into the economy...