I have put a posting up on the History of Economic Thought (HET) website today in answer to the following question raised by someone in the United States. The rest of this posting is my reply.
I have heard several economists say they are part-time Keynesians, part-time Monetarists, and part-time All-Schools-of-Thought. Under what conditions are Keynesian approaches relevant and good policy? What work is good on this?
It is interesting that this question has circled the world and come to me here in Australia with only a small handful of responses when to most queries by the time it reaches me there have usually been many. And this is an interesting question although one not typically looked at on an HET website. But it is something that does deserve an answer, it is something that HET specialists should have a deep interest in, and is certainly the central economic question of our time.
Part-Keynesian, part-monetarist and part-eclectic is the modern paradigm since every economist takes in with their mothers’ milk the notion of aggregate demand and the strong positive utility of fiscal policy during recessions. This is the Keynesian part. Monetarism as designed by Milton Friedman worked off this same framework built around aggregate demand but thought that fiscal policy was almost useless and that the really strong policy lever was the money supply, an approach which has now migrated over to adjustments in the rates of interest but with the relevant concepts still centred on the demand for money. The eclectic parts are the various strands of thought that everyone picks up along the way but would mostly revolve around microeconomic questions with a high level of interest in game theory and externalities. And this is to give the benefit of the doubt that there actually is a theory behind so much of the econometric work that now populate our leading journals.
The problem with the question asked – “Under what conditions are Keynesian approaches relevant and good policy?” – is that the answer is becoming more evident every day. There are no conditions when Keynesian approaches are relevant and good for policy. A Keynesian policy is a deficit-financed increase in public spending during recessionary periods to hasten a return to strong growth and full employment. It has never worked. Not during the New Deal, not during the Stagflation of the 1970s, not in Japan in the 1990s nor has it worked right up to this minute as embodied in the “stimulus” packages that followed the Global Financial Crisis. Economic theory is in crisis mode although no one goes around pointing it out. But whatever we economists might teach in the classroom, no one actually framing policy will ever again base what they do on the need to restore aggregate demand through higher levels of public spending. We may continue to teach it but no one will do it. Keynesian theory, so far as public policy is concerned, is dead in the water.
What work is good on this? Although I feel a bit embarrassed to say so, in a month’s time in June, Edward Elgar will be publishing my Free Market Economics – an Introduction for the General Reader. The book is drenched in the History of Economics, has two major chapters dealing with HET, but if it has a theme that exists from cover to cover it is that Keynesian theory has been an out and out failure, and that what is wrong with economics today was perfectly well understood by every mainstream economist prior to the publication of the General Theory in 1936. My book restates classical economic theory for the twenty-first century, but to write it requires you to go back to those pre-Keynesian economists of 75 years ago to find out just what it was they said. Even the title of my book is laced with HET, taken as it is from Henry Clay’s brilliant 1916 introductory text, Economics – an Introduction for the General Reader. That is why in many ways it requires someone steeped in the history of economic thought to take these issues on. Hardly anyone else is able to because hardly anyone else can and will read the business cycle literature pre-1936.
But if I were to give a reading list of what one ought to read, I would go back to the business cycle literature of the 1920s and 1930s and start with Gottfried Haberler’s Prosperity and Depression. The problem is that for those writing before the General Theory was published, the idea that aggregate demand deficiency would sweep the world as the mainstream theory would have been absurdly incomprehensible. To find a work with an overlap between an understanding of the classical literature and the Keynesian, there were a few but I don’t think there has been one published for forty years. Others might be able to suggest possible sources on where to turn but that is where I believe you need to go.