“We must exorcise the Keynesian incubus”

This is Hayek writing, or at least publishing, in 1979:

The primary duty today of any economist who deserves the name seems to me to stress, at every opportunity, the fact that the present unemployment is the direct and inevitable consequence of the so-called full employment policies pursued for the past twenty-five years. Most people still mistakenly believe that an increase in aggregate demand will eliminate unemployment for some time. Nothing short of the realization that this remedy, though usually effective in the short run, produces much more unemployment later, will prevent the public exerting irresistible pressure to resume inflation as soon as unemployment increases substantially.

To understand this basic truth is to recognize that the majority of economists whose advice governments have been following everywhere in Britain and the rest of the Western world during this period have thoroughly discredited themselves and ought to do penance in sackcloth and ashes. What was almost unquestioned orthodoxy for close to thirty years has been thoroughly discredited. And the economic crisis also marks a severe setback in the authority of economics – or at least marks the long-overdue collapse of the fashionable Keynesian doctrine that has dominated opinion for a generation. I am fully convinced that before we can hope to return to reasonable stability, not to mention lasting prosperity, we must exorcise the Keynesian incubus.

This is from “Unemployment: Inevitable Consequence of Inflation” (p 39) in a pamphlet titled, Unemployment and Monetary Policy put out by the Cato Institute during the Great Stagflation of the 1970s. To Hayek then, as it was to me just a couple of years ago, it seemed impossible that Keynesian economics could survive a disaster as deep and enduring as this. Yet the certainty is that rather than donning sackcloth and ashes, Keynesian economics is more entrenched than ever. The kind of writing seen here in Hayek writing in the 1970s has been mirrored by virtually no one today. I write this sort of thing, but who else, where else can you find it?

“Most people still mistakenly believe that an increase in aggregate demand will eliminate unemployment”. This is the fact of the matter, then as now. And if we do have that second wave recession, it will be blamed on the efforts made to remedy this problem, not on the public spending which came before. To this day, I cannot recall anyone arguing that it was the public spending that wrecked the Japanese economy in the 1990s. So it is with our economies today. Keynesian theory has had another triumph as will be recorded in all of the textbooks that are published hereafter.

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33 Responses to “We must exorcise the Keynesian incubus”

  1. Jim Rose says:

    Thomas Humphrey wrote an excellent 250 year long literature survey of the rules versus discretion debate in the 1998 Richmond Fed Quarterly.

    He wanted to know if macroeconomics was a progressive science in the sense that superior new ideas relentlessly supplanted inferior old ones.

    Humphrey found that:
    • Keynesian ideas and their many antecedents gain currency when unemployment was the main concern.
    • Monetarist ideas tended to reign when price stability was the main problem.

    The policy debate keeps recycling because
    1. people forget the lessons of the past and
    2. For better or worse, politicians and the public have tended to believe that central banks, the focus of his studies, have the power to boost output, employment, and growth permanently.

    Humphrey showed that stable policy rules are popular in good times to contain inflation, and when unemployment was rising, discretionary monetary policies returned to policy vogue.

    Humphrey concluded that doctrinal historian knows that much of what passes for novelty and originality in monetary theory and policy is ancient teachings dressed up in modern guises.

    Haberler, Jacob Viner and frank knight also all pointed out in their reviews of the General Theory that it lacked originality, and presented old ideas often incorrectly in confusing new vocabularies that made the book difficult to read.

  2. Rafe says:

    Nothing like a bit of maths plus a new vocabulary and obscurity to give the appearance of profundity. Keynes was ahead of the POMOS by a generation.

    A purge of school text books would help, with a lag of some decades while the past cohorts of students are still alive.

  3. Jim Rose says:

    Rafe,
    one of the few advantages of not being as young as I used to be is remembering the last time failed ideas came around such as fiscal policy to counter recessions, and industry policy to lift productivity.

  4. Fox says:

    It seems to me that the most convenient thing about Keynesian economics is that it supports increased government power…

  5. On your Marx says:

    Keynesian policy used in the 70s or before?

    Keynes urged that monetary policy be the prime instrument.
    The only time that fiscal policy was clearly superior to monetary policy was when there was a liquidity trap ( which was almost always the case in a deflationary depression ).

    I am at a loss why fiscal policy would have been actively used by ANY government in the Western World from the end WW2 to the 70s except for entertaining budget surpluses IF they were adhering to Keynesian policy.

    People here appear to be confusing deficit spending with Keynesian policy.

    Given that that Adam Posen has demolished the fact Japan had multiple fiscal stimuli in the 90s , it is a bit rich to restate this without any evidence.

  6. brc says:

    “People here appear to be confusing deficit spending with Keynesian policy.”

    I can’t think of a single time when running a deficit wasn’t accompanied by “there will be too much unemployment if we don’t”

    Of course they don’t say “we’re implementing a hybrid mutt of Keynesian policy with vote buying”. But make no mistake, underlying all their justifications is always some reference to aggregate demand. There’s always some discussion, however oblique, about a lack of spending being the issue, which can only be addressed by more borrowing.

    I think if you are going to make your point stronger, you’d be better off finding an example where deficit spending wasn’t invoked in Keynes name.

  7. Taylor says:

    “Nothing like a bit of maths plus a new vocabulary and obscurity to give the appearance of profundity. Keynes was ahead of the POMOS by a generation.”

    Not sure what this is about Rafe, the General Theory is not difficult to understand, though, granted, it does have some unfamiliar terms. Everyone who wants to understand economics should make an effort to read it. Whether they agree is another matter.

    Here’s one summary:

    “The General Theory is a hard slog, though not because it is mathematical. There is some math, but it is simple and, with the exception of the formula for the “multiplier” (of which more shortly), it is incidental to Keynes’s arguments. A work of elegant prose, the book sparkles with aphorisms (“It is better that a man should tyrannize over his bank balance than over his fellow-citizens”) and rhetorical flights (most famously that “madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back”). But it also bristles with unfamiliar terms, such as “unit-good” (an hour’s employment of ordinary labor), and references to unfamiliar economic institutions, such as a “sinking fund” (a fund in which money is accumulated to pay off a debt).”

    http://www.tnr.com/article/how-i-became-keynesian

  8. Jim Rose says:

    Paul Samuelson about the General Theory:

    “It is a badly written book, poorly organized; any layman who, beguiled by the author’s previous reputation, bought the book was cheated of his 5 shillings.

    It is not well suited for classroom use. It is arrogant, bad-tempered, polemical, and not overly generous in its acknowledgments.

    It abounds in mares’ nests and confusions. … In short, it is a work of genius.”

    from Development of Economic Thought, ed. by Henry William Spiegel (New York: Wiley, 1952), p. 767.

  9. Rafe says:

    I attempted to read it more than once and could not make head or tail of it. At first I thought that was my fault but later I realised the reason is that it does not make sense.

  10. Rafe says:

    Nice quote from Samuelson. How can he say that stuff and still call it a work of genius?
    He is the guy who copied Wordsworth, “joy it was to be alive” – for the mathematical, Keynesian and welfare state revolutions in the US (the trifecta!).
    He is also the man who thought that the Soviet economy was rapidly overhauling the US during the 1950s.
    Would you buy a used economic theory from him?

  11. Jim Rose says:

    Taylor,
    everyone who reviewed the general theory at the time of its publication commented politely about how a usually gifted stylist wrote a hard to read book.

    there is a massive literature about what did keynes actually say.

  12. Jim Rose says:

    Rafe,
    Samuelson’s comments about the USSR were beyond belief:

    In the 1989 13th edition of Economics, Samuelson opined that “contrary to what many skeptics had earlier believed” … “The Soviet economy is proof that … a socialist command economy can function and even thrive.”

    Samuelson was the only Western economist whose textbook was translated into Russian.

  13. Rafe says:

    Idiot savant is the term!

  14. Taylor says:

    Jim/Rafe

    I also tried more than once to read it. Ultimately it was well worth the effort.

    I’d rate it in terms of difficulty/reward with John Locke’s Second Treatise on Government (you have to wade through Locke’s critique of Filmer first, but that is the only way to understand the type of analysis he was up against).

    Equilibrium economics doesn’t make much sense to me in terms of practical business and finance. The General Theory is all about disequilibrium. I found it the best book on economic theory I’ve read.

    I think the main difficulty with reading the GT is that the early chapters (particularly 4-7) are solely about defining terms. They are a real effort to get through.

    It helps if you understand that Keynes basically uses a labour theory of value to measure changes in output (because capital equipment doesn’t vary in the short period). Also, he had a lot of practical experience in finance and the capital markets, which helps to understand the chapters on investment.

    However, I think anyone who reads the finance press regularly can get through the book, and get a lot out of it – whether they agree with the conclusions or not.

  15. Annabelle says:

    ‘Given that that Adam Posen has demolished the fact Japan had multiple fiscal stimuli in the 90s’

    what are you saying? Do you really believe that Japan had no fiscal stimulus in the 90’s? It is well established that Japan has had multiple stimulus programs!

  16. Sean says:

    Equilibrium economics doesn’t make much sense to me in terms of practical business and finance.’

    It’s a ruse probably being the main problem. Hayek did away with it in his pure theory of capital. Equilibrium is a useful abstract construct for postulating economic activity but it never exists. People replace Nokia’s with I-phones, rail with air freight etc. etc.

    the book sparkles with aphorisms

    So does Neitzsche, but nobody outside wacky post-modernists still take them seriously. A great work shouldn’t intend to leave people arguing over what ‘x really meant’. That was Popper’s aim anyway. If a theory is hard to understand the fault often lies with the writer not just the reader.

  17. Skuter says:

    I love it how supporters of Keynesianism resort to claiming it has never been tried.

    The only time that fiscal policy was clearly superior to monetary policy was when there was a liquidity trap ( which was almost always the case in a deflationary depression ).

    I am at a loss why fiscal policy would have been actively used by ANY government in the Western World from the end WW2 to the 70s except for entertaining budget surpluses IF they were adhering to Keynesian policy.

    Herein lies part of the problem. There are so many different interpretations of ‘what Keynes meant’. The policies implemented in the years after WW2 to the 1970s were an example of Abba Lerner’s interpretation of Keynes. This interpretation still lives on in Post-Keynesian circles (specifically known as Modern Monetary Theory). In a nutshell, they basically espouse constant budget deficits, low or zero interest rates and the use of taxation for fine tuning the economy. I suppose they think we are always in a liquidity trap…

    A great work shouldn’t intend to leave people arguing over what ‘x really meant’. That was Popper’s aim anyway. If a theory is hard to understand the fault often lies with the writer not just the reader.

    Sean, you are spot on…

  18. Jim Rose says:

    it is has to refute keynes if his followers build a protective belt of auxilary hypotheses to accomodate anomalies so to immunise his core thinking against falisfication.

  19. Rafe says:

    “It helps if you understand that Keynes basically uses a labour theory of value…”

    It helps even more if you know that the labour theory of value went out with whatever short-lived fashion was abroad in the 1870s (hint, the marginal revolution).

  20. Jim Rose says:

    references to the labour theory of value never increases your audience among the non-converted.

  21. Taylor says:

    Rafe

    It was just a methodological device – Keynes was smarter than that.

    I plan to look at Hayek’s theory of capital next, but I doubt that’s going to be much simpler.

    Any classic of economics (or politics or sociology) is bound to take a bit of effort because it will deal with big issues in a precise way.

  22. Jim Rose says:

    many classics of economics are easy to read.

  23. wreckage says:

    My experience with Hayek so far is that his writing is not very stylish, but it is very clear.

  24. Sean says:

    From the preface of Popper’s: The Logic of Scientific Discovery 1959.

    And yet, I am quite ready to admit that there is a method which might be described as ‘the one method of philosophy’. But it is not characteristic of philosophy alone; it is, rather, the one method of all rational discussion, and therefore of the natural sciences as well as of philosophy. The method I have in mind is that of stating one’s problem clearly and of examining its various proposed solutions critically.

    I have italicized the words ‘rational discussion’ and ‘critically’ in order to stress that I equate the rational attitude and the critical attitude. The point is that, whenever we propose a solution to a problem, we ought to try as hard as we can to overthrow our solution, rather than defend it. Few of us, unfortunately, practise this precept; but other people, fortunately, will supply the criticism for us if we fail to supply it ourselves. Yet criticism will be fruitful only if we state our problem as clearly as we can and put our solution in a sufficiently definite form—a form in which it can be critically discussed.

    I have no doubt Keynes was not an obscurantist like Deridda or Foucalt, but a problem of course is that a poorly written theory hinders rational/critical discussion. Criticise any Keynsian and he will tell you the problem is that ‘people just aren’t interpreting him right’ Krugman uses this line often in his NY Times dribble.

  25. Kant says:

    Hayek’s writing is certainly clearer but lacks the analytical sophistication of the GT.

  26. On your Marx says:

    Annabelle,

    If you look at figure 4 here, then you will see you are wrong.

    Parts of the GT are well written but some are not such as Chapters 13 & 14 which to my mind are quite profound.

    Keynes NEVER advocated constant deficits as they would not be needed.

    He also neglected banking crises.

    Keynes write much better in some of his other writings.

    Hayek was never a player in macro-economics after first Sraffa and then Kaldor tore his theory of ABCT to pieces in the 30’s. Perhaps that is a bit harsh however Hayek never was the same after this.

    Hayek was always to my mind much better at philosophy and which he concentrated on after these ‘debates’.

  27. JC says:

    “Parts of the GT are well written but some are not such as Chapters 13 & 14 which to my mind are quite profound.”

    Lol.

    Homer, that super snazzy spell and gram check app you have doesn’t quite mend the stupidity of your commenting, you nimrod.

    The above goes into Wikihomer as a well written but very stupid sentence.

  28. JC says:

    In any event Homer. You were banned from here and it wasn’t just because of your appalling diction and sentence construction. It was also because of your generalized stupidity.

    Please keep this in mind next time you’re wanting to gate crash uninvited.

  29. . says:

    “Hayek’s writing is certainly clearer but lacks the analytical sophistication of the GT.”

    Bullshit. It’s not empirical or a priori, it’s assertions backed up with dodgy maths.

    http://www.youtube.com/watch?v=pA67E8jMq84&feature=list_related&playnext=1&list=SPB3643DD9D6550C71

  30. Simon says:

    I think Hayek has forgotten that long term growth will only occur with immediate inputs, people who have been unemployed for long periods tend to lack the technical sophistication to reenter a modern workforce at which point the government or industry has to spend wadloads teaching old dogs new tricks which, by virtue of their shortened work/lifespans yield far less societally productive results. Like all businesses, it’s either get in on the ground floor or spend more to get your foot in the door. Hayeks main problem is that he isn’t cynical enough about the abilities or mindsets of people that have been left behind for longterm periods, although I agree the GFC could and should have been dealt with through Hayek biased framework as their was no prolonged history of workplace exclusion.

  31. . says:

    Hysteresis is real – did Hayek claim otherwise?

    Business don’t do long term planning – do you really believe this? The largest, most profitable firms make irreversible investments with 30 year horizons (paticularly with FDI).

    As for retraining – what a joke. Someone who can read and write and do maths like a 6th grader and who is able bodied should be able to be a bloody labourer. White card? What a crock. As for the idea that unskilled work doesn’t exist, secretaries in the golden west are earning in excess of 100k…

  32. Token says:

    …people who have been unemployed for long periods tend to lack the technical sophistication to reenter a modern workforce at which point the government or industry has to spend wadloads teaching old dogs new tricks which, by virtue of their shortened work/lifespans yield far less societally productive results.

    WTF?

  33. Jim Rose says:

    John Kenneth Galbraith wrote, “Unlike nearly all of Keynes’s other writing, this volume is deeply obscure.”

    HT: http://www.hoover.org/publications/policy-review/article/100836

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