Keynesian Revolution

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John Maynard Keynes
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The Keynesian Revolution was a fundamental reworking of economic theory concerning the factors determining employment levels in the overall economy. The revolution was set against the then orthodox economic framework, namely neoclassical economics.

The early stage of the Keynesian Revolution took place in the years following the publication of

neo-Keynesian economics, a mixture of neoclassical economics and Keynesian economics. The process of mixing these schools is referred to as the neoclassical synthesis
, and Neo-Keynesian economics may be summarized as "Keynesian in macroeconomics, neoclassical in microeconomics".

Historical context

The revolution was primarily a change in mainstream economic views and in providing a unified framework – many of the ideas and policy prescriptions advocated by Keynes had ad hoc

underconsumptionist
school of 19th-century economics, and some forms of government stimulus were practiced in 1930s United States without the intellectual framework of Keynesianism.

The central policy change was the proposition that government action could change the level of

tax cuts, and changes in interest rates and money supply (monetary policy) – the prevailing orthodoxy prior to that point was the Treasury view
that government action could not change the level of unemployment.

The driving force was the economic crisis of the

Second Red Scare (McCarthyism) and accused of Communism, but ultimately a form of Keynesian economics became mainstream; see textbooks of the Keynesian revolution
.

The Keynesian revolution has been criticized on a number of grounds: some, particularly the

freshwater school and Austrian school, argue that the revolution was misguided and incorrect;[citation needed] by contrast, other schools of Keynesian economics, notably Post-Keynesian economics, argue that the "Keynesian" revolution ignored or distorted many of Keynes's fundamental insights, and did not go far enough.[2]

Theory of employment

A central aspect of the Keynesian revolution was a change in theory concerning the factors determining employment levels in the overall economy. The revolution was set against the orthodox

Say's Law, argued that unless special conditions prevailed, the free market would naturally establish full employment
equilibrium with no need for government intervention. This view held that employers will be able to make a profit by employing all available workers as long as workers drop their wages below the value of the total output they are able to produce – and classical economics assumed that in a free market workers would be willing to lower their wage demands accordingly, because they are rational agents who would rather work for less than face unemployment.

Keynes argued that both Say's Law and the assumption that economic actors always behave rationally are misleading simplifications, and that the classical economics was only reliable at describing a special case. The Keynesian Revolution replaced the classical understanding of employment with Keynes's view that employment is a function of demand, not supply.[3]

Peter Drucker said:

He had two basic motivations. One was to destroy the labor unions and the other was to maintain the free market. Keynes despised the American Keynesians. His whole idea was to have an impotent government that would do nothing but, through tax and spending policies, maintain the equilibrium of the free market. Keynes was the real father of neoconservatism, far more than Hayek! [1]

Other "revolutions" in economics

Prior to Keynes

Professor Harry Johnson has written that economics in its modern form can be seen as dawning with the

marginalist revolution, which is taken to mark the transition from classical economics to neoclassical economics[6]
in the 1870s. Collectively, these fashioned the classical economic orthodoxy that Keynes attacked.

Note however that in economic practice, as opposed to economic theory, the behavior of industrializing nations in the 19th century has frequently been described[by whom?] as mercantilist or embodying economic nationalism, as in the American School of 19th-century American economic practice.

After Keynes

The rise of

The Great Moderation
.

Within academia the post WWII high point of

2008–09 Keynesian resurgence.[8]

Background

When Keynes published his General Theory in 1936, the influence of free market economics on policy making had already declined substantially compared to the almost unchallenged ascendancy it had enjoyed in Britain during the 1840s - 1860s.

Administered price theorists.[12]

In 1930, Keynes was in his late forties, and in October his

J A Hobson with his Physiology of industry (1889).[14]

The course of Keynesian Revolution

(Colander & Landreth 1996) argue that there are three components to the Keynesian revolution: a policy revolution, a theoretical (or intellectual) revolution, and a textbook revolution. These are addressed in turn.

Intellectual

Keynes's revolutionary theory was set out in his book

General Theory of Employment, Interest and Money, commonly referred to by the abbreviated title General Theory. While working on the book, Keynes wrote to George Bernard Shaw, saying "I believe myself to be writing a book on economic theory which will largely revolutionize, not I suppose at once but in the course of the next ten years – the way the world thinks about economic problems … I don't merely hope what I say, in my own mind I'm quite sure"[15] Professor Keith Shaw wrote that this degree of self-confidence was quite amazing especially considering it took more than fifty years for the Newtonian revolution to gain universal recognition; but also that Keynes's confidence was fully justified.[16] John Kenneth Galbraith has written that Say's Law dominated economic thought prior to Keynes for over a century, and the shift to Keynesianism was difficult. Economists who contradicted the law, which inferred that underemployment and underinvestment (coupled with over-saving) were virtually impossible, risked losing their careers.[17]

Keynes's General Theory was published in 1936 and provoked considerable controversy, yet according to professor Gordon Fletcher it rapidly conquered professional opinion.[3]

For biographer Lord Skidelsky, the General Theory triggered a massive reaction immediately after its release, with extensive reviews in journals and popular newspapers all around the world. While many academics were critical, even the harshest critics recognised there was a case to be answered. As with other theoretical revolutions, the young were most receptive with some older economists never fully accepting Keynes's work, but by 1939 Keynes's view had broadly gained ascendancy both in Great Britain and the US.[18]

According to

Austrian School
economist strongly opposed to Keynes:

the General Theory was, at least in the short run, one of the most dazzlingly successful books of all time. In a few short years, his "revolutionary" theory had conquered the economics profession and soon had transformed public policy, while old-fashioned economics was swept, unhonored and unsung, into the dustbin of history.

Rothbard goes on to describe that by the end of the 1930s every single one of Friedrich Hayek's followers at the LSE was convinced by Keynes's ideas – all economists who had previously opposed Keynes's advocacy of state intervention in the economy.[19]

Despite Keynes's early success, the revolutionary effect on theoretical economics was soon diminished. From the late 1930s, a process began to reconcile the General Theory with the classical ways of viewing the economy – developments which included

Neo-Keynesian and later New Keynesian economics
.

An alternative take was advocated at the dawning of the revolution by Dennis Robertson, who Fletcher has described as the most intellectually formidable of Keynes's contemporary critics. This view held that the great excitement triggered by the General Theory was unjustified – that genuinely new ideas presented were overstated and not supported by evidence, while the verifiable ideas were merely well-established principles dressed up in new ways. According to Hyman Minsky, this position eventually became dominant in mainstream academia, though it is by no means unchallenged.[20]

Origins

"Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone."

— John Maynard Keynes[21]

Lord Skidelsky has written that Keynes's motivation for the revolution arose from the failure of the British economy to recover from its post World War I recession in the manner predicted by classical economics – throughout the 1920s British unemployment remained at historically high levels not previously seen since a brief period in the aftermath of the Napoleonic Wars.[18] Skidelsky notes a December 1922 lecture to the British Institute of Bankers where Keynes noted that wages no longer fell with prices in the classical fashion, due in part to the power of unions and wage "stickiness".[18] Keynes recommended government intervention as the cure for unemployment in this circumstance, a position he never deviated from though he was to refine his thinking on what sort of intervention would work best. For Dr Peter the revolution can be seen as dawning in 1924 which was when Keynes first started advocating public works as a means by which the government could stimulate the economy and tackle unemployment.[22]

Policy

While much attention is given to the impact on academic economics, the revolution also had a practical dimension. It influenced decision makers in governments, central banks and global institutions like the International Monetary Fund (IMF). According to Lord Skidelsky, the revolution began in policy making terms as early as December 1930, with Keynes's participation in the Macmillan Committee on Finance and Industry.[18] The Committee had been formed to make policy recommendations for Britain's economic recovery – while Keynes's plans for an interventionist response were rejected, he did succeed in convincing the government that the classical conception that wages would drop along with prices and thus help to restore employment after a recession was wrong.[18] The first government to adopt Keynesian demand management policies was Sweden in the 1930s.[23][24]

Keynes had some influence on

Golden age of capitalism and the Age of Keynes, by others.[25][26] From the late sixties Keynes's influence was displaced following the success of "counter revolutionary" efforts by economists like Milton Friedman and others sympathetic to the free market. Following the financial crises in 2008, there has been a revival in Keynesian thinking among policy makers in favour of robust government intervention, which the Financial Times has described as a "stunning reversal of the orthodoxy of the past several decades".[27]

Textbooks

The importance and history of textbooks is less studied than other aspects of the Keynesian revolution, but some argue that it is of fundamental importance.[28]

In the United States, the 1948 textbook

William F. Buckley, Jr.

Samuelson's Economics was also subject to "conservative business pressuring" and accusations of Communism, but the attacks were less "virulen[t]" and Economics became established.[29] The success of Samuelson's book is attributed to various factors, notably Samuelson's dispassionate, scientific style, in contrast to Tarshis's more engaged style. Subsequent texts have followed Samuelson's style.

Keynesian Revolution questioned

According to

post Keynesian economists and some others such as Charles Goodhart, in the academic sphere the so called revolution failed to properly get off the ground, with neo-Keynesian economics being Keynesian in name only.[30] Such critics have held that Keynes's thinking was misunderstood or misrepresented by the revolution’s leading popularisers, the founders of neo-Keynesian economics such as John Hicks and Paul Samuelson.[3] The post Keynesians felt neo-Keynesianism excessively compromised with the classical view. For Paul Davidson the revolution was "aborted"[2]
in its early years; for Hyman Minsky it was "still born";[20] while for Joan Robinson the revolution led to a "bastard Keynesianism".[20]

A suggested reason for the distortion is the central role

IS/LM model played in helping other economists understand Keynes's theory – for post Keynesians, and by the 1970s even Hicks himself, the model distorted Keynes's vision.[2]

A second reason offered is the attacks on the more progressive expressions of Keynes's views that occurred due to McCarthyism. For example, while initially popular, Lorie Tarshis's 1947 textbook introducing Keynes's ideas, The elements of economics was soon heavily attacked by those influenced by McCarthy.[2] The book's place as a leading textbook for Keynes's ideas in America was taken by Paul Samuelson's Principles of Economics. According to Davidson, Samuelson failed to understand one of the key pillars of the revolution, the refutation ergodic axiom (i.e., saying that economic decision makers are always confronted by uncertainty – the past isn't a reliable predictor of the future).[2]

Economists

Animal Spirits
.

Another reason for the distortion of Keynes's views was his low level of participation in the intellectual debates that followed the publication of his General Theory, first due to his heart attack in 1937 and then due to his preoccupation with the war.[20] It has been suggested by Lord Skidelsky that apart from his busyness and incapacity, Keynes didn't challenge models like IS/LM as he perceived that from a pragmatic point of view they would be a useful compromise.[18]

Significance

Professor Gordon Fletcher stated that Keynes's General Theory provided a conceptual justification for policies of government intervention in economic affairs which was lacking in the established economics of the day – immensely significant as in the absence of a proper theoretical underpinning there was a danger that ad hoc policies of moderate intervention would be overtaken by extremist solutions, as had already happened in much of Europe back in the 1930s before the revolution was launched.

Financial crisis of 2007–2010.[31][32]

See also

Notes and references

  1. ISBN 0-333-08131-5
  2. ^ a b c d e
    ISBN 978-0-230-61920-3
    .
  3. ^ a b c d Fletcher, Gordon (1989). "Introduction". The Keynesian Revolution and Its Critics: Issues of Theory and Policy for the Monetary Production Economy. Palgrave MacMillan. pp. passim, esp. xix, xx.
  4. ^ John Woods, ed. (1970). Milton Friedman: Critical Assessments. Vol. 2. Routledge. p. 73.
  5. ISBN 9780415020053
    . Retrieved 10 February 2008.
  6. ^ Sometimes in sources discussing the revolution, neoclassical economics called is just plain classical.
  7. ^ The "monetarist revolution" in monetary theory, Karl Brunner, Review of World Economics (Weltwirtschaftliches Archiv), 1970, vol. 105, issue 1, pages 1–30
  8. ISBN 978-0-674-03538-6
    .
  9. Lloyd George. See The Great Transformation (book)
    chapters 12 - 18.
  10. ^ Cockett, Richard (1995). "Keynes and the crises of Liberalism, 1931–39". Thinking the unthinkable: think-tanks and the economic counter-revolution, 1931–1983. Fontana Press.
    ISBN 0-00-637586-3
    .
  11. ^ Like the Stockholm school Keynes may have been inspired in part by the earlier work of Knut Wicksell
  12. ^ Blyth, Makr (2002). Great Transformations.
    ISBN 0-521-01052-7
    .
  13. ^ Colander, David C. and Harry Landreth (1996). "Introduction". The Coming of Keynesianism to America: Conversations with the Founders of Keynesian Economics. Edward Elgar.
  14. ^ Hayes, M.G. (2008). The Economics of Keynes: A New Guide to the General Theory. Edward Elgar Publishing. pp. 2–17.
    ISBN 978-1-84844-056-2
    .
  15. ^ Keynes, J.M (1973). Donald Moggeridge (ed.). The Collected Writings of J. M. Keynes. Vol. XIV. London: Macmillan for the Royal Economic Society. pp. 492–493.
  16. ^ Shaw, Keith (1988). "9". Keynesian Economics: The Permanent Revolution. Edward Elgar Publishing Ltd. p. 142.
  17. ^ JM Galbraith. (1975). Money: Whence It Came, Where It Went, p. 223. Houghton Mifflin.
  18. ^ a b c d e f g Skidelsky, Robert (2003). John Maynard Keynes: 1883–1946: Economist, Philosopher, Statesman. Pan MacMillan Ltd. pp. 316, 419–426.
    ISBN 0-330-48867-8
    .
  19. ^ Murray Rothbard. "Keynes the man" (PDF). Ludwig von Mises Institute. Retrieved 13 June 2009.
  20. ^
    ISBN 9780071593021
    . Retrieved 13 June 2009.
  21. ISBN 1-57851-777-X
    , pg 408
  22. ^ Paul Addison. "The Intellectual Origins of the Keynesian Revolution". Oxford Journals. Archived from the original on 15 April 2013. Retrieved 30 November 2008.
  23. ^ Anders Åslund. "The Group of 20 must be stopped". The Financial Times. Retrieved 30 November 2008.
  24. ^ Otto Steiger. "Bertil Ohlin and the origins of the Keynesian Revolution". Duke University Press. Retrieved 30 November 2008.
  25. ISBN 1-85984-429-4
    .
  26. ISBN 1-85984-429-4
    .
  27. ^ Chris Giles; Ralph Atkins; Krishna Guha (30 December 2008). "The undeniable shift to Keynes". The Financial Times. Archived from the original on 27 May 2009. Retrieved 23 January 2008.
  28. ^ a b (Colander & Landreth 1998)
  29. ^ (Colander & Landreth 1998, p. 11–13, especially p. 12, footnote 33)
  30. ISBN 978-0-230-10254-5
    .
  31. ^ Sudeep Reddy (8 January 2009). "The New Old Big Thing in Economics: J.M. Keynes". The Wall street Journal. Archived from the original on 3 May 2009. Retrieved 12 March 2009.
  32. ^ Sumita Kale. "A global Keynesian revival". livemint.com in partnership with The Wall Street Journal. Retrieved 23 January 2009.

Further reading

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