Friday, June 25, 2010
Posted by dkuehn at 6:20 AM
Several interesting posts on Keynes recently. Scott Sumner writes about what he calls "the incredible shrinking General Theory". His point is that initially Keynesians said that fiscal policy was always important, then they said it was only important during recessions, and now they're saying it's only important in liquidity traps. I think historically speaking he's partially right about the direction Keynes has been taken, but I have a few concerns about this:
1. First, the General Theory needs to be read as a theory of output and the general glut, not as a theory of business cycles or as a policy manual. Keynes barely talks about policy, and in most cases when he does he writes about interest rate manipulation (i.e. - precisely the kind of policy Sumner is advocating!). There are points in the text where he says that in a lot of cases, adjustment of bank rates "should be sufficient". So yes, Keynesianism has moved away from fiscal policy over the years, but the point is this was never really that different from what Keynes said in the first place. That having been said,
2. The really important thing about Keynes was precisely that he raised reservations about monetary policy and pointed out why demand (of which government demand is one component) is so important for output determination. We shouldn't lose that in our understanding of the General Theory. I'm personally in that first group Sumner describes anyway (which I suppose might even make me something of a post-Keynesian). I think in theory fiscal policy can always be important. To a large extent it's an efficiency trade-off. Crowding out problems are real, as is bureaucratic inefficiency, and sometimes these problems are more relevant than others. Sometimes crowding out is OK (if a sub-optimally under-invested in public good crowds out a sub-optimally over-invested in private good, who the hell cares?), but very often it's not.
3. Much has been made of the liquidity trap recently (Jonathan Catalan thinks through it very carefully here). This is largely attributable to the work of Paul Krugman during Japan's Lost Decade. The liquidity trap for me introduces a situation where monetary policy is almost completely useless - that is its significance. I know of no reason why fiscal policy is only useful in a liquidity trap. I'm not sure how this meme got going. I always thought that the efficacy of fiscal policy was more dependant on the under-utilization of resources than on the trade-off between money and bonds. But what do I know? Certainly when interest rates are extremely low fiscal policy is obviously easier - but aside from that I'm not sure what people's point is when they cite liquidity traps. The relationship between fiscal policy, output, and employment doesn't seem to magically change in a liquidity trap.
Other things out there on Keynes recently:
- Jonathan Catalan thinks about why Keynes "avoided" the Austrians. Jonathan's point is first that he didn't. This is correct in my view. He doesn't treat it in detail, but it's in there. He also cites Bohm-Bawerk, and I believe even von Mises, and he engaged Hayek in debate throughout his life. I think the important thing to remember is that just because Austrians think of Keynesians as their opponents, it does not follow that Keynesians think of Austrians as their opponents. To a large extent, Keynesians are not focusing on Austrians - they're focusing on Classical and neo-Classical fallacies. Keynes's primary purpose was to vindicate Malthus in the Malthus-Say debates over general gluts, not to offer an alternative to a credit and capital based theory of the business cycle (as I've said in the past - Keynes isn't really interested in the business cycle - he's interested in output determination). I personally buy into a lot of the General Theory, and I also buy a lot of ABCT (I don't think it's necessarily important in explaining all downturns, but I think it has important and true insights). I maintain that while a few details probably clash, there's nothing inherently incompatible between ABCT and Keynesianism. There is something inherently incompatible between Classicism/new Classicism and Keynesianism. So of course that's where the attention gets directed.
- Paul Krugman puts forward his Dark Age of Macro thesis again, citing Keynes. I think the point is a little too strong - and much of the detour we went through in the late twentieth century at least had its origin in legitimate (if over-stated) concerns about Keynesianism as it was understood in the 50s and 60s - but the general point I think is still valid. Say's Law is more hueristic device than strict law now (less charitable writers use the word "straw man"), but its basic tenets are widely held. That's a big problem. People operate on the assumption that we're consistently on the Production Possibilities Frontier. We're not. We're simply not, almost never. Keynes explained why, but a lot of people have missed that and just thought of him as a counter-cyclical spending guru.