All entries for Wednesday 23 September 2009

September 23, 2009

The Essence of Keynes and the Value of Macroeconomics

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Reviewing Keynes: The Return of the Master, by Robert Skidelsky (Allen Lane), in The Observer on August 30, 2009, Paul Krugman remarked that Keynes himself at one time considered the core of his theory to be the rejection of Say's Law (that income is always spent);

Say's Law [Krugman writes] isn't true, because in a monetary economy people can try to accumulate cash rather than real goods. And when everyone is trying to accumulate cash at the same time, which is what happened worldwide after the collapse of Lehman Brothers, the result is an end to demand, which produces a severe recession.

At another time, however, Keynes suggested that the core lay in

uncertainty that cannot be reduced to statistical probabilities, what the former US defence secretary Donald Rumsfeld called "unknown unknowns". This irreducible uncertainty [Keynes argued and Krugman writes] lies behind panics and bouts of exuberance and primarily accounts for the instability of market economies.

Krugman noted that Skidelsky himself has moved closer to the second view.

Observationally, these two views are excellent markers today for positive and negative judgements of the field of modern macroeconomics. Those that emphasize uncertainty as the fundamental problem are likely to excoriate professional economists for the false precision of their mathematical modelling, and their inability to foresee the crash of 2008.

In contrast, those that emphasize the broken relationship between supply and demand as the core insight of Keynes are likely to commend many of the same economists for their prompt reaction to the same financial crisis; they were as good as their word, speedily putting in place the massive fiscal and monetary interventions that have saved us from a repeat of the Great Depression.

In truth and logic, these insights complement each other. If Say's Law held, uncertainty would not matter. Depressions are possible because Say's Law does not hold, but it is unpredictable animal spirits that trigger them. Thus both insights are essential to Keynesian macroeconomics

That being the case, it appears that macroeconomic policy makers did not completely lose sight of what matters most. Macroeconomic theory -- well, that's another story.

I am a professor in the Department of Economics at the University of Warwick. I am also a research associate of Warwick’s Centre on Competitive Advantage in the Global Economy, and of the Centre for Russian, European, and Eurasian Studies at the University of Birmingham. My research is on Russian and international economic history; I am interested in economic aspects of bureaucracy, dictatorship, defence, and warfare. My most recent book is One Day We Will Live Without Fear: Everyday Lives Under the Soviet Police State (Hoover Institution Press, 2016).

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