The greatness of John Maynard Keynes, our only guide in this crisis

Judging from the comments on the FM site, most readers should carefully review these articles.  I believe this crisis results from a paradigm crisis in Keynesian economics, as we reach the boundaries of his vision — specifically, the point at which aggregate private sector debt becomes a limiting factor for the economy’s growth.  But however inadequate, Keynesian theory is all we have until another such genius comes along.

It does not matter how inadequate Keynesian theory might be, it is all we have today.  Thomas Kuhn explained in his great work, The Structure of Scientific Revolutions (chapter 8) that paradigms can only be replaced, not disproven:

The decision to reject one paradigm is always simultaneously the decision to accept another, and the judgment leading to that decision involves the comparison of both paradigms with nature and with each other. (p. 79)

A scientist, and even more strongly a public official, can no more make economic decisions without a paradigm than a computer work without software.  Unfortunately, today Keynesian theory is all we have.  Competitors, such as Austrian and Marxist economics, provide neither the precision or scope of vision necessary to manipulate fiscal and monetary policy.  Hence I recommend reading this brief essays on the application of Keynes’ work (developed by his successors) to our crisis.

  1. What Would Keynes Have Done?“, Greg Mankiw, New York Times, 28 November 2008
  2. The Keynesian moment“, Paul Krugman, op-ed in the New York Times, 29 November 2008
  3. The greatness of Keynes“, Paul Krugman, op-ed in the New York Times, 30 November 2008

Excerpts

What Would Keynes Have Done?“, Greg Mankiw, New York Times, 28 November 2008 — Excerpt:

IF you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than a half-century ago, his diagnosis of recessions and depressions remains the foundation of modern macroeconomics. His insights go a long way toward explaining the challenges we now confront.

According to Keynes, the root cause of economic downturns is insufficient aggregate demand. When the total demand for goods and services declines, businesses throughout the economy see their sales fall off. Lower sales induce firms to cut back production and to lay off workers. Rising unemployment and declining profits further depress demand, leading to a feedback loop with a very unhappy ending.

The situation reverses, Keynesian theory says, only when some event or policy increases aggregate demand. The problem right now is that it is hard to see where that demand might come from.

The Keynesian moment“, Paul Krugman, op-ed in the New York Times, 29 November 2008 — Excerpt:

I think it’s worth saying a bit more about why, exactly, we’re in such a Keynesian moment.

If Keynes receded in our consciousness over the past few decades, it wasn’t mainly because of uninformed criticisms from the right; it was because central bankers seemed to have everything under control. Uncle Alan and his counterparts, by controlling the money supply, could do the job of stabilizing the economy, and Keynesian fiscal policy seemed irrelevant.

Now, Keynes understood the role of monetary policy quite well, and believed that it had been effective in the past. What he argued, however, was that there were situations in which monetary policy could do no more — and that the world economy he lived in was facing such a situation

The greatness of Keynes“, Paul Krugman, op-ed in the New York Times, 30 November 2008 — Keynes understood things that remain a mystery to non-economist policy gurus even today.  This brief essay is well worth reading in full.  Excerpt:

The greatness of Keynes is illustrated by the trouble people who consider themselves well informed have, to this day, in understanding the basic principles of how a depressed economy works.

Afterword

If you are new to this site, please glance at the archives below.  You may find answers to your questions in these.

Please share your comments by posting below.  Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

For more information from the FM site

To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp relevance to this topic:

Forecasts on the FM site about causes of the crisis:

  1. The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  2. Diagnosing the eagle, chapter I — the housing bust, 6 December 2007
  3. Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
  4. Let us light a candle while we walk, lest we fear what lies ahead, 10 February 2008 – Putting the end of the post-WWII regime in a larger historical context.
  5. A vital but widely misunderstood aspect of our financial crisis, 18 September 2008 — Too many homes.
  6. A picture of the post-WWII debt supercycle, 26 September 2008
  7. Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
  8. Causes of the financial crisis (no, its not the usual list), 29 October 2008
  9. Government policy errors and the Great Depession, 1 November 2008

Originally published at Fabius Maximus and reproduced here with the author’s permission.

7 Responses to "The greatness of John Maynard Keynes, our only guide in this crisis"

  1. Laura Harrison   December 5, 2008 at 11:34 pm

    Most of the recent writings about Keynes, including some but not all of what Greg Mankiw and Paul Krugman have written, neglects the important international dimension of what he was about. He advocated the international coordination of economic policies, and international economic institutions like those he helped to create at Bretton Woods (the World Bank and IMF), and for most of his life advocated free trade, including to promote peace between countries. Wht is this neglected so much, when it is so important to finding a way out of our current global mess? Anyone reading Markwell’s book on Keynes and international relations will see how central this was to Keynes’s thinking.

  2. Econophile   December 6, 2008 at 2:12 pm

    Why is everyone drinking the Keynesian KoolAid? Can anyone point out a situation where applied Keynesian remedies (massive deficit spending) actually worked? The “science” that Keynes and his supporters advocate is fundamentally a religious belief. The cause of the problem is not the lack of aggregate demand but the credit bubble that led to housing mania. Papering over the economy by the Fed and Treasury will not revive the economy. Only when all these bad assets are properly (de)valued will we recover. Massive spending will only lead to stagnation as it did in Japan.

    • Steven Hales   December 6, 2008 at 10:15 pm

      “Can anyone point out a situation where applied Keynesian remedies (massive deficit spending) actually worked?”Erm…WWII. Make products out the whazoo and dump them in the ocean, in a word that is war.

      • Econophile   December 12, 2008 at 1:01 pm

        Well, this is incorrect too. The economy really didn’t get back to normal until the ’50s. WWII reduced employment because, among other things, 8.5MM men were drafted into the armed services. There were wage and price controls and certainly full employment to support the war effort. But business investment fell as did consumer spending. So you can’t say that was a “recovery.”

  3. Guest   December 12, 2008 at 1:17 pm

    Keynes is a spleens. What a f*cktard. Except – We haven’t practiced Keynesian economics. He said government should spend in recession to stimulate, run a surplus in expansion to balance the debt.All we’ve done is continue the debt part, hence, we haven’t actually practiced Keynesian economics. We lack the political will for the balancing act.

  4. Javier   December 18, 2008 at 11:44 am

    the age of “les miserables” of wall street and the monetarists ended, welcome back JM Keynes but do not abuse of fiscal policy again, remember Tobin’s prudence.

  5. Ahmnodt Heare   February 1, 2009 at 11:42 am

    Keynesian economics is not the only option nor is it the best option. The only people who benefit from Keynesian economics are corporations with money to lobby legislative bodies.