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Monday, May 18, 2009

History Note: The Rise and Fall of Keynesianism

From the 05.14.09 podcast:

The history note:

In the mid - 1960's, it is no exaggeration to say, and Lord Eric Roll in his definitive History of Economic Thought did say, "... the New Economics enjoyed an acclaim unprecedented in its speed and intensity."

Economics and economists had penetrated the policy-making framework as never before. in the Depression, the New Deal Brain Trust around FDR drew some economists in, but by the 1950s and 1960s there was a systemic and institutional presence of economists in countries around the globe.

And as Lord Roll puts it ...

"for at least over thirty years after the appearance of Keynes' General Theory, the status of economics, largely with the kind associated with his name and general approach, increased steadily until it reached a position of authority, both as a branch of social science and as a perceived tool for the better ordering of human affairs, unparalleled in its history and unequalled by any of the other of the non-physical sciences."

This is not the situation today. A recent edition of Business Week lampooned economists as people who could not agree on what had happened, on what to do, on what would happen, and would be wrong anyway.

In a moment we will look at what happened to change the situation from a condition in which economics and economists were held in high regard to one in which they are ... not. But first, let me emphasize that the high standing and respect accorded to economists int he postwar years prior to 1970 is not my invention. The clear perception among politicians and the public was that Keynesian economics, demand side economics, had been refined and perfected and was responsible for that period of growth, prosperity, low unemployment and modest inflation.

What happened?

Two things: The stagflation of the 1970s and early 1980s and a counter-revolution.

Much could be said about the stagflation. It occasioned Richard Nixon's wage-price freezes, initially well-received, and later experienced as disruptive and counter-productive. Still ill-appreciated is the role of oil prices, energy prices, not just as demand shocks, but as directly eroding wages and incomes. Whatever might be said, the stagflation exploded the illusion of precision which economists had gathered around themselves, and offered the opening for a politically led counter revolution that unseated the orthodoxy of the New Economics.

I choose the words "politically led" very carefully. The Monetarist laissez faire supply side scheme that replaced the Keynesian conventional wisdom was by no means generally accepted among economists or among nations, though it has achieved sway among bankers. The revolution against Keynesianism was decidedly not a revolution led by economists. At most there was a civil war during which time the elections of Thatcher and Reagan put the new dogma into the seats of power in some influential countries.

Supply Side has never really been a branch of economics. More a parasitic vine. No serious academic lineage has followed it. Its advocates are not housed primarily in universities, but are centered in corporate-sponsored Right Wing think tanks like the American Enterprise Institute and the Heritage Foundation.

Monetarism, laissez fair, New Classical math-based, and Rational Expectations schools have enjoyed far less consensus among economists than the Demand Side schools that preceded them, although they too have been the beneficiaries of significant corporate sponsorship, in the form of endowed chairs and business school boosterism. However that may be, none of these schools carries any pretense of precision into the second year of this current recession.

The hybrid Monetarism and laissez faire philosophy that controls the Fed and Treasury can claim no precision now after so many years of false promises and predictions. To have the financial potentates still at the helm after so many protests that they had not seen it coming is one of the great ironies of the current year. The Rational Expectations and the mathematical strains of the New Classical school are clearly wrong or irrelevant. Libertarian bias sometimes masquerades as a market efficiency theme, but both are as completely out of place looking forward as they were in describing the corporate oligarchy that rose up behind the smokescreen of Reaganism.

The current crisis and its depth are impossibilities from the points of views espoused by these folks only a couple of years ago.

That said, until this recession, the collapse of this housing market and this financial sector, and for the twenty years prior, for an economists to be Keynesian or Demand Side in approach was to be hopelessly naive and stuck in the past, and to look for employment at the Post Office.

Keynesianism may have been defeated by a motley coalition of political opportunists, corporate connivers and academic hacks, but it WAS defeated.

I took my degree from a large state university in 1995. The name Keynes appeared about twice -- literally during my undergraduate education. It was not until after graduation I even learned how to pronounce the name of the greatest economist of the Twentieth Century. Only subsequent to the 2007 housing collapse and financial debacle did KEENES become Keynes again to the policy maker and the media talking head.

Paul Krugman's blog the other day said something about this period. Where is it?

Brad DeLong catches a footnote in a decade-old paper by Olivier Blanchard:

Paul Krugman recently wondered how many macroeconomists still believe in the IS-LM model. The answer is probably that most do, but many of them probably do not know it well enough to tell.

I actually have no memory of saying that. But I was worrying about the state of macro a decade ago. Here’s a short piece I wrote back then. Even then, it was obvious that the Great Forgetting was underway; only economists of a certain age knew how to think about what remain the essential insights of macro.

So in a way it should be no surprise to find, 10 years later, that we have entered a Dark Age of macroeconomics.

The IS-LM model was an invention of John Hicks, later Sir John Hicks. He won the Nobel Prize for it, which did not prevent him from later recanting, or more accurately, ascribing its relevance only to a narrow part of reality. But it was mathematical, and Keynesian. I'm not sure by this whether Krugman, DeLong or any others actually advocate this scheme. A paper Krugman wrote at that time makes this note:

Afficionados know that much of what we now think of as Keynesian economics actually comes from John Hicks, whose 1937 article "Mr. Keynes and the classics" introduced the IS-LM model, a concise statement of an argument that may or may not have been what Keynes meant to say, but has certainly ended up defining what the world thinks he said. But how did Hicks come up with that concise statement? To answer that question we need only look at the book he himself was writing at the time, Value and Capital, which has in a low-key way been as influential as Keynes' General Theory.

Hicks and the IS-LM were searching for precision and found it in irrelevance. But the formulation remained the central Macro formulation, event absent Keynes' name. It is best ignored for the present.

The Keynesian policies in play today are the federal infrastructure spending, the aid to states and local governments and assistance to health and education systems. You might also add the New Deal programs of social security and unemployment insurance as base supports of demand, but which are not strictly Keynesian. I combine the two in the definition of Demand Side.

These are the measures of which JMK would have approved.

Compare the "Timely Targeted and Temporary" tax cuts of early 2008, which was plainly a bust from the beginning from a Demand Side perspective. If you've been with us, you heard us among the voices discounting the efficacy of these checks to individuals, no matter their political popularity. The primary sponsor of Timely Targeted and Temporary was, of course, Larry Summers. As we predicted from before the beginning here on the podcast, that triple T stimulus was a non-starter in the real economy. Republicans and Conservative economists who continue to insist on tax cuts as being effective are ignoring this evidence.

Those who expect big things from loan guarantees and making nice with the banks so they will lend are destined for disappointment from the same cause. The consumer is not going to be the engine it once was. The why's go beyond the fact that his/her net worth is going negative fast and his/her income is dropping on average, but we won't go into them here.

Getting back to Timely Targeted and Temporary. Didn't work any better than tax cuts for the rich.

The entire Monetarist scheme to refloat the banks is from the Demand Side perspective a Monetarist scheme to refloat the banks. To us there is no clear reason why it should work as a remedy for the economy, since there is no clear motivation to invest or borrow or lend absent demand strength. It's great to have a good ferry, but if nobody wants to go across the river, nobody will benefit, even the ferry.

The idea that the financing function of the economy will be saved by salvaging the companies that screwed it up is dubious on its face. Or that ratifying their bad decisions by having the government cover them with taxpayer money? It does not stand the test of common sense, let alone the Demand Side theory. In fact, it's hard to see whose theory it does test out in. Perhaps the theory that those who control the government set the policy.

But this IS the history note. And the note is simply the contrast. First between the economic consultants of the New Deal and the economic establishment that grew out of Keynesianism to such prominence in the third quarter of the Twentieth Century, and second the contrast between that and the current Tower of Babel. The rise of Keyneisanism and Demand Side, its successful revolution against classical laissez fair and broad acceptance, to the unseating of that consensus by a commercial-political-economic gang that had no coherent or widely accepted replacement philosophy, sharing only the common trait of being contrary.

Anyway, that's the abbreviation of the Cliff Notes version of the Keynesian Revolution, the establishment of the first coherent policy framework, and the subsequent fall into intellectual chaos.