In memory of Gilles Dostaler  

A paper presented to the annual meeting of the Canadian Economics Association, Université d’Ottawa, June 4, 2011. to be read in conjunction with After the Crash: Rediscovering Keynes and the Origins of quantitative easing. (available on this blog June 3, 2011  see displayed list of recent posted titles to your right) 

Harold R.Chorney, Professor of political economy and public policy Concordia university, Montréal

It is now 75 years since Keynes had published his General Theory of Employment , Interest and Money. Despite close to thirty years of sustained attack and then neglect by the majority of the mainstream of the economics profession with the coming of the great crash of  2008 Keynes once again became the centre of attention as policy makers struggled to find a way to deal with the near implosion of the global economy. Where did the panicked politicians, central bankers and finance journalists turn to for guidance in their time of peril ? To The General Theory and the body of knowledge and scholarship and policy analysis that has grown up around this seminal work. There were not many of us who willingly called ourselves Keynesian economists or followers of Keynes prior to the crash but it was this group that led the way in proferring usable and sensible and I would argue relatively effective policy advice during the crisis. Indeed, in my own case as in the case of very few other economists I began to warn about the crisis and the need for an appropriate policy response as early as the fall of 2007.I did so in contacts with politicians,both in Canada and abroad, comments in the financial press and media generally and interviews with journalists as well as on my own blog. I also had been teaching about what Charles Kindleberger famously had called manias , panics and crashes for the past 25 years in my courses on Keynes and the monetarists and business cycles.I had lectured on Minsky’s work for years and used his conception of financial panic and Ponzi finance in my courses along side a thorough discussion and textual analysis of Keynes and his circle.

As far back as 1983 I had also developed an analysis of debt management and economic stimulus which had advocated what I had called monetizing a greater portion of the debt than the conventional wisdom, now known as quantitative easing. I did so because I was aware of the fact that such an approach had been used in the 1930s by the Japanese and that Keynes, Lerner and other members of their circle had always included the notion of an accomodating monetary policy as an essential ingredient in any strategy of fiscal stimulus in overcoming a crisis of prolonged unemployment following a financial crash. In response to the claim made by monetarists such as Karl Brunner who had argued that Keynes could only work if there were full monetary easing including the creation of high powered money which in his view would be ultimately inflationary I tested this out with respect to Canadian data on rates of inflation and the ratio of central bank holding of government debt as a fraction of the broadly defined money stock over forty years of data. I found no consistent pattern and a very low R square with respect to the extent that inflation could be explained by variations in the rate of monetization.Inflation was clearly due to other factors, contrary to the conventional wisdom. So of course you can imagine how satisfied I was to see after more than a quarter of a century the successful use of quantitative easing without any inflationary fallout, just as I had predicted would be the case. Inflationary pressure is largely absent outside of the cartel that dominates the petroleum markets. Whatever inflation results there are has nothing to do with excessive ease of monetary policy. So in my view and it has been my view all along ever since I first began my study of Keynes in the mid 1960s, but perhaps more definitively since I began to teach  him again in the early 1980s there is a great deal of contemporary relevance to his work even today after 75 years have passed.

It is sometimes suggested that Keynes needs to be updated and revised to deal with the complexity of the modern global economy and that economic stimulus simply does not work in the way that he and his contemporary circle of supporters expected that it would.Of course, if you read Keynes carefully you will discover that he is a far more subtle analyst than his critics contend. For example, in his discussion of the multiplier and its limitations he recognizes the likelihood that there will be leakages because of factors like trade dependency and a tendency to hoard cash. At the same time he points out a factor that has all too often been ignored that to the extent our trade partners benefit from our domestic stimulus in later rounds provided these countries also import from us their strengthened economy will transmit stimulus to us in a similar manner to the way we have stimulated them.

Similarly as I have pointed out many times in my own work Keynes had a far more elaborate theory of inflation that was cost push, profit push and production disproportionality based than the simpliste theory of excess aggregate demand that he is often wrongly credited with.He was fully aware and argued that prices would begin to rise well before one reached full employment. Initially the vector forces would act largely on output and employment but as these rose the force would be transferred to to the price side and diminish on the output side because of disproportionalities, bottlenecks and other supply constraints. A proper reading of  chapter 21 on the theory of prices in the General Theory makes this clear, particularly ( pp 294-298).

It is also claimed quite falsely that Keynes is all about price rigidity preventing the market forces from operating to clear labour markets. For the past thirty years this has been at the centre of policy advice about the labour market clearing process. But this ignores as James Tobin and others were careful to show the extent to which a simple reading of Keynes shows that he begins his work with the assumption of working through the consequences of a fall in the real wage upon employment. (GT p 15) As Tobin puts it “The central Keynesian proposition is not nominal price rigidity but the principle of effective demand.” (p.136, Snowdon and Vane) and also  ‘ The method (of modern disequilibrium theory’ is misleading when it conveys the impression that Keynesian economics assumes price rigidities and indeed is defined by that assumption.,It is especially misleading if it gives an idea that such an assumption is necessary.”(p.145)

Tobin also suggests something which Joan Robinson, Kalecki and virtually all post Keynesians suggested that he would have been better off to have modelled his micro foundations on what actually does prevail in a market capitalist economy, imperfect or monopolistic  competition.  I understand why he did not want to because of his determination to rebut Say’s law and to explain how despite the best laissez-faire assumptions a slump would not clear of its own accord no matter how much wages might fall and budgets be cut. He had already seen the disasterous consequences of the return to the gold standard and the resulting industrial unrest that resulted from attempts to cut workers wages and deflate the economy to the new and unrealistic exchange rate.

His very definition of involuntary unemployment turns on this fact.His rather convoluted definition of involuntary unemployment once thought through and diagrammed properly(See for example James Trevithick, Involuntary Unemployment  on this) makes it clear. Keynes believes that nominal wage cutting may be problematic but real wage cutting is not. However, no worker or trade union can dictate what their real wage will be since the millions of decisions involved in a market economy are well beyond their capacity to control. So real wages may well fall but there is no certainty they will fall to precisely the point that guarantees stable full employment. Once a slump occurs there is no simple route back through the labour market clearing process to full employment.

Keynes is not principally about rigidities rather the GT is about effective demand, inadequate effective demand that is a tendency in capitalist society for business cycle and distributional reasons and for reasons associated with the problem of uncertainty and expectations or as Paul Davidson likes to put it the non ergodic side of economic reality. Keynes wishes to show that in the absence of intervention to stimulate aggregate demand after a severe slump you can end up with a large involuntary unemployment equilibrium in the sense of an economy stuck at a point well below the optimal utilization of its resources labour and otherwise. This kind of stagnation was a widely feared phenomenon during the 1920s and 1930s and it has become again a widely feared outcome in the U.S. and European and Japanese economies in the contemporary era. It is also a phenomenon totally at odds with classical doctrine. This is the essence of Keynes’ General Theory and this is why Keynes is so relevant to this era. The same sorts of arguments which Keynes faced in the late 1920s and early 1930s have resurfaced again in the Republican critique of President Barack Obama.

The Republicans have made some headway in the U.S. by claiming that Obama’s stimulus inspired by Keynes has been tried and has not worked to restore lower unemployment in the U.S. (see for example, Data on Jobs May hold Key To President’s (Fate),  Binyamin Applebaum , New York Times June 2, 2011.) The essence of their argument is resolutely anti-Keynesian and based on a large dose of deficit hysteria but because of the politics involved ,the Obama administration has partly trapped itself in this position by initially not having spent a large enough amount in its stimulus package, implemented it too slowly and in too much of a piecemeal fashion and foolishly signed onto the deficit reduction austerity program prematurely. This policy error may now be showing up in the sluggish job creation data and the very slow rate at which unemployment is dropping in the U.S. In fact the latest data released on Friday showed that the unemployment rate has risen to 9.1 % this may be a temporary hiccup connected to the slowdown in  auto parts supply because of the Japanese tsunami but if it persists it will be a worrying sign. (See Paul Krugman’s op ed in the New York Times, June 2, 2011, The mistake of 2010 )

The Obama administration have also not done a good job of explaining the significance of the U.S. debt including to whom it is owed, the difference between net debt and gross debt, explaining how the debt to GDP ratio has varied over time and the nature of whatever burden it imposes including rebutting the largely mythological nature of inter- generational burden.They have also failed to explain the extent to which debts are often valuable assets to which market actors flee when the equity markets are hit by a panic wave of selling. I have explained these issues at length in my published work on deficits and debt management, in my blogs and also there is a substantial body of scholarly literature on these issues. (See  Harold Chorney . Politicaleconomist on blogspot and Haroldchorneyeconomist on wordpress and Harold Chorney After the crash:rediscovering Keynes and the Origins of Quantitative Easing, particularly the bibliography as well as  the article Back towards a U.S. double dip by Robert Reich in the Financial Times June 1, 2011 where Reich argues these points and in favor of a second larger round of deficit financed stimulus to prevent a double dip recession.)

But if one goes back to the debates of the late 1920s and early 1930s and then to the GT itself one finds exactly the same sorts of arguments being used against and confronted by Keynes and his circle . Not all that much has changed. In many ways we are living an extraordinary déjà vu.I have not the time in this short prefatory paper to explore all of this but if you would like the evidence simply read through Keynes’ Essays on Persuasion, Peter Clarke’s work The Keynesian revolution in the Making and his recent biography of Keynes, The Rise, Fall And return of the 20th Century’s Most Influential Economist on Keynes in 1930 and his struggle in the Macmillan Committee to establish his position on the need for and logic of stimulus and the volumes of his correspondence  and debate with colleagues like Dennis Robertson, Joan Robinson and R.F.Kahn in the CW just before and after the GT as well as Keynes lectures in Chicago in 1931 to the Harris foundation and of course  the GT itself. If you take the time to do so I predict you will be astonished to discover just how close we are to these times and debates.

But that is not my task today. Rather I wanted to show you what aspects of the GT and Keynes’ ouvre is still powerful in terms of the guidance it can give. Here it is perhaps useful to begin by consulting the previous and perhaps still hegemonic school the monetarists as to their core principles and focus on some of those that  Keynes rejects. He rejected a number of these and it is useful to explore why his rejection is still of considerable value. Certainly Thomas Mayer identifies the quantity theory of money as primary. Of course , for Keynes the General Theory was the product of a long struggle to escape from the quantity theory of money as one of the habitual modes of thought and expression that he had sought to shed. (see his preface to the GT)

Mayer in his classic essay on The Structure of monetarism(Snowdon and Vane) has listed ten core principles of the doctrine drawing from Karl Brunner, Milton Friedman and other leading members of this school. Among them is the principle that markets work best when they are left alone  and not interfered with by government. He summarizes these views under principle 3 and 12 . 3 being the inherent stability of the private sector and 12 being dislike of government intervention. This view  is the basis of the doctrine of laissez-faire which goes back to the 18th century and the English revolution of the seventeeth century  and which has been the ideological inspiration for much of the neo-conservative movement for the past half century. Not all monetarists would swear by the doctrine but most would and certainly Milton Friedman and Hayek did. Strictly speaking of course Hayek is not a monetarist but in most respects he had a strong alliance with the University of Chicago school that led the way in monetarist doctrine and policy.

Maynard Keynes and his school specifically and forcefully rejected this claim that the private sector was inherently stable and  markets were always rational and never needed regulation. Indeed it was precisely this point that has caused the global economy such disastrous destructive trouble in 2007-2008. What is outrageous, of course, and totally contrary to the ideological claims of the theory that spawned it , was the fact that the perpetrators of the excesses that led to the collapse and crisis got rescued with funds provided by or liable to the general taxpayers. It is these very same taxpayers who are often told to fend for themselves when they get into trouble  on the specious grounds that helping them would be economically inefficient and morally wrong. There are many consequences of the great crash of 2008 but one that will take a long time to fade is the widespread public cynicism about the claims of the private sector to be self sufficient and in no need of public support yet deserving of the bailout on the grounds that they were too big to fail. Such claims of entitlement will be taken with a grain of salt for a long time to come.

Keynes, is also about a humanist vision that lies as he himself stated on the left side of celestial space. Athol Fitzgibbons has made this point exceedingly well in his brilliant study of Keynes with the apt title Keynes’s vision. Influenced by his study of Burke, his deep knowledge of Hume and Ricardo and his early mentor G.E. Moore, Keynes was both the product of and the further developer of  a kind of pre modern way of thinking. In this way of thinking theory that led to policy outcomes which were unjust or which violated moral precepts of justice had to be flawed in theoretical soundness. So for example a theory like Say’s law of markets  which led to tolerating substantial involuntary unemployment was in Keynes’ view ethically deficient and therefore faulty and  unsound.

Hence Keynes was an easy convert to and active member of Bloomsbury that extraordinary group of writers, philosophers and artists who broke with the repressive Victorian order and the devotion to duty of Victorian England in order to embrace a new humanist and artistic social movement with a powerful new aesthetic and moral tolerance of sexuality, individual freedom, fulfilment in love, pacifism and feminism. This aspect of Keynes is fundamental to understanding who he was and what he hoped for. Almost a century later it seems clear that some of  these revolutionary ideas have partly won the day and they remain centrally important and contemporary.

So to conclude this contribution to assessing Keynes and his General theory on the 75th anniversary of its publication let me say again the times are extraordinarily propitious for the return to prominence of this theorist. As you can judge by reading my much longer paper After the Crash:Rediscovering Keynes and the Origins of Quantitative Easing (On this blog March 16, 2011)I consider Keynes ‘s contribution to be outstanding and still  highly relevant. By combining the tools of monetary policy including temporary monetization of a portion of the debt to prevent financial crowding out now known as quantitative easing with a multiplier strategy of fiscal stimulus which privileges both investment and mass consumption to overcome the paralysis of uncertainty and the liquidity trap and to combine these approaches with a reinvigoration of financial regulation necessary because of the nature of financial speculation and the tendency to Ponzi finance and financial instability provides a full policy package of lasting contemporary value. Globalization does complicate the efficacy of the policy but despite these problems we can see that when there was an internationally co-ordinated approach the policy worked to rescue the global economy from the depths of a potentially deep depression. Once this co-ordination broke down and policy has prematurely shifted toward austerity in too many countries at the same time the results are less impressive.

There needs to be further work on these questions as well as on the economic impact of the petroleum cartel but overall Keynes and his vision is alive and well . It was always premature to dismiss him as a dated relic since his insights about the nature of capitalism , investment behaviour under conditions of uncertainty and risk and the operation of the labour market clearing process were profound and in many ways form much of the bedrock of modern macro-economic analysis. Like Minerva’s owl he returned at dusk and he will be with us for some time to come.

Bibliography:

John Maynard Keynes, The General Theory of Employment , Interest and Money, N.Y.&London, Harcourt Brace&Co., 1964 ed.

Essays in Persuasion, N.Y. :Harcourt Brace&Co., 1932.

The General Theory and After:Parts One, Two and the volume  A Supplement vols. 13, 14 & 29, The Collected Writings of John Maynard Keynes, 1973&1979, Macmillan, Cambridge University Press for The Royal Economic Society

Peter Clarke, Keynes:The rise, fall and return of the twentieth century’s most influential economist, N.Y.:Bloomsbury Press, 2009.

The Keynesian Revolution in the Making, 1924-1936, Oxford :Clarendon Press, 1988.

Athol Fitzgibbons, Keynes’s Vision, Oxford:Claredon press, 1988.

Hyman Minsky, Can It happen again ? :Essays on Instability and Finance, M.E.Sharpe, 1982.

Stabilizing an Unstable Economy,N.Y.:Mcgraw-Hill, 2008 .

J.A.Trevithick, Involuntary Unemployment:Macroeconomics from a Keynesian Perspective, N.Y.&London:Harvester Wheatsheaf, 1992.

Brian Snowdon&Howard Vane,eds.  A Macroeconomics Reader, London&N.Y.:Routledge, 1997.