Monday, December 1, 2008

Recent economist writeups on John Maynard Keynes

There have been several writeups lately about John Maynard Keynes, and specifically of his ideas. There now is a growing consensus that his policy prescriptions could be best to get the market flowing again.

This is from a writeup by Greg Mankiw from the New York Times.

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.

Keynesian theory suggests a “paradox of thrift.” If all households try to save more, a short-run result could be lower aggregate demand and thus lower national income. Reduced incomes, in turn, could prevent households from reaching their new saving goals.

That leaves the government as the demander of last resort. Calls for increased infrastructure spending fit well with Keynesian theory. In principle, every dollar spent by the government could cause national income to increase by more than a dollar if it leads to a more vibrant economy and stimulates spending by consumers and companies.

Paul Krugman summarizes Keynes ideas in these bullet points (HT Mark Thoma)

Stripped down, the conclusions of The General Theory might be expressed as four bullet points: • Economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment
• The economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully
• Government policies to increase demand, by contrast, can reduce unemployment quickly
• Sometimes increasing the money supply won’t be enough to persuade the private sector to spend more, and government spending must step into the breach

Robert Reich operationalizes the ideas further:

John Maynard Keynes understood: when the economy has as much underutilized capacity as we have now, and are likely to have more of, government spending that pushes the economy to fuller capacity will of itself shrink future deficits.

Conservative supply-siders, meanwhile, will call for income-tax cuts rather than government spending, claiming that people with more money in their pockets will get the economy moving again more readily than can government. They're wrong, too. Income-tax cuts go mainly to upper-income people, and they tend to save rather than spend.

Even if a rebate could be fashioned for the middle class, it wouldn't do much good because, as we saw from the last set of rebate checks, people tend to use extra cash to pay off debts rather than buy goods and services. Besides, individual purchases wouldn't generate nearly as many American jobs as government spending on infrastructure, social services, and green technologies, because so much of we as individuals buy comes from abroad.

So the government has to spend big time. The real challenge will be for government to spend it wisely -- avoiding special-interest pleadings and pork projects such as bridges to nowhere. We’ll need a true capital budget that lays out the nation’s priorities rather than the priorities of powerful Washington lobbies.


Laura Harrison said...

In the love/hate blogathon of Paul Krugman and Greg Mankiw...

It is significant that Greg Mankiw, an economist with links to Bush and Romney, should in his excellent article encourage us to approach the current economic crisis through the eyes of John Maynard Keynes.

However, his answer to the question "what would Keynes have done?" ignores an element that would clearly have been uppermost in Keynes's mind - how to get international action to solve the crisis.

Keynes would clearly have wanted international coordination of economic policies (monetary and fiscal) between the major economies, and would have wanted international economic institutions (the World Bank and the IMF, both of which he helped to found) to act in ways to free individual countries to take action (e.g. fiscal stiumulus) to overcome the crisis.

Anyone wanting background to this integral part of Keynes' thinking should read Donald Markwell's path-breaking study of "John Maynard Keynes and International Relations, Economic Paths to War and Peace", published in 2006 by Oxford University Press.

Mankiw's argument that it is hard to see how to get effective stimulus to consumption, investment, net exports and even government purchases makes it even more important that the United States provide leadership and encouragement to international action to overcome the crisis - and all the more surprising that in this otherwise compelling article he neglects to say anything about US leadership to get international stimulatory action.

Unfortunately, Krugman's response to Mankiw - in his blog on Saturday - does not make this point about the need for international cooperation on economic policy. He does make it, in effect, in his excellent article in the NY Review of Books, where he talks of a "global rescue",etc.

It is a shame Krugman does not (as Keynes would have done!) argue the case for international action in his blog and NY Times articles.

Arthur James said...

Robert Reich argues that we need a debate on how best to apply Keynesian policies in the US today. I agree with the thrust of what Laura Harrison writes - that we also need a debate about the fact that the revival of the United States economy depends on the revival of the global economy, and vice versa. So the US needs to provide leadership to the rest of the world economy, and this needs to encourage other major countries to act in ways that will be helpful to us. To give leadership in this, we need to stand firm against protectionism ourselves, as well as coordinating our fiscal (tax cuts or spending) and monetary stimuli with other major economies. Markwell's book on Keynes and international relations leads me to believe that this is precisely what Keynes had in mind in the 1930s (after he got over his short temptation to protectionism) and would again today. Keynesianism has to be internationally focussed if it is really to work.

Anonymous said...

Ironically, the spending intended to stimulate the economy ARE pork projects and "bridges to no-where".

Keynesian Fiscal Policy is hard to achieve in this manner, as a majority of projects done merely to stimulate the economy result in nothing done but money being spent and no worthwhile gain otherwise.