An obituary for Keynesian economics: born 1936 – died 2010

The recent decisions to retain the ‘Bush tax cuts’ in the United States and to withdraw the trillion-dollar-plus expenditure bill from the American Senate before it was even put to a vote are a red letter moment in the life of Keynesian economics. So far as policy goes, Keynesian economics, born with the publication of Keynes’s General Theory in 1936, is now for all practical purposes dead.

The same thoughts might now accompany the decision by the British government to cut its own expenditures even in the midst of recessionary times. Where is there a textbook in the world that would advise a government to do that? Yet it is clearly what needs to be done.

The very idea of a Keynesian stimulus to propel an economy out of recession is now so discredited it may not be for another forty years - that is, it may not be until the passing of this entire generation of policymakers - that such policies will ever be on the agenda again.

I must mention, however, the one problem with this hopeful scenario. It is that we are almost certain to continue to teach Keynesian economics to our students. The model of expenditure as the basis for growth is found in nearly every macroeconomics text and is taught to virtually every student of economics.

No one’s education as an economist is complete without having come to terms with aggregate demand and C+I+G. If you, the reader, are unaware of what these letters mean, you have at least been spared the mis-education in economics that has been provided to just about everyone else.

These models, in spite of everything we have gone through, are being taught even now to economics students everywhere. Amongst economists, for most of the profession it is all they know. It is unlikely they would even know where to begin to find something else even assuming it occurred to them to look.

But as it happens, there already exists a completely thought through theory of the cycle that incorporates every feature of a theory of recession and unemployment one could want. If we are going to make economics into a useful study, we will have to resurrect and then redevelop for our circumstances today the pre-Keynesian theory of the cycle that before 1936 had been the mainstream.

Dr Steven Kates will be speaking on ‘The Basic Axioms and Fundamental Principles of a Free Market Economy’at the IEA on 18 January 2011. Click here for details of the event.

Alas, I wish I were so sanguine. As Stephen Kates observes, the next generation of economists and policy makers is being given a firm grounding in Keynesian economics, something that is profoundly worrying. Moreover, Keynesian-style solutions are still being advocated around the world by prominent economists and applied by policy-makers. Far more economists publically support high levels of public spending than support deficit reduction as the recent 'letters' war showed. In the UK, for instance, the Labour party has managed to promulgate the idea that deficit reduction is 'taking money out of the economy' and might create a 'double-dip' recession. These ideas have not been seriously questioned in the public narrative - the government's counter-arguments are based upon the need to avoid debt default and to maintain low rates of borrowing and absolutely not upon the economic fallacies underlying the 'stimulus' spending in the first place, which is almost never queried. Increasing or stimulating aggregate demand is still the conditio sine qua non of government policy. Whilst the fiscal side of stimulus has been attacked to a degree, the monetary side remains unquestioned. Quantative Easing and low interest rates provide a far more powerful - and damaging - stimulus to the US and UK economies and, as we know, are stoking up a boom ready for another future bust. Whilst the fiscal debate is still being fought out (it has by no means been won) the monetary one has barely been touched. The political power and appeal of Keynesianism continues relatively unabated, as demostrated by much public opposition to budget cuts throughout Europe. Politicians still want to buy the favour of their constituents and the constitutents are happy to be bought. The concentrated benefits accuring to special interest groups still overpower the distributed costs to taxpayers of such spending. At the same time, many individuals advocate high levels of government spending whilst either ignorant of or content to accept the economic consequences because they believe that this spending is 'fair' or promotes 'equality' or some such moral or political preference - a question on which the Keynesian debate has little real bearing because it priviledges non-economic factors. Heroic efforts have been made to discredit Keynesian economics (not least by Stepehn Kates - to him our sincere thanks and support) and, to a point, this has gained traction and some degree of public support in the US and political support elsewhere. That said, this is probably the result of pre-exisiting preferences rather than any particular success on behalf of the anti-Keynesian economists. The public, academic and political consensus still remains broadly Keynesian. I think the old Mark Twain line that the reports of its death have been somewhat exaggerated might apply.
You are aware of austrian econ aren't you? And if your not...
Keynesian theory is the zombie that refuses to die. Actually it's impossible to falsify because whenever Keynesian stimulus fails to work, the stock reply is that the stimulus is too small. Paul Krugman said exacly that; he wrote an article arguing that the reason US stimulus didn't work was that 'it hasn't been tried.' Interestingly it has been Austrian proponents that have the best track record in predicting the recent meltdown. Peter Schiff warned of the real estate bubble at a conference for the mortgage industry in 2005 - and was publicly ridiculed for doing so. Despite that, Keynesian thought will continue to dominate precisely because leaders can be seen to take action - imagine the political fate of a leader who promised to take no action over the recession compared to one who promised 'swift action and stimulus programs to rescue the economy.' No contest really.
As a current AS economics student, i can confirm that we are currently taught keynesian economics, and we are made to learn almost off-by heart AD=C+I+G+(X-M) (aggregate demant = consumption + investment + government spending + (exports - imports)). The worst thing is that we do not know the proportion these are in. BTW, i believe in a mixture of both economic theories. The government should cut back on spending & taxes and de-regulate the market, yet it should be there for the unemployed people, and partially their for when the economy falls on hard times. I also think that the ideal role model for the coalition is John James cowperthwaite and positive non-interventionism
I fear I must agree with the gloomy prediction underlying Professor Kates’s initial optimism: not only will Keynesian survive because its errors have become part of mainstream economic teaching, but because the modern impulse for government intervention into the economy for ulterior political motives predates Keynes’s General Theory and helps to account for its acclaim. As Murray Rothbard writes in Keynes, the Man: ...governments as well as the intellectual climate of the 1930s were ripe for such conversion. Governments are always seeking new sources of revenue and new ways to spend money, often with no little desperation; yet economic science, for over a century, had sourly warned against inflation and deficit spending, even in times of recession. [...] Now along came Keynes, with his modern “scientific” economics, saying that the old “classical” economists had it all wrong: that, on the contrary, it was the government’s moral and scientific duty to spend, spend, and spend; to incur deficit upon deficit, in order to save the economy from such vices as thrift and balanced budgets and unfettered capitalism; and to generate recovery from the depression. How welcome Keynesian economics was to the governments of the world! (Rothbard, 2010, 37-38) Alas, as Mark Twain once quipped about himself, rumours of Keynesianism’s demise are greatly exaggerated!
Felix, you might want to download the IEA's monograph "Were 364 Economists All Wrong?" which has several chapters on this subject (by prominent economists, both for and against). In my own chapter, I regard the approach you describe as "economics without prices". In other words, it is assumed that if "G" increases then "demand" increases as if there are no implications for anything else and no change in relative prices (in this case, if T does not increase then government borrowing will incease and either the exchange rate or interest rates are likely to increase with implications for C and/or I and/or E). There are assumptions under which this does not happen, of course, but the proponents of economics without prices should make their assumptions clear otherwise, quite frankly, it is not economics that is being taught.
Keynesian economics (also known as witchcraft, since it makes no rational sense and is contrary to human action and logic) is the disease. The Austrian school of economics is the cure.

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