Everyone knows Keynes’ witticism, making fun of the economics profession’s ability to take the long, long view, no matter how much suffering there may be on the way. “In the long run we all dead”, the world’s greatest economist sagely observed. Less well known are the arguments that come from his pathbreaking book, “The General Theory of Employment, Interest and Money”, written in midst of the Great Depression of the 1930s. One of the most important is that while in a time of recession it might seem good for individuals to save against a rainy day, it is bad for rescuing the national economy. What is needed is a fiscal stimulus from the mass of consumers spending almost up to their last penny.
It has been the fashion since Keynes died for many economists to deride him — not least the school of monetarists led by Chicago University’s Milton Friedman, who argued that money supply was far more important than fiscal policy in controlling an economy. Not for them the great fiscal stimulus that President Barack Obama has just steered through Congress.
Even whilst alive it was sometimes hard for Keynes to get an audience. He advocated that the Great Depression would be solved if governments borrowed and spent and thus put the unemployed back to work. Only the onset of World War II, with the fast buildup of expenditure on war machines, implemented Keynes’ ideas and reduced unemployment as the economy purred once more. This did not make Keynes happy. For him it was an avoidable war. Long before he had denounced the Versailles Treaty inflicted on Germany at the end of World War 1, that reduced Germany to being an economic pigmy, a policy that propelled Hitler to the heights of power.
Still, since then, Keynesian prescription became established the world over and deficit finance in a time of recession has been rarely questioned.
However, other parts of Keynes’ theories were cast aside. Perhaps most importantly, argue Nobel prize winning economist George Akerlof and Robert Shiller in their new book “Animal Spirits”, was Keynes’ emphasis on the irrational activities of the consumer — animal spirits, he called it. “People have noneconomic motives. And they are not always rational in their pursuit of economic interests.” In Keynes’ view animal spirits are the main reason why the economy fluctuates as it does. They are also the main cause of involuntary unemployment”. Just as Adam Smith’s “invisible hand” (whereby capitalism’s private markets, if left unregulated, would lift all boats) is the keynote of classical economics, Keynes’ animal spirits are the keynote to a different view of the economy. Keynes saw that there was an underlying instability within capitalism.
We see how correct he is with the present world crisis. Left to their own devices capitalist economies will pursue excess. There will be manias and manias will be followed by panics. There will be joblessness. Minorities will be mistreated. House prices, oil and stock markets will boom and then bust. As ex-President George W. Bush said, “Wall Street got drunk”, without seemingly being aware that his government, so intent on deregulating government’s supervisory role, was a very big part of the reason for economic inebriation.
Alas, Keynes’ insights, until this crisis, have been studiously ignored by most economists. His advice became so diluted that by the 1970s a new school of economists developed who called themselves the New Classical Economists. It was back to Adam Smith. It became a political mantra: “I am a believer in free markets.” And the megaphone politics of Margaret Thatcher and Ronald Reagan spread the message far and wide. Three decades later we see what their policies of “excess is acceptable”, with minimal regulation and supervision, have wrought.
The intellectual job now is to incorporate the idea of animal spirits back into macroeconomic theory in the way that Keynes advocated. We have forgotten the hard earned lesson of the 1930s — that capitalism can gives us the best of all possible worlds, but it does so only on a playing field where the government sets the rules and acts as referee.
And it is up to individuals and to banking and financial services to realize what system they are part of. Capitalism does not just sell to people what they really want. It also sells them what they think they want. Especially in financial markets this leads to wild excesses and to bankruptcies. In households it leads to too much debt, whether it is credit card debt or buying a new car or house on a loan they cannot hope to pay off in a reasonable time.
At the moment the big world economies are engaged in a massive rescue operation of the kind that Keynes would have approved of, in fact would want more of. But policymakers must get off their pedestals and read the rest of Keynes’ great book. There are other things to be done.
