The Return of Keynesianism

By Boudreaux, Donald J. | Freeman, June 2009 | Go to article overview

The Return of Keynesianism


Boudreaux, Donald J., Freeman


In our Brave New World of Change We Can BeUeve In, I wonder about some recent changes - changes that I can't beUeve in.

For example, why are so many economists suddenly changing their minds about the economics of John Maynard Keynes (1883-1946)? Veritable stampedes of my feUow economists are rushing to take up again the banner of Keynesian economics, which most economists had abandoned by 1980.

Keynesian economics is an account of economywide employment that rather too simply alleges that economic health and growth - and, hence, the number of jobs - decUnes with decreases in "aggregate demand" and improves with increases in "aggregate demand." No need to bother with questions about how well individual markets are working; no need to worry that the money supply might be growing too fast and causing individual prices to be out of whack - no! The economy is really much simpler, said Keynes, than those silly classical economists, such as Adam Smith, made it out to be.

All that really matters is the total demand for output ("aggregate demand"). If consumers cut back on their spending to save more, aggregate demand falls. As aggregate demand faUs, firms scale back their operations. Workers are laid off. As workers are laid off, aggregate demand faUs even further, causing even more layoffs. The economy spirals down into an "unemployment equilibrium."

Only higher spending can salvage the situation, and the only agency sufficiently immune to animal spirits to know what to do - and that has the wherewithal to spend with sufficient gusto - is government. If government spends, the resulting increase in aggregate demand will restore "confidence" to the economy. Business people will again be confident that they can sell what they produce, so they'll hire more workers. These newly hired workers will also spend. The economy will be saved.

The only trick is to make sure that the government doesn't spend too much. If it does, the result wiU be inflation.

Economists before Keynes (at least, those who were taken seriously) rejected such ideas. These economists - labeled disparagingly by Keynes as "classical economists" pointed out that if people reduce their consumption expenditures and save more, the additional savings push down interest rates and prompt entrepreneurs to invest more. Rather than disappear from the spending stream, these savings are spent, but they're spent as demand for investment goods rather than as demand for consumer goods.

Classical economists argued, therefore, that higher savings were good, for they meant that the size of the economy's capital stock would increase. More saving meant more and better machinery, larger factories, more R&D, more worker training, more infrastructure. Over time this larger capital stock makes workers more productive and thus pushes real wage rates higher. Living standards increase.

"Pshaw!" respond the Keynesians. "If consumers spend less on consumption goods, why would entrepreneurs increase the capacity of their operations? Moreover, even if people saved more today with the goal of consuming more tomorrow, investors' motives are so haunted by animal spirits that we can't rely on investors to read lower interest rates as a signal to invest more. Alas, only government can provide the rationality, stability, and spending necessary to keep the economy at full employment."

The "classical economists" - which include in this case not just scholars who preceded Keynes, but also the likes of Frank Knight, Ludwig von Mises, and EA. Hayek, who were contemporary with Keynes or even younger than him - pointed out that an increase in savings doesn't mean a permanent desire to consume less in an absolute sense. …

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