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links for 2007-06-03

On Keynesian Economicses and the Economicses of Keynes

With respect to, I think that there are two ways to understand the divergence of perspectives here. The first is to note that Jamie Galbraith sees Keynes's General Theory as part of something bigger: combine it with John Kenneth Galbraith's New Industrial State, with Hyman Minsky's approach to financial crises, and perhaps with Piero Sraffa's Production of Commodities by Means of Commodities and you have an alternative theoretical framework for economics that owes very, very little to the Marshallian or even the Smithian tradition--and that owes nothing at all to the Walrasian tradition. Call this "East Anglian Keynesianism."

My macroeconomics teachers--Kindleberger, Eichengreen, Dornbusch, Fischer, Abel, Blanchard, Sargent--by contrast, see Keynes's macroeonomics (not just the single book that is the General Theory, but also How to Pay for the War, The Economic Consequences of Mr. Churchill, the Tract on Monetary Reform, and so forth) as part of a different bigger thing: they see, Keynes, Wicksell, and even Milton Friedman (though he would rarely admit it) as all groping toward an understanding of the macroeconomy that ends in the belief that limited, strategic, focused, yet powerful government interventions can create a situation in which the market economy could then work more-or-less along Smithian lines--that these focused government policies can, as I like to say, make Say's Law true in practice even though it is false in theory. Call this "MIT Keynesianism."

MIT Keynesianism tends to downplay the most Galbraithian moments of Keynes--for example, his cracks about how bankers would prefer to fail in a conventional manner than to profit and grow rich in an unconventional manner--and to regard the General Theory as just one of Keynes's works written at a particular time (one of Great Depression) and thus focusing on the issues of greatest importance at that particular historical moment.

East Anglian Keynesianism throws Keynes's earlier work out the window, and argues that the General Theory marks a genuine epistemological and theoretical break. But it has problems with passages in the General Theory like this one, which Keynes puts at the very end of the book, where he argues that his theory is:

moderately conservative.... The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rate of interest.... I conceive... that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of... devices by which public authority will co-operate with private initiative.... Our criticism of the accepted classical theory of economics has consisted... in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world. But if our central controls succeed in establishing an aggregate volume of output corresponding to full employment... the classical theory comes into its own... then there is no objection to be raised against the classical analysis of the manner in which private self-interest will determine what in particular is produced, in what proportions the factors of production will be combined to produce it, and how the value of the final product will be distributed between them... no objection...against the modern classical theory as to the degree of consilience between private and public advantage in conditions of perfect and imperfect competition respectively.... [T]he result of filling in the gaps in the classical theory is not to dispose of the ‘Manchester System’, but to indicate the nature of the environment which the free play of economic forces requires.... [T]here will still remain a wide field for the exercise of private initiative and responsibility. Within this field the traditional advantages of individualism will still hold good.

Let us stop for a moment to remind ourselves ... the advantages of efficiency — the advantages of decentralisation and of the play of self-interest.... and of individual responsibility.... [A]bove all, individualism, if it can be purged of its defects and its abuses, is the best safeguard of personal liberty... it greatly widens the field for the exercise of personal choice... the best safeguard of the variety of life... the loss of which is the greatest of all the losses of the homogeneous or totalitarian state. For this variety preserves the traditions which embody the most secure and successful choices of former generations; it colours the present with the diversification of its fancy; and, being the handmaid of experiment as well as of tradition and of fancy, it is the most powerful instrument to better the future...

And this one from the start of chapter 2 of the General Theory:

[O]rdinary experience tells us, beyond doubt, that a situation where labour stipulates (within limits) for a money-wage rather than a real wage, so far from being a mere possibility, is the normal case. Whilst workers will usually resist a reduction of money-wages, it is not their practice to withdraw their labour whenever there is a rise in the price of wage-goods. It is sometimes said that it would be illogical for labour to resist a reduction of money-wages but not to resist a reduction of real wages. For reasons given below (section III), this might not be so illogical as it appears at first; and, as we shall see later, fortunately so. But, whether logical or illogical, experience shows that this is how labour in fact behaves...

Thus not just Keynes's earlier work, but chunks of the General Theory have to be purged and thrown overboard.

MIT Keynesianism does not claim that East Anglian Keynesianism is not "Keynesianism." (It claims that it is not a fruitful research program, that given the world as it is pursuing its line of research is harmful to graduate students' careers, and that its model-building practices lead to fuzzy thinking, but it doesn't excommunicate East Anglian Keynesianism.)

By contrast, East Anglian Keynesianism does excommunicate MIT Keynesianism. We've seen this here, with Thomas Palley's claim that "[t]oday’s orthodoxy is laissez-faire neo-classical economics" and that "the last time a paper on macroeconomics with a Keynesian structure was published in the American Economic Review was in the early 1980s. Send in such a paper and it will be immediately rejected as “old” economics." Whatever you think of the MIT Keynesians, they were never laissez-faire--orthodoxy yes, neoclassical yes, but never laissez-faire.

My view is that, as a matter of the history of economic thought, the MIT Keynesians have the better of it. But my view is that both research programs are useful and both should be pursued (although I think the MIT Keynesian one has been more successful, and I find that I have a much easier time working within it), and that both are very far indeed from any form of laissez-faire.

The second way to understand the difference of perspectives is to interpret Jamie Galbraith as noting that there are two right-wing reactions to Keynes's: "The Economic Consequences of Mr. Churchill." The first is Milton Friedman's reaction: if the problem is that Churchill as Chancellor of the Exchequer pursues a stupid monetary policy, the answer is to get Churchill's hands off the steering wheel and make monetary policy automatic. The second is Friedrich Hayek's reaction: if the problem is that nominal wages cannot be easily forced down to their equilibrium level because the labor unions have too much bargaining power, the answer is to destroy the unions so that workers have no bargaining power to keep nominal wages sticky at all.

Now Keynes rejected both of these reactions. He wrote chapter 12 "The State of Long-Term Expectation" in the General Theory in order to say contra Friedman that "automatic" monetary policy cannot do the job. He wrote chapter 19 "Changes in Money Wages" to argue contra Hayek that sticky nominal wages are more likely to be a stabilizing than a destabilizing factor.

According to this second way of understanding this conversation, Galbraith is saying that modern orthodox establishment MIT Keynesianism gives much too little weight to ideas springing from chapter 12 and chapter 19. This is essentially the criticism of establishment MIT Keynesianism made by Axel Leijonhufvud in his book on Keynesian Economics and the Economics of Keynes. If this is what Galbraith is saying, I agree with him--and I think others agree with him too: Mark Gertler, Ben Bernanke, Larry Summers, James Tobin, Stanley Fischer, Rudi Dornbusch, and Robert Shiller are the first names that spring to my mind.