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Maynard Keynes Might Say: JMK Comments on Christina Romer's Analysis of the Benefits of Quantitative Easing in the Great Depression

From RJW:

Robert's Stochastic thoughts: C Romer with lots of data in 1992 "What Ended the Great Depression?" The Journal of Economic History vol 52 pp 757-784:

This paper examines the role of aggregate demand stimulus in ending the Great Depression. Plausible estimates of the effects of fiscal and monetary changes indicate that nearly all the observed recovery of the U.S. economy priort to 1942 was due to monetary expansion. A huge gold inflow in the mid- and late 1930s swelled the money stock and stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. That monetary developments were crucial to the recovery implies that self-correction played very little role in the growth of real output between 1933 and 1942.

Now, I'm not sure if Obama understands that Romer is saying that the US recovered because of Hitler who scared the gold out of Europe (she is very clear on this point in the text). She makes a strong case, but the party line is that Roosevelt deserves the credit.

Keynes, with almost no data and writing in 1935 (hence before the flight), understood the issue. In The General Theory of Employment Interest and Money, Chapter 23: Notes on Notes on Merchantilism, the Usury Laws, Stamped Money and Theories of Under-consumption, Keynes argued that back in the bad old days, going for the gold was the only feasible approach.

Now, if the wage-unit is somewhat stable and not liable to spontaneous changes of significant magnitude (a condition which is almost always satisfied), if the state of liquidity-preference is somewhat stable, taken as an average of its short-period fluctuations, and if banking conventions are also stable, the rate of interest will tend to be governed by the quantity of the precious metals, measured in terms of the wage-unit, available to satisfy the community’s desire for liquidity.

At the same time, in an age in which substantial foreign loans and the outright ownership of wealth located abroad are scarcely practicable, increases and decreases in the quantity of the precious metals will largely depend on whether the balance of trade is favourable or unfavourable.

Thus, as it happens, a preoccupation on the part of the authorities with a favourable balance of trade served both purposes; and was, furthermore, the only available means of promoting them. At a time when the authorities had no direct control over the domestic rate of interest or the other inducements to home investment, measures to increase the favourable balance of trade were the only direct means at their disposal for increasing foreign investment; and, at the same time, the effect of a favourable balance of trade on the influx of the precious metals was their only indirect means of reducing the domestic rate of interest and so increasing the inducement to home investment.

That does not mean that Keynes was a merchantilist. In particular, one can imagine how delighted he was by a process that enriched the USA at the expense of Europe:

For this and other reasons the reader must not reach a premature conclusion as to the practical policy to which our argument leads up. There are strong presumptions of a general character against trade restrictions unless they can be justified on special grounds. The advantages of the international division of labour are real and substantial, even though the classical school greatly overstressed them. The fact that the advantage which our own country gains from a favourable balance is liable to involve an equal disadvantage to some other country (a point to which the mercantilists were fully alive) means not only that great moderation is necessary, so that a country secures for itself no larger a share of the stock of the precious metals than is fair and reasonable, but also that an immoderate policy may lead to a senseless international competition for a favourable balance which injures all alike.[4] And finally, a policy of trade restrictions is a treacherous instrument even for the attainment of its ostensible object, since private interest, administrative incompetence and the intrinsic difficulty of the task may divert it into producing results directly opposite to those intended.

Thus, the weight of my criticism is directed against the inadequacy of the theoretical foundations of the laissez-faire doctrine upon which I was brought up and which for many years I taught;— against the notion that the rate of interest and the volume of investment are self-adjusting at the optimum level, so that preoccupation with the balance of trade is a waste of time. For we, the faculty of economists, prove to have been guilty of presumptuous error in treating as a puerile obsession what for centuries has been a prime object of practical statecraft...

Basically, Keynes' insight into the results reported by C. Romer is that, given the fools in the Fed and the timidity of Roosevelt, the US might as well have been an early modern country (and US policy was relatively Keynesian compared to say that of France).