Grasping Reality on TypePad, by Brad DeLong

As John Maynard Keynes said:

Whilst… [my theory] would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism. I defend it… as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative.

For if effective demand is deficient, not only is the public scandal of wasted resources intolerable, but the individual enterpriser who seeks to bring these resources into action is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros, so that the players as a whole will lose if they have the energy and hope to deal all the cards. Hitherto the increment of the world’s wealth has fallen short of the aggregate of positive individual savings; and the difference has been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. But if effective demand is adequate, average skill and average good fortune will be enough.

The authoritarian state systems… solve the problem of unemployment at the expense of efficiency and of freedom. It is certain that the world will not much longer tolerate the unemployment…. But it may be possible by a right analysis of the problem to cure the disease whilst preserving efficiency and freedom.

The FT: How to preserve America’s recovery:

For the third year running America’s economic recovery appears to be stalling…. As with the previous two years, Americans can point to a number of external culprits. Last year it was the nuclear disaster in Fukushima, the euro crisis and the rise in oil prices. This year, slowdowns in China, India and Brazil come on top of a euro crisis that looks set to get worse. The only respite is in the oil price, which has dipped in recent weeks chiefly because of the worldwide slowdown. What then can be done to rekindle the American economic recovery?

Alas, there are no magic new remedies that have not already been used and tried before. Almost certainly, though, both principal tools – monetary and fiscal – have yet to be deployed as effectively as they could. And the third, which we might label “psychological”, is being wielded mostly to negative effect. In addition to the global deceleration, the US recovery is hindered by the spectre of another looming tussle over the sovereign debt ceiling at the end of this year. On all three counts there is still plenty that could be done.

First, and most immediately, Ben Bernanke could reverse the hawkish drift at the Federal Reserve and announce a third round of quantitative easing at the next Federal Open Market Committee meeting, later this month. Pessimists have been forecasting runaway inflation since the start of the financial crisis in 2008. Clearly the markets do not agree. US Treasury yields continue to plummet – last week the 10-year bond hit a record low of 1.45 per cent. It is obviously impossible for the Fed to cut its discount rate to below zero. But if things deteriorate further, it could double its inflation target to 4 per cent.

Second, fiscal policy is turning into a drag on what little growth the US is generating. This is unnecessary and destructive. At these low yields, the US government is essentially being offered free money to invest in America’s future productive capacity. Indeed, as Brad DeLong and Lawrence Summers have recently argued, whatever is invested at these rates is likely to pay for itself in higher growth and revenues. The size and nature of the market for US sovereign debt means that bond buyers are no flight risk, unlike in many smaller economies. The US can and should, therefore, choose a more expansive fiscal policy. Budgets should ideally balance over the cycle. But they should also be counter-cyclical. One possible remedy would be to link the duration of another stimulus to the return to trend growth. That in turn would trigger a medium-term plan to reduce the US deficit along the lines set out by the Simpson-Bowles plan. In theory this should not be difficult.

Which brings us to the state of US politics. In practice, the chances of a fiscal stimulus are close to zero before November. The well is too poisoned on Capitol Hill for such an initiative to succeed. But there are marginally better grounds for hope that the two parties could at least begin talks to avert a fiscal meltdown after the election. Uncertainty over America’s “fiscal cliff” is having a chilling effect on companies, which remain reluctant to invest their record hoard of cash reserves. To be sure, most of that reluctance is due to anaemic demand. But fiscal uncertainty is a growing hindrance. Is it too much to ask Congress to begin work now to avoid that looming train wreck?

John Maynard Keynes:

The General Theory of Employment, Interest and Money, Chapter 24: [My]theory is moderately conservative in its implications…. It is not the ownership of the instruments of production which it is important for the State to assume. If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary…. I agree with Gesell that the 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 if it is to realise the full potentialities of production…. Within this field the traditional advantages of individualism will still hold good… advantages of efficiency — the advantages of decentralisation and of the play of self-interest… individualism… the best safeguard of personal liberty in the sense that, compared with any other system, it greatly widens the field for the exercise of personal choice… the best safeguard of the variety of life, which emerges precisely from this extended field of personal choice, and the loss of which is the greatest of all the losses of the homogeneous or totalitarian state….

Whilst… [my theory] would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism. I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative.

For if effective demand is deficient, not only is the public scandal of wasted resources intolerable, but the individual enterpriser who seeks to bring these resources into action is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros, so that the players as a whole will lose if they have the energy and hope to deal all the cards. Hitherto the increment of the world’s wealth has fallen short of the aggregate of positive individual savings; and the difference has been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. But if effective demand is adequate, average skill and average good fortune will be enough.

The authoritarian state systems of today seem to solve the problem of unemployment at the expense of efficiency and of freedom. It is certain that the world will not much longer tolerate the unemployment which, apart from brief intervals of excitement, is associated and in my opinion, inevitably associated with present-day capitalistic individualism. But it may be possible by a right analysis of the problem to cure the disease whilst preserving efficiency and freedom.