Australian Lefty on Politics, Governance, Science and Info Management

What we should have learnt from Keynes

Posted by Dave Bath on 2008-05-21

Regular readers will know I’m a fan of Galbraith and Keynes, and thus will point to a nuanced paper from the Centre for Economic Policy Research (hat tip to the superb VoxEU economics site), CEPR Policy Insight 23: "Keynes and the Crisis" by Axel Leijonhufvud, University of Trento.

It goes into a fairly wide range of Keynes’ works, the differences between then and now, and contrasts the successes of different "Keynesian" actions by various countries over recent decades (notably the lack of effect of Japanese infrastructure spending, and the successes of Swedish devaluation after their housing bubble burst).

Bolding in blockquotes is mine.

There are two aspects of the wreckage from the current crisis that have not attracted much attention so far.  One is the wreck of what was until a year ago the widely accepted central banking doctrine.  The other is the damage to the macroeconomic theory that underpinned that doctrine.

It’s a paper I’ll have to re-read a few times before I appreciate everything it says, but it already has me rethinking things I’d thought axiomatic, including the need for independence of reserve banks from politicians.

When monetary policy comes to involve choices of inflating or deflating, of favouring debtors or creditors, of selectively bailing out some and not others, of allowing or preventing banks to collude, no democratic country can leave these decisions to unelected technicians.  The independence doctrine becomes impossible to uphold.

Mind you, I’ve been touting the possibility of stagflation more than almost anyone I know, so it’s rewarding that my amateurish worries are supported by the following, which I think applies as much to Oz as it does to the US:

The likely prospect for the United States in any case is a period of stagflation.  The issue is going to be how much inflation and how much unemployment and stagnation are we going to have.

Countering that is some fairly dense prose that demands significant concentration, even though I’m familiar with Ricardo:

Ricardian equivalence was another property of rational expectations monetarism.  It was in effect tested by the Bush administration, which swung the federal budget into large deficit.  The increase in the deficit was not compensated by increased private saving. Instead, American households decreased their saving to basically nothing.  The violation of Ricardian equivalence suggests that the transversality condition imposed in intertemporal general equilibrium models has no empirical counterpart.  Without such a condition, consistency of all decisions is no longer guaranteed in intertemporal models. But bubbles and crashes are admitted.


4 Responses to “What we should have learnt from Keynes”

  1. agnes said

    i suggest you read the entire corpus of antale fekete (not me despite same name) at as a trained biological scientist (three years younger than you), i started my obsession with macroeconomics when i verified the following statement: “NO currency has ever survived in the history of the world unless it was tied to a commodity.” in duration, the u.s. is now at about three standard deviations….

  2. Raf said

    Nice paper Dave.

    The key point to note for me is how Greenspan’s reflating of the .com bubble lead to

    “virtually no CPI inflation, but drastic price inflation and very serious deterioration of credit standards”.

    This leads to the trainwreck that is central bank doctrine i.e. targeting CPI as a measure of economic stability.

    Any central banker going to put their hand up and say its wrong?

    Deafening silence…….

    Let’s keep trotting out complete nonsense about inflation as measured by CPI and ignore what the money supply is doing.

  3. Dave Bath said

    Agnes: Interesting point. The greenback’s value has been kept up by trading partners (probably enemies!) investing in US bonds to keep US consumers spending, and confidence that the US will pay its debts. I’d also say that it needn’t be a HARD commodity (like gold), but a soft one, like productive inventiveness, that could support a currency.

    Raf: Yep. I’ll note that I don’t understand the paper’s full implications, but I /can/ see that it’s pointing to the massive rethink needed – and what seems like the bigwigs (technocrat and political) have been cossetting the financiers and speculators rather than the REAL economy that provides food, housing, etc, that people need.

    I’d also argue that decreasing “economic activity” is not necessarily a bad thing – if essentials are still provided even though GDP falls, then things are actually more efficient. Its a matter of focus on metrics that reflect real world needs – by analogy, we are measuring health by medical expenditure rather than mortality/morbidity rates.

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