An interesting article in the Swedish newspaper Svenska Dagbladet by Richard Wall about:
J. Meynard Keynes and his talented economic theories
Keynes turned the subject of national economy upside down
The idea to keep the money during booms and spend them during recessions turned John Maynard Keynes into one of the most significant economists of the 1900s. But in today's market economy his view of government regulation is not highly valued.
Today it is 80 years since the most groundbreaking book on Economics of the 1900s was published - John Maynard Keynes "The General Theory of Employment, Interest and Money ".
It is also70 years since its author, undoubtedly the most influential economist of the last century, passed away. However, it is sometimes argued that even the whole school of education that was founded by Keynes - Keynesianism is dead. I will explain why that rumor, however, is greatly exaggerated.
Keynes was born in the summer of 1883. The young Keynes grew up in an academic environment. His father was a professor of economics at Cambridge. Thereby, but also on his own merits, he came to get valuable help in his career in the early 1900s by various leading scholars of national economy. Keynes presented his doctoral thesis, "A Treatise on probability," in 1907. He became editor of The Economic Journal year in 1911.
During the First World War he worked for the British Treasury, and subsequently was appointed its representative at the peace negotiations in Versailles. After intensive academic activities, he at the end of the 20’ies was becoming famous as the most prominent national economist in the world. But then the Great Depression hit the world. As a result Keynes name today is mainly associated with a recipe for how to help an economy to emerge from recession.
Before the publication of the "General Theory" in 1936, Keynes made the contents known in a variety of lectures and articles. Several of his thoughts and recommendations were at odds with what until the early 30th century had been considered self-evident. One such belief was that the self-healing market forces ensure that the economy is constantly moving toward equilibrium with full employment. The Great Depression, however, meant mass unemployment of unprecedented scope, which also did not want to give in despite years going by. Economists were perplexed.
In this situation Keynes presented the first macro-economic model that explained how an economy can get stuck in equilibrium with high unemployment. More importantly, he also gave suggestions on how to act in times of unemployment. Established thinking had previously decided that everybody, including the state, should be responsible and not spend money in bad times. Keynes recommended the opposite: the state should stimulate the economy during a recession to increase demand, drive down unemployment and nudge the economy toward equilibrium with full employment. During a boom, the state would similarly tighten spending. This to prevent overheating the economy, but also because saving during good times would make it possible to spend during bad times. Keynes thus introduced the concept of countercyclical economic policy, something that finance ministers today try to apply as much as possible. New thinking then, self-evident today.
Keynes' model represents a major step forward for economic science. His political ideas were applied in the 1930s in countries such as Sweden and the USA. However, Keynes model includes only the "real" part of the economy, focusing on employment and national income. But already in 1937 another British economist, John Hicks, succeesfully added to the Keynes model, i.e. a model that included money and interest rates. In Hicks model an economy can be in equilibrium only if both the real and monetary sectors simultaneously are in equilibrium.
Both Keynes and Hicks models described closed economies, i.e. those where neither exports nor imports exists. During the 30s and 40s trade between countries in the world was insignificant. The models gave a good picture of what reality looked like then. But with time trade between countries increased. In response to this development, Robert Mundell and Marcus Fleming in 1962 expanded Hicks model. What was added was a country's trade with the outside world. According to the Mundell-Fleming model, a country may be in equilibrium only if the real and monetary sector is in equilibrium when at the same time there is a balance in foreign trade. Thus the Keynesian model was fully developed.
Common to the Keynes, Hicks and the Mundell-Fleming models was that they all deallt with commercial demand. If consumers demand products the economy adopted to produce what was requested; An assumption that reflected the conditions of the 1930’ies with mass unemployment and unused production capacity. During the record years of the 1960'ies economists began to be increasingly aware of the economy's supply side. They saw signs that supply had difficulties meeting increasing demand pressures. Instead of the economy supplying more goods and services, inflation arose when buyers competed for a finite product range.
The oil crises of the 1970ies proved that not all production resources can always be assumed to be available in unlimited quantities. They saw further that high taxes can effect labor supply. The consequence was that it kept the Keynesian framework as a model for the demand side of the economy, but now, supply was also considered. During the 1980'ies the concept the of supply-side of economics was taken into consideration, and implemented politically by the likes of Margaret Thatcher in Britain and Ronald Reagan in the United States. This was a paradigm shift. The textbooks in economics were rewritten on this basis in the mid-1980ies.
Since then, to this day, not much has been added to the development of the macro-economic models. The theoretical backbone that was established in the 1970ies and 1980ies still applies, and the foundation was laid by Keynes in the 1930ies.
Keynes's idea that the state should save in the barns in good times and put the money rolling in bad has been hampered. It soon turned out that it was far more difficult to save during the good times than spend during the bad. State budgets in most countries therefore showed severe deficits over the economic cycle. State debts rose. Many countries had such weak public finances when the financial crisis broke out in 2008 that they almost went broke trying to fend off the effects of the crisis with an expansionary fiscal policy; Greece is probably the clearest example. Keynes had argued that the state and the state alone, possessed resources that were large enough to affect the economy. A few years around 2010, many wondered uneasily if things had gone so far that even the state did not have enough money. Today we can hope (!) to feel safe with our international financial system as it might have survived the stresses of the financial crisis (the future will informm us about the truth of this).
Keynes developed not only the foundation of economic policies of our time. After the Second World War, he laid out the guidelines for how the entire economic policy should be shaped. The counter-cyclical policy was one of several foundations. Another had an ideological tinge - that the state should increase its financial responsibilities. Keynes argued that market forces needed regulation. Much of this may seem to be in line with the rationing and regulation economy forced onto the nations by the first world war. For Keynes it, however, was more based on the conviction that the state should control prices, banks, interest rates, credit and rents, conduct business activities and regulate both public and private monopolies. Keynes considered it particularly important that the state controlled international capital flows - a prerequisite for a country to maintain a fixed exchange rate, which Keynesian economists in general considered desirable. Fixed exchange rate gives companies engaged in foreign trade stability in the money flows. With Keynes as the main architect, the West constructed a fixed exchange rate system, the Bretton Woods system, which had its heyday in the 1950'ies and 1960'ies.
The Bretton Woods system lasted until the 1971 when fluctuating inflation rates in several large countries made it impossible to keep exchange rates fixed. Then came the oil crisis and stagflation (stagnant growth and high inflation). This confronted Western economies facing new challenges that the Keynesian economic model, the Bretton Woods system and government regulations could not handle. Instead, we switched to a world of floating exchange rates, increased globalization with freer international capital movements and greater scope for market forces, with abolition of state monopolies and deregulation. In that sense, one can say that since the 1980’ies we are in a postkeynesiansk era.
Yet the foundation of our macro-economic models are still based on Keynes 1930’ies model; Modern economic policies pursue countercyclical strategies à la Keynes. In that sense, Keynesianism is very much alive.
And the fact is that although many important building blocks of the economic models that characterize postkeynesianismen - the importance of expectations for policy action and so-called natural rate of inflation - already discussed by Keynes, although he did not take them into account in his economic model.
It is tempting to exclaim: everything is in the "General Theory"!
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