2008–2009 Keynesian resurgence

John Maynard Keynes

Starting in 2008, there has been a resurgence of interest in Keynesian economics among various policy makers from the world's industrialized economies. This included discussion and implementation of economic policies in accordance with the recommendations made by John Maynard Keynes in response to the Great Depression—such as fiscal stimulus and expansionary monetary policy.

From the end of the Great Depression until the early 1970s, Keynesian economics provided the main inspiration for economic policy makers in western industrialized countries. The influence of Keynes's theories waned in the 1970s, due to stagflation and critiques from Milton Friedman, Robert Lucas, Friedrich Hayek and other economists who were less optimistic about the ability of interventionist government policy to positively regulate the economy. The advent of the global financial crisis in 2008 prompted a resurgence of interest in Keynesian economics among policy makers. Paralleling this change, there has also been some rethinking of the relevance of Keynes' ideas among academics, however, the revival of Keynesian economics in academia has been less obvious.

Background

Competing views on macroeconomic policy

Macroeconomic policy focuses on high level government decisions which affect overall national economies rather than lower level decisions concerning markets for particular goods and services. The Keynesian resurgence can be understood in the context of various competing perspectives from which policy recommendations originate. A key issue of contention is the optimal level of government intervention in economic affairs. For an overview on the different perspectives, see Liberal, Realist & Marxist. For more detail on specific systems of thought relevant to debate on this fiscal policy see Keynesian economics, Monetarism, Austrianism, New Classical economics, Real business cycle theory, and New Keynesian economics.

Over the last sixty years, most strikingly in the Anglo American economies but to a large extent worldwide, the two competing views receiving the most attention at policy-making level have been Keynesianism and Monetarism. Commentators such as Sunday Times economics editor David Smith have gone as far to say the "entire economics debate could be characterized as a struggle between Monetarists and Keynesians".

Monetarists advise minimal government intervention in the economy, apart from tightly controlling the money supply and publicizing targets for future modest expansion, thus setting expectations so as to reduce inflation. Monetarists also tend to favor free market policies such as clamping down on powerful labor unions, fairly light regulation, and generally small government – although not typically to the extremes favored by other economic liberals such as Austrian school economists and Libertarians.

Keynesians, in contrast to Monetarists, tend to place greater importance on the role of fiscal policy over monetary policy in the ups and downs of the economic cycle; they advise government intervention, especially in a recession where the standard recommendation is for increased government spending - especially on capital projects such as infrastructure - and tax reductions in order to stimulate aggregate demand. In a boom they often suggest measures to dampen demand such as raising taxes and interest rates, and throughout the business cycle they prefer regulation of economic activity.

Keynesian Economics evolved from the Keynesian Revolution. In contrast to the recent resurgence of Keynesian policy making the revolution comprised primarily a shift change in theory. There had been several experiments in policy making that can be seen as precursors for Keynes ideas, most notably Franklin D. Roosevelt's famous "New Deal" (Roosevelt was US president from 1933 to 1945). These experiments however had been influenced more by morals, geopolitics and political ideology than by new developments in economics, although it is notable that Keynes had found some support in the US for his ideas about counter-cyclical public-works policy as early as 1931. According to Gordon Fletcher, Keynes' General Theory provided a conceptual justification for 'New Deal'-type policies which was lacking in the established economics of the day - immensely significant as in the absence of a proper theoretical underpinning there was a danger that ad hoc policies of moderate intervention would be overtaken by extremist solutions, as had already happened in much of Europe. Keynes did not however agree with all aspects of the New Deal; he considered that the almost immediate revival of business activity after the program's launch could only be accounted for by psychological factors, which are dangerous to rely on, such as the boost to confidence by Roosevelt's inspiring oratory.

Since the 1940s the influence of Keynesian Economics on government policy makers has both waxed and waned under pressure from free market economics, and now appears to be waxing once again.

The Keynesian ascendancy: 1941–1979

Clement Attlee, British Prime Minister from 1945 to 1951, based his government's economic policy on Keynes' ideas.

See also: Golden Age of Capitalism

While working on his General Theory, Keynes wrote to George Bernard Shaw saying "I believe myself to be writing a book on economic theory which will largely revolutionize, not I suppose at once but in the course of the next ten years – the way the world thinks about economic problems … I don't merely hope what I say, in my own mind I'm quite sure". Professor Keith Shaw wrote that this degree of self confidence was quite amazing especially considering it took more than fifty years for the Newtonian revolution to gain universal recognition; but also that Keynes's confidence was fully justified. Keynes provided the main inspiration for European and American economic policy makers from about 1941 – 1979. The fifties and sixties, where Keynes's influence was at its peak, appears in retrospect as a golden age. In late 1965 Time magazine ran a cover article with the title inspired by Milton Friedman's statement, later associated with Nixon, that "We Are All Keynesians Now". The article described the exceptionally favourable economic conditions then prevailing, and reported that "Washington's economic managers scaled these heights by their adherence to Keynes's central theme: the modern capitalist economy does not automatically work at top efficiency, but can be raised to that level by the intervention and influence of the government." The article also states that Keynes was one of the three most important economists ever, and that his General Theory was more influential than the magna opera of his rivals - Smith's The Wealth of Nations and Marx's Das Kapital.

Displacement by monetarism: 1979–1984

Main article: Post-war displacement of Keynesianism

The stagflation of the 1970s, including Richard Nixon's imposition of wage and price controls on August 15, 1971 and in 1972 unilaterally canceling the Bretton Woods system and ceasing the direct convertibility of the United States dollar to gold, as well as the 1973 oil crisis and the recession that followed, unleashed a swelling tide of criticism for Keynesian economics, most notably from Milton Friedman, a leading figure of Monetarism, and the Austrian School's Friedrich von Hayek. In 1976, Robert Lucas of the Chicago school of economics introduced the Lucas critique, which called into question the logic behind Keynesian macroeconomic policy making. By 1979, the election of Margaret Thatcher as UK prime minister brought monetarism to British economic policy. In the US, the Federal Reserve under Paul Volker adopted similar policies of monetary tightening in order to squeeze inflation out of the system.

The monetarist experiments in the UK in the early 1980s succeeded in bringing down inflation, but at the cost of unemployment rates in excess of 10%. Contrary to monetarist predictions, the relationship between the money supply and the price level proved unreliable in the short- to medium-term. The US Federal Reserve officially discarded monetarism in 1984 and the Bank of England likewise abandoned its sterling M3 money targeting in October 1985.

The era of pragmatism: 1984–2007

The early 90s saw some instances of fiscal intervention by policymakers in the US and UK, and such Keynesian remedies were never wholly dropped in Europe and other parts of the world. This period has been described as a time of pragmatism, when, rather than following any one economic doctrine, policymakers chose whatever solution seemed to suit the particular circumstances they faced best. Yet free-market influences broadly sympathetic to Monetarism remained very strong at government level in powerful normative institutions like the World Bank, IMF and US Treasury, and in prominent opinion-forming media such as the Financial Times and the Economist.

The Keynesian revival of 2008–2009

In the wake of the Financial crisis of 2007–2009 the free market consensus began to attract negative comment even by mainstream opinion formers from the economic right.

In the United States and Britain

In March 2008, free-market guru Martin Wolf, chief economics commentator at the Financial Times, announced the death of the dream of global free-market capitalism, and quoted Josef Ackermann, chief executive of Deutsche Bank, as saying "I no longer believe in the market's self-healing power." Shortly afterward economist Robert Shiller began advocating robust government intervention to tackle the financial crisis, specifically citing Keynes. Macro economist James K. Galbraith used the 25th Annual Milton Friedman Distinguished Lecture to launch a sweeping attack against the consensus for monetarist economics and argued that Keynesian economics were far more relevant for tackling the emerging crises. .

A series of major bailouts followed, starting on September 7 with the announcement that the U.S. government was to nationalize the two firms which oversaw most of the U.S. mortgage market—Fannie Mae and Freddie Mac. In October, the British Chancellor of the Exchequer referred to Keynes as he announced plans for substantial fiscal stimuli to head off the worst effects of recession, in accordance with Keynesian economic thought. Similar policies have been announced in other European countries, by the U.S., and by China. This is in stark contrast to the scope given to Indonesia during its financial crisis of 1997, when the IMF forced it to close 16 banks simultaneously, prompting a bank run.

Prominent Keynesian economists included Paul Krugman, Robert Reich and Joseph Stiglitz . Greg Mankiw argued that Keynes was the economist who provided the greatest single insight into the crisis, but later encouraged skepticism about a fiscal stimulus.

The works on Keynes of Hyman Minsky, Robert Skidelsky, and Donald Markwell were widely cited. Much discussion reflected Keynes's advocacy of international coordination of fiscal or monetary stimulus, and of international economic institutions such as the International Monetary Fund and World Bank, which he had helped to create at Bretton Woods in 1944, and which many argued should be reformed at a "new Bretton Woods". This was evident at the G20 and APEC meetings in Washington, D.C., and Lima, Peru, in November 2008, and in coordinated reductions of interest rates by many countries in November and December 2008. IMF and United Nations economists and political leaders such as British Prime Minister Gordon Brown advocated a coordinated international approach to fiscal stimulus. The President of the World Bank, Robert Zoellick, advocated that all developed country pledge 0.7 percent of its stimulus package to a vulnerability fund for assisting developing countries. It was argued (e.g. by Donald Markwell) that the absence of an international approach in the spirit of Keynes, or its failure, risked the economic causes of international political conflict which Keynes had identified (e.g. in the 1930s) coming into play again. [8]

Keynesian thinking was reflected in U.S. President Barack Obama's appointing Lawrence Summers, Timothy F. Geithner and Christina Romer to principal economic positions in his administration. In a speech on January 8, 2009, President Obama unveiled a plan for extensive domestic spending to combat recession, further reflecting Keynesian thinking. The plan was signed by the President on February 17, 2009. There had been extensive debate in Congress concerning the necessity, adequacy, and likely effects of the package, which saw it being cut from $819 to $787 billion during its passage through the Senate.

Critics on the left question whether government policy has become sufficiently Keynesian – in their view Obama's economic team is disappointingly centrist, with its inclusion of economists who have previously been associated with support for the neoliberal or pro free market agenda, such as Jason Furman and Larry Summers.

In various nations

A renewed interest in Keynesian ideas was not limited to western countries. In a speech delivered in March 2009 entitled Reform the International Monetary System, Zhou Xiaochuan, the governor of the People's Bank of China revived Keynes's idea of a centrally managed global reserve currency. Dr Zhou argued that it was unfortunate that Keynes's Bancor proposal was not accepted at Bretton Woods in the 1940s. He argued that national currencies were unsuitable for use as global reserve currencies as a result of the Triffin dilemma - the difficulty faced by reserve currency issuers in trying to simultaneously achieve their domestic monetary policy goals and meet other countries' demand for reserve currency. Dr Zhou proposed a gradual move towards adopting IMF Special Drawing Rights (SDRs) as a centrally managed global reserve currency.

Effectiveness

China was one of the first nations to launch a substantial fiscal stimulus package , estimated at $586 billion spread over two years , and in February 2009 the Financial Times reported that both government officials and private investors were seeing signs of recovery, such as rises in commodity prices, a 13% rise in the Chinese stock market over a period of 10 days, and a big increase in lending—reflecting the government's success in using state owned banks to inject liquidity into the real economy .

As late as April, central bankers and finance ministers remained cautious about the overall global economy, but in May 2009 the Financial Times was able to report that according to a package of leading indicators there are signs that recovery is now imminent in Europe to, after a trough in March. The US was one of the last major economies to implement a major stimulus plan, and the slowdown there looks set to continue for at least a few more months . There has also been a rise in business and consumer confidence across most of Europe, especially in the emerging economies such as Brazil, Russia and India. In June, OECD reported improvements to the global economic outlook , with overall growth now forecast for 2010 instead of a small contraction. OECD specifically credited stimulus plans, which they warned should not be rolled back too swiftly . The IMF also reported a better than expected global economic outlook in July, though warning the recovery is likely to be slow. Again they credited the "unprecedented" global policy response and echoing the OECD in urging leaders to avoid complacency and not to unwind recession fighting fiscal and monetary policy too soon.

Criticism

Notable policymakers around the world currently see Keynesian solutions as the best option for shielding their populations from the current crisis. Nevertheless, this revival of Keynesian ideas has attracted considerable criticism. While there has been broad consensus among international leaders concerning the need for co-ordinated stimulus, the German administration initially stood out in their reluctance to wholeheartedly embrace Keynesian policy.

Critics focus on arguing that Keynesian policy will be counter-productive – reasons given include assertions that it will be inflationary, create more income disparity and cause consumers to rein in their spending even more as they anticipate future tax rises. In 2009 more than 300 professional economists, led by three Nobel Laureates in economics - James M. Buchanan, Edward Prescott and Vernon Smith, signed a statement against more government spending arguing that "Lower tax rates and a reduction in the burden of government are the best ways of using fiscal policy to boost growth." Robert Barro, an economics professor at Harvard University, argues that multiplier effect of government spending on GDP is less than 1, in other words that the government spending dampens economic output, and questions the logic behind US stimulus package. From those who remain hostile to far-reaching state intervention in the economy, there have also been arguments that the late 2000s crisis was caused not by excessively free markets but by the remnants of Keynesian policy. Luigi Zingales of University of Chicago argues that "Keynesianism is just a convenient ideology to hide corruption and political patronage". Libertarian think tanks such as the Cato Institute have argued that markets in the United States suffered from harmful distortions caused by government stretching back to the Sherman Anti Trust Act of 1890. Austrian school economic historian Thomas Woods published a book, Meltdown, in 2009 which places the blame for the crises on government intervention, and blames the Federal Reserve as the primary culprit behind the financial calamity.

The Keynesian resurgence in academia

With a few notable exceptions (such as Robert Shiller, James Galbraith and Paul Krugman among others), the Keynesian resurgence has been largely driven by policy makers rather than academic economists. Until very recently mainstream economists have not generally favoured robust counter-cyclical fiscal policies. While the school of thought known as New Keynesian economics has dominated the teaching of macroeconomics at universities, New Keynesians largely believed that monetary policy was enough to stabilize the economy, and largely rejected interventionist fiscal policy (as advocated by Keynes) as unnecessary. Some economists (primarily post-Keynesians) have accused the New Keynesian system of being so integrated with pro-free market neo-classical influences that the label 'Keynesian' may be considered a misnomer.

Yet there has been a shift in thinking amongst many mainstream economists, paralleling the resurgence of Keynesianism among policy makers. The New York Times reported that in the 2008 annual meeting of the American Economic Association mainstream economists remained hostile or at least sceptical about the government’s role in enhancing the market sector or mitigating recession with fiscal stimulus - but in the 2009 meeting virtually everyone voiced their support for such measures. However a substantial shift in opinion is less obvious in the academic literature. Speaking in March 2009, Galbraith has stated that he has not detected any changes among academic economists, nor a re-examination of orthodox opinion in the journals.

The 2008 financial crisis has led some in the economic profession to pay greater attention to Keynes’s original theories. In February 2009, Robert Shiller and George Akerlof argued in their book Animal Spirits that the current US stimulus package was too small, as it does not take into account loss of confidence or do enough to restore the availability of credit. In a September 2009 article for the New York Times, on the lessons economists should learn from the crisis, Paul Krugman urged economists to move away from neoclassical models and employ Keynesian analysis:

So here's what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit ... that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they'll have to do their best to incorporate the realities of finance into macroeconomics.

See also

• Financial crisis of 2007–2009
• Late-2000s recession
• Keynesian economics
• Neo-Keynesian economics
• New Keynesian economics
• Post-Keynesian economics
• Post-capitalism

External links

• A global survey of stimulus plans
• Donald Markwell, Keynes and International Economic and Political Relations, Trinity Paper No. 33, Trinity College, University of Melbourne, 2009 [9]

Further reading

• Robert Skidelsky (2009). Keynes: The Return of the Master. Allen Lane. ISBN 184614258X.