In the spring of 2005 a panel of “conservative scholars and policy leaders” was asked to identify the most dangerous books of the 19th and 20th centuries…. Charles Darwin and Betty Friedan ranked high on the list. But The General Theory of Employment, Interest, and Money did very well, too. In fact, John Maynard Keynes beat out V.I. Lenin and Frantz Fanon. Keynes, who declared in the book’s oft-quoted conclusion that “soon or late, it is ideas, not vested interests, which are dangerous for good or evil,” [384] would probably have been pleased.
Over the past 70 years The General Theory has shaped the views even of those who haven’t heard of it, or who believe they disagree with it. A businessman who warns that falling confidence poses risks for the economy is a Keynesian, whether he knows it or not. A politician who promises that his tax cuts will create jobs by putting spending money in peoples’ pockets is a Keynesian, even if he claims to abhor the doctrine. Even self-proclaimed supply-side economists, who claim to have refuted Keynes, fall back on unmistakably Keynesian stories to explain why the economy turned down in a given year….
It’s probably safe to assume that the “conservative scholars and policy leaders” who pronounced The General Theory one of the most dangerous books of the past two centuries haven’t read it. But they’re sure it’s a leftist tract, a call for big government and high taxes…. [T]he arrival of Keynesian economics in American classrooms was delayed by a nasty case of academic McCarthyism. The first introductory textbook to present Keynesian thinking, written by the Canadian economist Lorie Tarshis, was targeted by a right-wing pressure campaign aimed at university trustees. As a result of this campaign, many universities that had planned to adopt the book for their courses cancelled their orders, and sales of the book, which was initially very successful, collapsed. Professors at Yale University, to their credit, continued to assign the book; their reward was to be attacked by the young William F. Buckley for propounding “evil ideas.”
But Keynes was no socialist – he came to save capitalism, not to bury it. And there’s a sense in which The General Theory was… a conservative book…. Keynes wrote during a time of mass unemployment, of waste and suffering on an incredible scale. A reasonable man might well have concluded that capitalism had failed, and that only… the nationalization of the means of production – could restore economic sanity…. Keynes argued that these failures had surprisingly narrow, technical causes… because Keynes saw the causes of mass unemployment as narrow and technical, he argued that the problem’s solution could also be narrow and technical: the system needed a new alternator, but there was no need to replace the whole car. In particular, “no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community.”… Keynes argued that much less intrusive government policies could ensure adequate effective demand, allowing the market economy to go on as before.
Still, there is a sense in which free-market fundamentalists are right to hate Keynes. If your doctrine says that free markets, left to their own devices, produce the best of all possible worlds, and that government intervention in the economy always makes things worse, Keynes is your enemy. And he is an especially dangerous enemy because his ideas have been vindicated so thoroughly by experience.
Stripped down, the conclusions of The General Theory might be expressed as four bullet points:
1. Economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment
2. The economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully
3. Government policies to increase demand, by contrast, can reduce unemployment quickly
4. Sometimes increasing the money supply won’t be enough to persuade the private sector to spend more, and government spending must step into the breach
To a modern practitioner of economic policy, none of this – except, possibly, the last point – sounds startling or even especially controversial. But these ideas weren’t just radical when Keynes proposed them; they were very nearly unthinkable. And the great achievement of The General Theory was precisely to make them thinkable….
So now let’s talk about the core of the book, and what it took for Keynes to write it…. In Book I, as Keynes gives us a first taste of what he’s going to do, he writes of Malthus, whose intuition told him that general failures of demand were possible, but had no model to back that intuition: “[S]ince Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to provide an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain.”… That need to “provide an alternative construction” explains many of the passages in The General Theory that, 70 years later, can seem plodding or even turgid…. When you’re challenging a long-established orthodoxy, the vision thing doesn’t work unless you’re very precise about the details….
Keynes’s struggle with classical economics was much more difficult than we can easily imagine today. Modern introductory economics textbooks – the new book by Krugman and Wells included – usually contain a discussion of something we call the “classical model” of the price level. But that model offers far too flattering a picture of the classical economics Keynes had to escape from. What we call the classical model today is really a post-Keynesian attempt to rationalize pre-Keynesian views…. The real classical model… was, essentially, a model of a barter economy, in which money and nominal prices don’t matter, with a monetary theory of the price level appended in a non-essential way, like a veneer on a tabletop. It was a model in which Say’s Law applied…. One measure of how hard it was for Keynes to divest himself of Say’s Law is that to this day some people deny what Keynes realized – that the “law” is, at best, a useless tautology when individuals have the option of accumulating money rather than purchasing real goods and services….
There’s a widespread impression among modern macroeconomists that we’ve left Keynes behind, for better or for worse. But that impression, I’d argue, is based either on a misreading or a nonreading…. If you don’t read Keynes himself, but only read his work as refracted through various interpreters, it’s easy to imagine that The General Theory is much cruder than it is…. Let me address one issue in particular: did Paul Samuelson, whose 1948 textbook introduced the famous 45-degree diagram to explain the multiplier, misrepresent what Keynes was all about? There are commentators who insist passionately that Samuelson defiled the master’s thought. Yet I can’t see any significant difference between Samuelson’s formulation and Keynes’s own equation for equilibrium employment, right there in Chapter 3: [29]. Represented graphically, Keynes’s version looks a lot like Samuelson’s diagram; quantities are measured in wage units rather than constant dollars, and the nifty 45-degree feature is absent, but the logic is exactly the same.
The bottom line, then, is that we really are all Keynesians now. A very large part of what modern macroeconomists do derives directly from The General Theory; the framework Keynes introduced holds up very well to this day.
Yet there were, of course, important things that Keynes missed or failed to anticipate. The strongest criticism one can make of The General Theory is that Keynes mistook an episode for a trend. He wrote in a decade when even a near-zero interest rate wasn’t low enough to restore full employment, and brilliantly explained the implications of that fact – in particular, the trap in which the Bank of England and the Federal Reserve found themselves, unable to create employment no matter how much they tried to increase the money supply. He knew that matters had not always been thus. But he believed, wrongly, that the monetary environment of the 1930s would be the norm from then on…. In the United States the era of ultra-low interest rates ended in the 1950s… Yet the United States has, in general, succeeded in achieving adequate levels of effective demand. The British experience has been similar. And although there is large-scale unemployment in continental Europe, that unemployment seems to have more to do with supply-side issues than with sheer lack of demand…. [Keynes] underestimated the ability of mature economies to stave off diminishing returns. Keynes’s “euthanasia of the rentier” was predicated on the presumption that as capital accumulates, profitable private investment projects become harder to find…. [T]he euthanasia of the rentier does not seem imminent. But there’s an even more important factor that has kept interest rates relatively high, and monetary policy effective: persistent inflation, which has become embedded in expectations…. [E]ven now, when inflation is considered low, most of the 20-year rate reflects expected inflation rather than expected real returns.
The irony is that persistent inflation, which makes The General Theory seem on the surface somewhat less directly relevant… can be attributed in part to Keynes’s influence, for better or worse. For worse: the inflationary takeoff of the 1970s was partly caused by expansionary monetary and fiscal policy, adopted by Keynes-influenced governments with unrealistic employment goals…. For better: both the Bank of England, explicitly, and the Federal Reserve, implicitly, have a deliberate strategy of encouraging persistent low but positive inflation, precisely to avoid finding themselves in the trap Keynes diagnosed….
What makes The General Theory truly unique… is that it combined towering intellectual achievement with immediate practical relevance to a global economic crisis…. There has been nothing like Keynes’s achievement in the annals of social science. Perhaps there can’t be. Keynes was right about the problem of his day: the world economy had magneto trouble, and all it took to get the economy going again was a surprisingly narrow, technical fix. But most economic problems probably do have complex causes and don’t have easy solutions….
Law of Markets 