Searching for a defunct economist

Lorenzo Bini Smaghi of ECB gives another super speech turning Keynes’ dictum on its head. And no, it is not the usual criticising Keynes idea but revisiting what Keynes said and read him carefully :

“The economist John Maynard Keynes is back in fashion”, writes Robert Skidelsky in the preface of his most recent book ‘Keynes, the Return of the Master’, published less than one year ago. The reason, says Skidelsky, is not so much that the world is facing the worst crisis since the Great Depression and that governments all over the world have embarked on stimulative packages to support the economy, as the author of the General Theory had advocated, but because Keynes “provides the right kind of theory”, a theory which is “ an indispensable guide for the future”.

A question that comes to mind in reading these words is why Keynes had to make a comeback in the first place, why the General Theory was forgotten and its prescriptions abandoned. If the Theory was indeed general, it should apply in all circumstances and not only when the world is on the verge of collapse.

He says Keynes made many contributions and needs to be read properly:

There are two possible answers to the question. The first is that the Theory is not general, and thus cannot apply to all economic states of the world. The second is that Keynes’ famous admonition in the last page of his General Theory – according to which “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist” – has been turned upside down. In other words, defunct economists – and their theories – are usually enslaved by practical men who do not fully understand them.

I side with the second interpretation and will use this lecture today to explain why. In my view, the most important contribution that Keynes has made throughout his life is to warn practical men, including policy-makers, not to remain trapped in pre-conceived ideas when addressing new issues. In ‘The Economic Consequences of the Peace’ (1919) he warned against adopting the traditional practice of peace treaties – namely, extracting huge reparations from the defeated countries, without taking into account the general economic situation and the burden that this would also impose on the victorious countries. In ‘A Tract on Monetary Reform’ (1923), he warned against a precipitous return to the Gold Standard which prevailed before the war as a way to reinstate monetary discipline and fight against inflation. In ‘The General Theory of Employment, Interest and Money’ (1936) he warned against the predictions of the classical theory, in particular when the underlying assumptions of such a theory are not fulfilled, as was the case during the Great Depression.

He reviews Keynes contribution to probability and uncertainty, role of govt intervention and effectiveness of stabilisation policies. Lessons for today:

Let me elaborate on my personal views, considering in particular the role of policy-makers. Keynes has taught us to assess carefully the state of the world we live in before designing the policies that authorities should implement. When heightened uncertainty prevails, government has a role to play in adopting measures that contribute to reducing the state of uncertainty and in helping economic agents coordinate expectations towards a socially optimal outcome. This raises a few difficulties for policy authorities. First, they have to assess whether the state of uncertainty is such as to justify active intervention. Second, they have to design policies that help to reduce uncertainty, rather than increase it. History is full of examples of policy mistakes made in both directions, i.e. of states of heightened uncertainty which were not recognised and were not accompanied by adequate actions, and states which were considered as being of heightened uncertainty even though they were not and were accompanied by policy actions which increased uncertainty instead of decreasing it. These are the typical type I and type II errors recognised in statistical analysis.

In the end he says:

If the above hypothesis is correct, then it’s a mistake to think that we can get out of this crisis and back on a path of sustainable growth only through the support of fiscal and monetary policies. To paraphrase Keynes, monetary and fiscal policies are “a subtle device for linking the present to the future”. These policies may be seriously misguided if they are based on false expectations about the future. On the other hand, the success of these policies in averting a collapse of the world economy right after the Lehman Brothers’ failure, in the autumn of 2008, might fuel the illusion that the same policies can bring us back to the halcyon days of mid-2007, when we were “still dancing” as one famous banker put it. It would be an illusion, as I just said. And a waste of time and effort.

To avoid this waste, we need to come back to Keynes’ intuition, which is that the problems of the future cannot be dealt with simply by applying the solutions of the past, because the problems of the future are different from the problems of the past. If we want to put our societies back on a path of sustainable prosperity we must stand ready to fundamentally reform the way in which our economies work and compete in the global environment.

In doing that, we may well have to resuscitate some defunct economist. And read their work carefully.

Hmmm. very well said…

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2 Responses to “Searching for a defunct economist”

  1. Kindly stop this Keynes vs Smith/Friedman debate « Mostly Economics Says:

    […] recipe for government’s role was for the depression. Outside of depression, he had different ideas for markets and many creative […]

  2. How would Schumpeter view this crisis? « Mostly Economics Says:

    […] nearly a defunct economistGreat stuff. Knowing about both Eichengreen and Schumpter’s views in one place. Knowing more […]

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