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We Forgot Everything Keynes Taught Us
One must bear in mind that Keynes's aphorisms, which seem so apposite today, were for years dismissed with a pitying smile as the product of a primitive state of economic thinking that had been rendered obsolete by powerful desktop computers and Ph.D. math unavailable to economists of Keynes's generation.
The second strand of Keynes's economics was formed by the depressed 1930s, rather than the booming '20s. His main insight was that a wounded economy would not simply bounce back but might take years to recover. In his language, it might remain a long time in a state of "underemployment equilibrium," from which it could be rescued only by a massive external shock. As we know, this proved to be the case. It was not the New Deal that brought the U.S. economy back to full employment, but the huge increase in government spending caused by World War II.
The long Japanese stagnation of the 1990s is another example of how long it can take for toxic debt to work itself off the balance sheet of banks, and how relatively powerless governments are to produce recovery in the face of flight into cash. This may or may not be our fate today. We all hope that the new Nobel laureate Paul Krugman is right that the rescue operations taken in the past couple of weeks may be enough to stem the financial crisis. But the wreckage may be with us for a long time to come.
Of course the problem of what a government can or should do to prevent or mitigate these financial storms is not disposed of by pointing out that economies don't behave in the way economists claim that they do. Keynesians want to create financial corridors to limit "the flight of the butterfly," in Paul Davidson's graphic phrase. Free-marketers argue that the cost of periodic crashes and massive rescue operations is worth paying to preserve freedom of capital movements and technological dynamism. Today, as the costs of the bailout mount up, this argument is heard much less.
We know now that we know very little. But Keynes's insights should not be tossed away as old garbage. At the very least we can say that we have no warrant for basing economics on assumptions that are so often discredited by events. Suitable perhaps for professors and students, such economics are likely to be especially toxic for policymakers.
Robert Skidelsky is the author of "John Maynard Keynes: Economist, Philosopher, Statesman."