Monday, January 30, 2012
Keynes and the Keynesians
Posted by David Smith at 01:00 PM
Category: Thoughts and responses

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Jonathan Portes of the National Institute of Economic and Social Research asked me what I meant by 'Keynesian'. Jonathan's post is here, and there is an interesting one here from Simon Wren-Lewis. This is what I said:

The National Institute was founded in 1938, so I suppose strictly speaking "taking its back to its Keynesian roots" implies taking it back to the economics of Keynes, rather than post-war Keynesian economics, which David Colander many years ago described as Lernerian rather than Keynesian.

What is Keynesian economics? In Britain it was common to think of it as the 1950s and 1960s belief in fiscal fine-tuning, and the primacy of fiscal over monetary policy, buried in the 1970s by stagflation and the rise of monetarism, and encapsulated in the Jim Callaghan/Peter Jay 1976 speech to the Labour party conference.

What it means now is more difficult. Paul Samuelson famously wrote that all economists should think of themselves as post-Keynesians, "keen to render obsolete any theories that cannot meet the test of experience".

Do only Keynesians support an emergency fiscal stimulus in a crisis and deep recession? No. Robert Lucas was half -joking when he said he guessed everybody was a Keynesian in a foxhole, and it is true that some US economists were opposed. But support for the stimulus was pretty universal among the economic mainstream.

The IMF was criticised by some in the emerging world for abandoning the Washington orthodoxy, in which its standard prescription for developing economies in difficulty was fiscal austerity. Instead it supported a temporary fiscal stimulus, though with the proviso that countries should also put in place credible medium-term fiscal consolidation plans.

Is it Keynesian to call for a slowdown in the pace of those consolidation plans? A lot of this gets mixed up in the nonsense over "expansionary fiscal contraction". Every UK recovery from the 1970s has been accompanied by a significant fiscal consolidation. Would those recoveries have been stronger without the fiscal consolidation? Initially, certainly yes. This time, also yes, as I pointed out last May:

"Let me adjudicate. Summers says he would be astonished if Britain boomed over the next two years and so would everybody else. He has set up a straw man.

"The governmentís deficit programme has removed the threat to Britainís AAA rating and probably kept interest rates low. You cannot, however, hike taxes and cut spending without some impact on growth, even if there was no realistic alternative.

"As for the free marketeers, it is true that over time the private sector will expand into the space left by a smaller state. But in the short-term, in an economy when bank finance is scarce, growth will be slower than without cuts. As I say, Britain had little choice but to get the deficit down."

So is it Keynesian to say that, given the size of the deficit, the government should slow the pace of fiscal consolidation? Going back to where we started and Keynes, we cannot say, but I am not sure this would have been Keynes's view. Robert Skidelsky might argue otherwise.

But it is Keynesian in the sense that if you believe the fiscal multipliers are big enough, that Ricardian equivalence is a myth or greatly exaggerated and that there are no adverse consequences from the potential loss of fiscal credibility - which, as I have said, is the main reason why gilt yields are so low and the AAA rating still intact - you should slow the pace of consolidation or even put it into reverse? Yes, though this may be unfair to some Keynesians.