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Why Not Keynes?

[1]In the high crisis just two years back, the cult of John Maynard Keynes saw a dramatic revival. Deficits were acceptable, stimulus plans became law, books entitled Return of the Master and The Keynes Solution rushed into print. Enthusiasts spoke of a “new New Deal.” Today, although the economy has not recovered, and although unemployment remains near 9 percent, none of this remains.

Barack Obama declined to become a third Roosevelt. His Bernard Baruch proved to be Robert Rubin. There is no Wagner in the Senate, no Eccles or Currie at the Federal Reserve. The agencies that harbored Leon Henderson and the young John Kenneth Galbraith do not exist. If Keynes were alive today and came to visit, one wonders who in official Washington would see him.

The new dawn of the Keynesian idea has gone dark.

That it was a false dawn goes without saying. People who had actually read and understood Keynes never came close to power. Those who did come to power under Obama were False Keynesians. They would support a “stimulus,” but only if it were limited and temporary. To Lawrence Summers, a two-year program met the definition of “sustained.” $800 billion spread over two years—about 3 percent of a GDP in free-fall—qualified as “substantial.” Ben Bernanke and Christina Romer, both of whom had reputations as experts on the Great Depression, were closer to Milton Friedman’s view of that matter—that the Fed did it—than to Keynes.


The False Keynesians also relied on forecasting models that were conceptually anti-Keynesian because they incorporated the notion of a “natural rate of unemployment.” The models assumed that economic recovery would occur, returning us to an unemployment rate near 5 percent after five years. This would happen—so said the models—no matter what the policies were. The models thus defied the commonsense perception that we were in a deep and systemic crisis. In 1930 Keynes wrote, “The world has been slow to realize that we are living this year in the shadow of one of the greatest economic catastrophes of modern history.” In 2009 we realized it. But our computers, and the technicians who ran them, overruled us.

As a result, policies were inadequate and the results fell short. In March 2009 I predicted in The Washington Monthly that a temporary program—rather than strategic effort coupled with forceful financial reform—would not foster business investment and sustainable renewed growth. As the stimulus package wore off, the economic recovery would be slow. This prediction came true with disastrous political effects for Obama. And so the False Keynesians went home—Romer back to Berkeley, Summers to Harvard. The reputation of Keynesianism is just part of their collateral damage.

After the midterm elections, all attention turned to the victors’ agenda: the federal budget deficit, the public debt, spending cuts, and the cause of “entitlement reform”—our Orwellian phrase for slashing Social Security and Medicare. How can we understand this march of budget-cutters and free-market fundamentalists? Where do their ideas come from? Unlike the Reagan revolutionaries of 30 years ago, they have no academic messiah, no newspaper apostles, and, so far as one can tell, no sacred text. “Monetarism” plays no role, nor does “supply-side economics.” They are not really “Austrians,” though some claim as much. If they are “slaves of some defunct economist”—then of whom?

The answers are not far to seek. Adam Smith and David Ricardo—and also their acolytes, the late 19th-century Social Darwinists Herbert Spencer and William Graham Sumner—can be heard murmuring in the vapors of our present discourse. And far more than Marx or Keynes, Thurman Arnold and Thorstein Veblen can help us grasp what their message actually is.

Adam Smith, the most humane and optimistic of all economists, adapted his theory of value from the Physiocrats he’d encountered in France, who held that economic value arose on the land. Smith was not comfortable with that, so instead he wrote that value was vested by labor in physical products, which could then be exchanged. Those who made things were “productive” and those who did not were not. Government (including soldiers), alongside the arts and domestic service, fell into the unproductive category. These activities were necessary, even desirable, but only up to a point. They had to be supported out of “revenue,” economic rent, and did not accumulate as wealth. A country that allowed too much of those sorts of things would become poor.

This idea contradicts the accounts of national income that give us our modern definitions of economic activity and growth. Government purchases are indeed part of the GDP. So are the labors of ballet dancers and college professors. The accounts make no distinction between public and private spending or between tangible and intangible wealth.

Yet Smith’s idea appeals powerfully to instinct—even to common sense. Surely there must be “good” and “bad” spending. Just as we approve of factories, just as we dislike “planned obsolescence” in the private sector, so we consider much of what government does to be “wasteful” and “fundamentally unproductive.” Waste, of course, is a burden by definition, and unproductive activity is to be kept to a minimum. The issue, once framed in this way, becomes one not of whether to cut, but of “how much” and “what” and “on whom.” We forget entirely (until the victims remind us) that, by accounting, budget cuts will reduce income, cost jobs, and cause economic activity—and business profits—to fall.

Then there is the question of whether the fall in spending, profits, and jobs will be made up quickly and easily by some other sector. Leaving aside exports, here there are two possibilities: private consumption and business investment.

On this issue David Ricardo championed another Frenchman, Jean-Baptiste Say, whose Law held that savings creates investment or, equivalently, that supply creates demand. If there was ever an excess of production, then prices would fall, demand would increase, and that would take care of it. Thus it was impossible for there to be a general glut, meaning sustained mass unemployment. The system was self-correcting; crises did not happen. This powerful confidence now sustains the Tea Party; they have blotted the collapse of the private banking sector from their minds.

The rabbit in Ricardo’s hat was the nature of money in his time—mainly coins and paper backed by gold or silver. The quantity of money thus didn’t fall in a glut, and its purchasing power would rise as prices fell. Consumption and investment would take up the slack.

[2]But we no longer live in that world. In our credit-money economy, purchasing power goes away when banks stop lending, and the money stock falls. This is why Milton Friedman and Anna Schwartz could blame the Depression on the Federal Reserve, and why Ron Paul favors abolishing the Fed and a return to the gold standard.

With gold-money unavailable, the Republican staff of the Joint Economic Committee has a new paper on how big budget cuts might support economic growth. They offer no theory, just citations to empirical papers that turn out to be highly implausible or else unsupportive. But this work, alongside the balanced-budget amendment cosponsored by all the Republican senators, presumes that some force will drive up business investment to a more-than-offsetting degree, creating a larger and more private economy than we have now. The Keynesian “multiplier” is negative in this view.

This argument dovetails with the line of the business lobbies, who whine on about regulations and “uncertainty,” as if we hadn’t spent the past 30 years deregulating everything in sight. In their version of the story, interference by government is a choke-leash on the animal forces of free-market dynamism. Lift regulation, they say, and business investment will rise to the challenge of replacing the demand and incomes lost to budget cuts. While the public-spending multiplier is negative, the private-investment multiplier is anything but.

How can this be? It’s an old theme, redolent of the Social Darwinists’ view of the divine right of the rich to rule. Thurman Arnold in The Folklore of Capitalism captured the spirit in this description of a 1936 meeting with bankers, businessmen, lawyers, and others up in arms because the Interstate Commerce Commission was proposing a cut in fares on the New Haven Railroad:

[One] gentleman present had the statistical data on why the railroad would suffer. In order to take care of the increased traffic, new trains would have to be added, new brakemen and conductors hired, more money put into permanent equipment. All such expenditures would, of course … remove persons from relief rolls, stimulate the heavy goods industries, and so on. This, however, was argued to be unsound. Since it was done in violation of sound principle it would damage business confidence, and actually result in less capital goods expenditures, in spite of the fact that it appeared to the superficial observer to be creating more…

And Thorstein Veblen, in The Theory of Business Enterprise, in 1904, explained what the sound principle underlying it all was. The bottom of the matter was emotional: “Depression is primarily a malady of the affections of the business men. … Any proposed remedy, therefore, must be of such a nature as to reach this emotional seat of the trouble. … What is required is a business coalition … loosely called a ‘trust’.”

There you have it: business people need to be in charge. And more than that: they need to feel in charge. Anything else is fundamentally unsound.

That is what made Keynes insufferable. It wasn’t that as a young man he liked boys. It wasn’t that he taught that that thrift is a vice, or that savings are pathological, that deficits are helpful, that debt is necessary, that interest rates should be kept low, that the economy should be run at full employment for the good of all. It wasn’t even his reference at the end of The General Theory to the “euthanasia of the rentier.”

No, it was the fact that Keynesian policy required Keynes. And if Keynes were in charge, then the captains of industry could not be. Larry Summers is not Keynes. But he did give the impression, for a while, of running the show. This was a fatal error. It was the impression of making policy that business and the Tea Party could not stand. A better policy would not have been better liked.

With Jeffrey Immelt, we now have a business face and no economic policy at all. The president has learned. Whether it will save him be remains to be seen. A full government of business people would be much more authentic.

Meanwhile, in the halls of Congress, as well as at Westminster and in Frankfurt and Brussels and Berlin, the ghosts of Smith and Ricardo mutter on about unproductive government and how savings create investment. So they cut and cut, and when that doesn’t work they call for more cuts. And the penetrating voices of Arnold and Veblen can be heard too, explaining what is really behind it.

Madmen in authority, distilling their frenzies indeed. Keynes got that right.

James K. Galbraith is the author of The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too [3]. He teaches Keynes at the University of Texas at Austin.

Robert P. Murphy responds. [4]

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68 Comments (Open | Close)

68 Comments To "Why Not Keynes?"

#1 Comment By Ben, Okla. City On June 17, 2011 @ 7:42 am

The lesson of Greece is don’t issue debt denominated in a currency you don’t manage.

Barry: I don’t know who called you stupid, but it sure wasn’t me. I don’t play that game. I try to take everyone’s ideas seriously.

LJ: Please give me an example of a Welfare State degenerating into a police state.

#2 Comment By Libertarian Jerry On June 17, 2011 @ 12:46 pm

Ben…Sparta,Athens,Rome,Holland (17th Cent.),Germany(1920s)plus several others.

#3 Comment By Boyd, NYC On June 17, 2011 @ 12:49 pm

Prof. Galbraith, you assert in an above post:

In an age when the rest of the world uses US Treasury bills and bonds as the principal reserve asset, the US has to run a budget deficit, even for the most part in good times, in order to accommodate them.

Surely you don’t suggest the US Congress runs a budget deficit for the financial planning convenience of foreign powers? As a thought experiment, what do you think would have happened had the Congress actually achieved surpluses for the 10 years to ’08? Specifically, would this have had any effect on dollar/yen and dollar/yuan rates?

#4 Comment By Paul Johnson On June 17, 2011 @ 5:56 pm

Adam Smith on kings and ministers: “They are themselves always, and without any exception, the greatest spendthrifts in the society. Let them look well after their own expense, and they may safely trust private people with theirs. If their own extravagance does not ruin the state, that of their subjects never will.”

It’s a bit late in the game to invoke Adam Smith on policy. And Republicans as disciples of Smith? Surely you must be joking sir.

#5 Comment By Tim Cavanaugh On June 18, 2011 @ 9:11 am

So they cut and cut, and when that doesn’t work they call for more cuts.

Um, what has been cut? The federal budget is larger this year than it was last year, larger last year than it was the year before, and so on as you keep going back. The Veblenian idealogues Galbraith imagines are in control of the government have not even reduced the rate at which spending is growing, let alone cut anything. You may have heard talk about this “debt ceiling” that has to be raised every few months?

#6 Comment By Polaris On June 19, 2011 @ 7:08 am

This seems to be an argument that the stimulus was quantitiatively insignificant: $800 billion spread over two years—about 3 percent of a GDP

As I recall from the Commerce Department’s GDP data, for the recession of December 2007 to June 2009, GDP growth was positive in 2007, 0.0 in 2008, -2.6% in 2009, and positive in 2010. So in that recession the total decrease in output was 2.6% in one year.

So the stimulus bill, at 3% of GDP, should have totally counteracted the recession and then some.

And that doesn’t take into account the Keynesian “multipliers.”

#7 Comment By Polaris On June 19, 2011 @ 8:56 am

Ben: The crowding out argument is used by some free market critics of Keynesianism and other government intervention. The problem with that argument is that currently there is no evidence of crowding out. Interest rates are incredibly low.

That’s because the Fed has been engaging in expansionary monetary policy of unprecedented magnitude over the last few years. Since December of 2008 its target range for the Federal Funds interest rate has been zero (!) to one quarter of one percentage point.

#8 Comment By Rex Lowe On June 19, 2011 @ 10:48 am

The flaw in this essay is the basic assumption by Keynes is that government will act in accordance with the will of the people. To do what is right over the long haul, without casting an eye toward the possibility of achieving and maintaining a long-term acquisition of power. That is to say, Keynes assumed that governments and politicians were not corrupt enough to twist a market situation into a personal or political gain. How naive.

#9 Comment By Rex Lowe On June 19, 2011 @ 11:06 am

Please check out John King’s comments above. His view on the self-perpetuating welfare state is aligned with my own. Only I feel he did not say enough. I feel the liberals have expanded the dependency state in an attempt to gain long-term control over the people. I hear many a Democrat complain about government intrusion in their lives, yet not a peep at the proposed expansion of the federal government under the current administration. ( Obamacare) I don’t know, maybe I don’t get it, but it seems quite ironic.

#10 Comment By Rex Lowe On June 19, 2011 @ 11:17 am

Libertarian Jerry: What will happen is that the nation will reach a “tipping point”. At that moment, tax revenues, borrowed money, etc. will no longer be adequate to sustain the “non-productive” weight of the welfare state. When that occurs, so will the runaway inflation. Those state checks will start looking quite meager in comparison to the prices that must be paid for basic necessities. Then the rioting and looting will start. Spreading out at first from the inner cities, and into the adjacent suburbs. Our government knows this is coming, hence their stepped up efforts to deprive us of our Second Amendment Rights. I’m not a gun nut,don’t even own one. But the Constitution, to me, is damn near sacred.

#11 Comment By Ben, Okla. City On June 20, 2011 @ 12:13 pm


The efficacy of QE2 is highly questionable in terms of its impact on long bonds (5-10 years). Maybe the 10 year US Treasury would be at 3.17% today, rather than it’s present level of 2.97%. But seriously, does that make a big difference in the grand scheme of things? I think not.

If one is to believe that market interest rates contain information about expectations of future inflation, then the market is expecting no inflation in the future. If the inflationistas are right, the yields on 30-year and 10-year treasury bonds would be skyrocketing. It just hasn’t happened.

Factory capacity utilization is low. Unemployment is high. Business executives cite “sales” as their biggest concern right now. Translation: The problem is lack of aggregate demand and the solution is some kind of stimulus, since the private sector is reluctant to step up right now.

Do I believe that we can come up with some kind of stimulus idea that can be supported by a broad swath of the American electorate? Yes, but we will probably have to go through several more months of disappointing economic data and a realization that the Confidence Fairy isn’t coming without some help from fiscal policy.

#12 Comment By beowulf On June 22, 2011 @ 3:21 pm

“So it looks to me like Keynes is advocating capital budgeting be taken out of the equation when aiming for balancing the remaining non-capital budget over the cycle. In terms of the way the US currently budgets, my understanding is that there is not capital budgeting.”

Ben, I was on vacation so sorry for the late hit… OMB does track “public investment” spending on infrastructure, education and R&D, for FY ’11 they total $600 billion. Taking capital spending off-budget would cut the deficit by that amount, but really that’s just moving numbers around. To get the economy moving again, we should enact a payroll tax holiday and then do something about the imports.
Our trade deficit is huge demand leakage, first quarter of this year it was $571 billion annualized. Eliminating the trade deficit (by, say, Warren Buffett’s cap and trade “import certificate” plan) would do more to stimulate demand and boost wages and (as an almost irrelevant side effect) reduce the deficit than any of the weak tea proposals offered by either the White House or the Republicans in Congress.

#13 Comment By Polaris On June 22, 2011 @ 7:31 pm


First, thanks for disagreeing with facts and logic. I’m embroiled in another “debate” in a different forum in which I’m just being insulted.

If one is to believe that market interest rates contain information about expectations of future inflation, then the market is expecting no inflation in the future.
But it’s not the market. That’s the point. Interest rates right now are the result of a massive monetary policy intervention.
Here’s some background on this from the NY Fed Bank: [7]

The Fed has more than tripled its balance sheet (via monetary expansion) recently. A few years ago, its Open Market Account was less than $800 billion. Now, per the link above, it’s more than $2.6 trillion! (And the Open Market Account isn’t the entire balance sheet.)

Second, the Fed thinks it can affect long-term interest rates by using the “extended period” language in its policy announcements on short-term rates. (Presumably via the Expectations Theory of the term structure.) They might be right, and anyway if they’re wrong then the experts on monetary policy don’t understand how it works. This doesn’t increase one’s confidence in fiscal policy, set by politicians who are most definitely not experts in macroeconomics!

Please don’t take any of this as an assertion of 100% crowding out.

#14 Comment By Sama On July 4, 2011 @ 3:17 pm

The born-again deficit hawks and anti-government crowds (who were in a state of coma during Reagan and Bush years) conveniently forget a couple of important points:

1) What would be the unemployment rate in the absence of the “Obam’s miserable stimulus?” 5 or 15 percent? The latter is more likely. If investment and consumption (private sector spending) haven’t rebounded yet in a significant way, why would any reasonable person think that they would have done so automatically when the economy was shedding 700,000 jobs per month?
Lesson: The electorate is myopic. You don’t get credit for averting a disaster.

2) There is a very disconcerting “fiscal pathology” in this country. As the electorate, we want it all: lower taxes, more public services and benefits, and a balanced budget!! (Remember the old Tea Party guy who was protesting against “big government/Obma care” with a sign which said “hands off my Medicare?!”) When politicians respond to our wishes by favoring simplistic fiscal “solutions” to complex problems, we (re)elect them as champions of fiscal responsibility. Many of us merely talk about “big government” until we’re asked to sacrifice. Then we say that “what is mine is mine… what’s yours is negotiable.”

Lesson: The first step in achieving fiscal sustainability is for the public to understand that “there is no free lunch.” We are not merely onlookers. We’re a big part of the problem!

#15 Comment By rodney On August 17, 2011 @ 6:29 am

great article. the big problem today is that most people, like libertarian jerry, have a limited/flawed veiw of economics. they erouneously beleive that the us government is going to cause galloping inflation with its spending or beleive in the confidence fairy. The government is the issuer of money. It will never go broke. ever. I don’t understand why this is an issue. Government debt has nothing to do with the current situation. Cutting spending will have a multiplier effect. my spending is your income. Any talk of crowding out is bad economics. This is not the gold standard. The fed is the absolute master of interest rates. Its balance sheet expansion is not inflationary. Someday when unemployment is not 20% it may be, but to suggest that the quantity theory of money has any merit is just silly. The fed doesn’t print money. It assigns bank reserves. All this fear mongering is preventing the government from doing what it needs to do to resolve this situation which is spend. people are saving and not spending. huge demand leakage. replace it wiht govt. spending. This has worked since ww2 but now everyone seems to be concerned that government is running out of money. throwing grandma on the street isn’t the answer. becoming an export nation isn’t either. The only way we can acheive a comparitive advantage is to bring down the value of the currency to make us competitive. that really means to bring down our standard of living. thats the only way we can compete with the likes of china. what kind of game is that. the government can borrow right now for nothing. NOTHING. why doesn’t it? people are suffering.

#16 Comment By Oma Blanchett On November 26, 2011 @ 4:45 am

MRG, if you read the comment section, MP Baker confirmed he endorses Toby’s plan. I specifically asked him. So there is nothing unfair here.

#17 Comment By Chad Yost On May 14, 2012 @ 8:53 am

Why Not Keynes? Because I want my savings to be worth something in 5 years. Because I don’t want out of control government spending. Because even Keynes couldn’t tell you exactly how much to spend and how low to take interest rates. Keynes is great because with a little bit of number play he can take all the credit for growth and non of the responsibility for a recession.  If the stimulus doesn’t work the fed didn’t print enough money. If the stimulus works he was right but the results are only temporary and the markets see eventually correct the mal-investment with a bust. 

Fear the boom. Stop Keynes. 

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