But Keynes is now accepted across the political spectrum.
Unfortunately true, because politicians love meddling with the economy. There's too much political capital to be gained to pursue a laissez-faire
approach. It was in this sense that Nixon said "we're all Keynesians now." Bush is no exception: his fiscal policies, especially on the expenditures side, have
been a disaster and the deficits are reaching truly dangerous levels. But for Keynesian economists to criticize him for running up a deficit during a recession is, as I noted above, the height of hypocrisy, since that is exactly
what their models call for.
but you can’t be an economist without accepting that much of what Keynes said was accurate, particularly, of course, his thoughts on the role of government and fiscal policy, as well as the influence of the “liquidity preference” that was one factor in the great depression (and I think even Hayekians accept that these days).
I wouldn't agree with this -- there are plenty of heterodox economists, especially Austrians, who think nearly every key point in The General Theory
is wrong. See http://www.mises.org/etexts/hoppekeynes.pdf
for an example.
Regarding liquidity preference, it is certainly true that the desire to hold cash may increase during economic crises, and that this will exert a downward pressure on prices. But Keynes interpreted the interest rate as the price that clears the money market
, whereas one of the Austrians' (including Hayek) most foundational theories is that the interest rate clears the time market
, that it is the discount rate that brings the present-oriented activity of consumption into equilibrium with the future-oriented activity of saving.
In the Keynesian model, savings have no direct effect on the interest rate, and hence no direct effect on business investment or aggregate expenditures. Savings are "sterile" and simply disappear from the economy: an exogenous increase in savings will shift or rotate the aggregate expenditures line down, resulting in lower equilibrium incomes and output. The quantity of savings that triggers this contraction never re-enters the circular flow; it just vanishes, presumably under someone's mattress.
Likewise, the funds that the government spends to rejuvenate the economy appear
out of nowhere. Government must pay for every dollar of spending through taxation, borrowing, or printing money. The first option reduces aggregate expenditures, causing further problems. The third option is allegedly ineffective in a depression, due to the liquidity trap: new money is held instead of spent. The second and preferred method should theoretically crowd out private investment as the neoclassicals argued, but Keynesians maintain that it does not. The question then arises: where do these funds come from? They must
be diverted from consumption spending, investment spending, or savings -- there is no other source of funds. But if that's the case, we're back to the circular flow, and the government is simply redirecting -- not injecting
-- spending streams. How can government spending in place of private spending be stimulative to the macroeconomy?
These problems are caused by the fact that, in the Keynesian system, savings and investment are not linked in any meaningful way. Of course, by the rules of national income accounting, S + T must equal I + G, but this relationship is mathematical, not causal: the other variables (Y and C or preferably G and T) must do the adjusting to make S = I. But from an income-expenditures perspective, one is counterproductive and should be discouraged, while the other fluctuates wildly according to the "animal spirits" and psychological instabilities of the business community. What a surprise, then, that Keynes ends up with a profoundly unstable economy? In such an environment, of course we need government as a balancing force. If the interest rate is assigned the function of coordinating money demand, not coordinating the capital structure, the policy conclusions flow almost trivially.
As Roger Garrison of Auburn University notes
, any macroeconomic theory should explain how the economy can work right before tackling how and why things can go wrong, because we observe empirically that the economy functions at a basic level. Keynesian theory is unable to do this -- full employment, or anything remotely resembling full employment, only happens by accident.
[Edited 2004-08-27 20:00:00]
Keynes is dead and we are living in his long run.