Rhetoric of Economic Thought Keynes, and Liberal macroeconomics

Economic Development Theories Mercantilism (16th – late 18th century) Classical Economics (1776-1870s) Neo-classical Economics (1870s-1930s) Keynesian Economics (1930s-1970s) Development Economics (1940s-1990s) Neoliberalism (1990s-2008) Timeline does not necessarily imply loss of significance of a particular theory

Economic analysis – key contributors, 20th century 2000 1900 1950 Alfred Marshall (1842 – 1924) John Maynard Keynes (1883 – 1946) Keynes Thorstein Veblen (1857 – 1929) Joseph Schumpeter (1883 – 1950) Friedrich A. von Hayek (1899 – 1992) Hayek Ronald Coase (1910 – ) Milton Friedman (1912 – 2008) Samuelson Paul Samuelson (1915 – ) Kenneth Arrow (1921 – ) Friedman Gary Becker (1930 – ) Robert Lucas (1937 – ) Lucas

Schools of thought in mid-20th century macroeconomics Keynesianism is the view that economies are inherently unstable, that they may in fact settle at less-than full employment equilibrium, that Aggregate Demand is the primary determinant of output and employment, and that authorities can intervene in an economy to stabilize it. Keynesians generally express a preference for fiscal policy as a stabilizing tool. Monetarism is the view that economies are inherently stable, that the quantity of money has a major influence on economic activity and the price level, and that the objectives of monetary policy are best achieved by targeting the rate of growth of the money supply. Monetarists generally express a preference for monetary policy as a stabilizing tool relative to prices only, being generally skeptical of attempts to manage output. Keynes Samuelson Friedman Greenspan

Democracy & Capitalism = Compromise Marx believed that compromise between workers and capitalist was impossible Keyenesianism (1930s) provided ideological and political foundations for compromise State reconcile private ownership with democratic management Sweden first country to promote employment policies in 1932 but not income distribution

Democracy & Capitalism For Keynes the engine of the economy is consumption Thus his solution to economic recession = increase demand (consumption) How? Raising wages Transfers to the poor by ad hoc programs Government spending Or reducing taxes

Keynes’ Policy Full employment and equality (creation of welfare programs) Over time capitalists and socialists struck different compromises. Capitalists understood that Socialists had the votes to rule and accepted a certain degree of regulation and employment and welfare policies as the lesser of two evils (a communist revolution)

Liberal View Liberals opposed Keynes’ ideas because: Higher wages and more social services raised the cost of production The welfare of the poor was not the responsibility of the government (by manipulating economic policy) but of private charities

Classical economics Based on critique of Mercantilism (Adam Smith) General belief on economic development through free market (i.e. trade without barriers) Adam Smith’s Wealth of Nations (1776) marks the beginning Self-interest as economic drive Limited government intervention—free trade; self-regulating markets [contrast: mercantile protectionism] Market prices limited by competition Invisible hand of self-regulating markets transform self-interest into public virtue Division of labor (i.e. specialization) enhances production [distinctively industrial orientation] Division of labor limited by the extent of market

Theories of Public Debt (Less-than-full employment) Fiscal policy and government finance Theories of Public Debt Keynesian (Less-than-full employment) Classical (Full employment) If an economy is in a state of “under production”, expansion of debt could conceivably make both current and future generations better off. Views countercyclical public debt policy as an optimal response to the business cycle – “appropriately timed” deficits can benefit all. Neoclassical (Non-Ricardian) Ricardian Debt-financed deficits make households feel wealthier in the short run, thereby raising current levels of output. Public debt competes with private debt for available funds, thus driving up interest rates and changing the composition of output (lowering investment) with deleterious effects for long-term growth. Debt-financed deficits imply higher future taxes, and thereby constitute a burden on future generations. Debt-financed deficits imply higher future taxes with a present value equal to the value of the debt. Rational agents (behaving according to the “Permanent Income / Life Cycle model of consumption) will adjust current saving plans in anticipation of the future taxes. Debt-financed deficits will not change households perception of wealth, and therefore will not precipitate any change in current levels of output.

Schools of thought in late-20th century macroeconomics New Keynesianism is the view that market failures and microeconomic coordination failures give rise to macroeconomic instabilities that frequently cause economies to settle at less-than full employment equilibrium, that both aggregate demand and aggregate supply are important determinants of output and employment, and that authorities can intervene with fiscal and monetary policy tools to stabilize an economy New Classicalism is the view that economies are inherently stable, that fiscal and monetary interventions tend to be destabilizing, and that cyclical fluctuations are caused by either real shocks to the economy or unanticipated policy shocks. New classicals generally express a preference for microeconomic policies aimed at fostering aggregate supply, and a predictable monetary policy to maintain price stability. Bernanke Mankiw Prescott Lucas

We’re all Keynesians now. Keynes or Keynesianism? The Employment Act of 1946: The Congress hereby declares that it is the continuing policy and responsibility of the Federal Government to use all practicable means consistent with its needs and obligations and other essential considerations of national policy … to promote maximum employment, production, and purchasing power. What is at stake in our economic decisions today is not some grand warfare of rival ideologies which will sweep the country with passion, but the practical management of a modern economy. What we need is not labels and cliches but more basic discussion of the sophisticated and technical questions involved in keeping a great economic machinery moving ahead. John F. Kennedy, 1962 We’re all Keynesians now. Richard Nixon, 1971

The Keynesian “revolution” Beyond all this stretched the ‘Keynesian Revolution’ – the logic and practice of managing economies so as to maintain full employment and avoid depressions like that of 1929 – 33. In the form Keynes left it, his Revolution was never wholly accepted; and the debate about its value and relevance, and its author’s place in the pantheon of thought and statesmanship, continues. Robert Skidelsky, John Maynard Keynes, Volume III, Fighting for Freedom, 1937 – 1946 (2000) Now, after more than three decades in the wilderness, Keynesian-style fiscal policy seems to be staging a comeback. “A stimulating notion,” The Economist, February 16, 2008.

Our problem is to work out a social organization Hayek and Keynes on free markets and social justice Our problem is to work out a social organization which shall be as efficient as possible without offending our notions of a satisfactory way of life.  John Maynard Keynes 1883 – 1946 The End of Laissez-Faire (1926) We must face the fact that the preservation of individual freedom is incompatible with a full satisfaction of our views of distributive justice Individualism, True and False (1945) Friedrich Hayek 1889 – 1992