The legacy of John Maynard Keynes

John Maynard Keynes was born on June 5th, 1883. He died aged 62 in 1946, having left an enduring legacy on the world, not all of it good. He effectively founded modern macroeconomics, and left his name to a school of economic thinking called Keynesian economics. He thought that economic activity was ultimately determined by aggregate demand, or total spending in the economy. High interest rates, which can attract savers, can result in inadequate aggregate demand, leading to periods of high unemployment.

During recessions, therefore, governments should intervene with spending, pushing forward with such things as infrastructure projects and public works, borrowing the money to back them. He thought the deficit spending could be used to stimulate economic activity and employment. The debts could be paid off in times of economic growth. The basis of Keynesian economics is thus economic management, in which governments are supposed to smooth the economy, putting out money when it is sluggish, and taking it in when it is booming. Intervention via fiscal and monetary policies was to be used to micromanage the economy.

During the Depression of the 1930s, this was music to the ears of politicians. Instead of waiting for the economy to recover, here appeared to be a formula by which they could prod it into recovery. Keynes’ ideas came along at an opportune time, providing a theoretical justification for politicians to spend money and to be seen to be doing something. In democratic societies politicians tend to favour policies that go down well at the ballot box, and here were opportunities for them to buy the support of various interest groups through spending programmes for which they could claim Keynesian justification.

Keynesian economics gave politicians the excuse to go far beyond anything Keynes himself would have supported, borrowing from the future, for example, to fund the social programmes of today. This is attractive to politicians because today’s people have the vote, but tomorrow’s do not (not today, that is).

Post World War II, the Keynesian approach came in for sustained theoretical criticism, notably from Milton Friedman’s monetarism and F A Hayek’s Austrian School. It was pointed out that Keynesian policies could bring about “stagflation,” the combination of stagnation and inflation, something that should not happen under Keynesianism. Inflation and unemployment were thought to be trade-off, as in the Phillips Curve - high inflation went with low unemployment. Unfortunately in the 1970s the Phillips “Curve” became a vertical line, as soaring inflation brought no reduction in unemployment, and the stagflation predicted by the monetarists appeared in reality. Keynesian economics became a minority view.

Keynesianism came briefly back into fashion following the Financial Crisis of 2007-2008, as indeed did Marxism, but both depend on the notion that governments, or the few individuals who direct them, can second guess economic events with more precision and accuracy than the millions of people who participate daily the real economy. More recent criticism suggests that when politicians use Keynesian methods to “smooth” the business cycle, the are depriving the economy of its beneficial effects, which include shedding failing businesses during downturns, and redeploying capital to newer, more successful ones that can stimulate the upturns.