Download Are we all Keynesians?

After the crisis:
Are we all Keynesians?
Marc Lavoie
But first what is Keynesian economics?
• New Keynesians
– Nominal rigidities
– Real rigidities
– Coordination problems, multiple equilibria
• New Consensus Keynesians (New neoclassical synthesis:
endogenous money, real business cycles, rigidities)
• Post-Keynesians
– Fundamentalist Keynesians
– Kaleckians/Kaldorians
– Neo-Ricardian Keynesians
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What defines Keynesians? Is it a belief ….
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In the existence of involuntary unemployment
In the principle of effective demand and the paradox of thrift
In the existence of an independent investment function
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That capitalism is the best system but that it needs to be tamed
That markets, especially financial markets, are inherently unstable
The need for capital movement impediments, managed exchange rates
The need for fiscal counter-cyclical policies
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In animal spirits and fundamental uncertainty
In path dependence, multiple equilibria, and hysteresis
In the non-neutrality of money, the significance of liquidity
The dangers of wage and price deflation
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In the existence of imperfections that thwart price adjustments
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The question in the title seems to imply that
Keynesianism is making a comeback.
Was Keynesianism ever set aside?
• The answer is yes and no.
• Clearly, in academia, Keynesianism was a dirty word in the late
1970s and early 1980s, and it is only in the late 1980s and early
1990s that the New Keynesians made it respectable again.
• In academia, macroeconomics was built on three concepts: the
natural rate of unemployment hypothesis, supply-side
economics, and the exclusive reliance on monetary policy.
• Any attempt at using fiscal policy as an expansionary measure
had to be thwarted by a compensatory action of the monetary
authorities, through an increase in interest rates.
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Was Keynesianism ever set aside?
• However, at the policy level, at least in several of the rich
industrialized countries, “the macroeconomic research of the
past three decades has had only minor impact on the practical
analysis of monetary or fiscal policy” (Mankiw 2006).
• Policy makers and international organizations still opt either for
the simple Keynesian counter-cyclical policies or for simple preKeynesian policies (cf. James Galbraith 1994-5).
• Central bankers have reverted to interest-rate targeting, as
argued in the days of the Radcliffe committee 50 years ago,
which was influenced by Cambridge Keynesians.
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The financial crisis has brought about
mistrust in free markets
• G20 leaders have moved away from unfettered
markets and uncontrolled capitalism; financial
regulation is back.
• According to Gordon Brown (UK), author of the
‘golden rule’:
“The Washington consensus is out”;
• Financial Times: “The credit crunch has destroyed
faith in the free market ideology”.
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The financial crisis has brought about a
second Keynesian pragmatic revolution
• In 2009, there was a “Keynes moment” when nearly all
governments implemented fiscal stimulus packages.
• These were based on Keynesian demand-side ideas regarding
the merits of running budget deficits in times of recession.
• These ideas, defended by policy makers, were in strong conflict
with the views of most academic economists who had been
trained for decades to believe that budget deficits are
destabilizing because they would ultimately lead to higher
interest rates and higher rates of inflation, thus requiring
deflationary monetary policies.
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The pragmatic revolution is not yet over
• In contrast to previous financial crises, the IMF has advocated
low interest rates and government stimulus packages with
budget deficits for industrialized countries.
• G20 press releases, often based on IMF advice, keep calling for
stimulus packages in countries that can afford it.
• Still today (this week), the IMF is begging the USA not to hit the
« fiscal wall » and to act upon its « debt ceiling ».
• However, as early as the Fall of 2009, G20 press releases were
asking governments to prepare medium-term fiscal
consolidation plans, so as to retain credibility and provide
sustainable sovereign debt ratios.
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The financial crisis has brought about
a hybrid view, the “new fiscalism”
• The concern with debt sustainability does not necessarily mean
a return to « sound finance », and does not imply that the
expansionary fiscal policies were misguided.
• Most policy makers would still argue that these Keynesian
policies were necessary in the midst of the financial crisis.
• What we have is a form of new fiscalism (Mario Seccareccia),
which is neither traditional sound finance nor Keynesian
functional finance (of the Abba Lerner type).
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Is there also a second Keynesian academic
revolution? A rather negative answer:
“These changes in ideology among world politicians
create a different environment for economists. But as
yet there are no strong shifts of opinion or practice
among academic leaders of our profession. We
search in vain for similar conversions or recantations.
The signs are business as usual” (Hodgson, CJE
2009)
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But there are indeed some academic leaders
that reject current mainstream macro theory
• Richard Posner, University of Chicago Law school, 2009:
– « Keynes wanted to be realistic about decision-making
rather than explore how far an economist could get by
assuming that people really do base decisions on some
appromimation of cost-benefit analysis ».
• Akerlof and Shiller, 2009, p. 168:
– « It is necessary to incorporate animal spirits into
macroeconomic theory in order to know how the economy
really works. In this respect the macroeconomics of the past
thirty years has gone in the wrong direction. In their attempt
to clean up macroeconomics and make it more scientific, the
standard macroeconomists have imposed a research
structure and discipline by focusing on how the economy
would behave if people had only economic motives and they
were also fully rational ».
Brazilian Keynesian
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Association,
AFEP
Porto
Paris
Alegre,
2012 September 2009
And others have even a harsher diagnostic
• Willem H. Buiter 2009, LSE professor, former member of the
Monetary Policy Committee of the Bank of England:
• « The typical graduate macroeconomics and monetary
economics training received at Anglo-American universities
during the past 30 years or so [Lucas,Prescott, Sargent, Barro,
Woodford], may have set back by decades serious
investigations of aggregate economic behaviour and economic
policy-relevant understanding. »
• « Most of the profession continued to swallow the EMH [efficient
market hypothesis] hook, line and sinker, although there were
influential advocates of reason throughout, including James
Tobin, Robert Shiller, George Akerlof, Hyman Minsky, Joseph
Stiglitz and behaviourist approaches to finance. »
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This is unlikely to change mainstream
scholarly activity in macroeconomics however
• While there is a certain amount of tolerance in microeconomics,
with experimental economics and behavioural economics at the
vanguard, game theory and multi-agent modelling, things are
very much different in macroeconomics.
• David Colander, who claims that mainstream theory has
changed, gives many examples of tolerance in microeconomics,
but few or none in macroeconomics.
• Indeed, the accepted framework for macroeconomics has
become more orthodox and stringent (Dutt 2003, King 2008).
• Experience as a recent writer for the Canadian version of the
Baumol and Blinder principles of economics textbook has shown
that it is much easier to introduce heterodox themes and
critiques in microeconomics than it is to do so in
macroeconomics.
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There is a very strong counter-revolution
against the revival of Keynesian economics
• It is claimed by defenders of the market faith that government
intervention and bad regulation were the causes of the crisis.
Free-market capitalism is essentially perfect and stable.
– The US government would have forced banks to grant
subprime loans.
– The Fed set short-term rates at too low a level (from 2002 to
2004).
– The Chinese rigged the exchange rate and flooded longterm bond markets, also leading to overly low long-term
rates.
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The counter-revolution against the revival of
Keynesian economics
• There would be no crises if government was small and interest
rates were always set at their natural levels.
• Stimulus packages have and have had no impact on aggregate
output (J.B. Taylor).
• Expansionary fiscal policy and low interest rates will prolong the
crisis, as it did in the 1930s.
• Measured unemployment is of a structural nature, not of a
cyclical nature, therefore we need more structural reforms, that
is, more flexible labour markets, and less protection for the
workers.
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There is a very powerful counterrevolution in European policy circles
• Pragmatism is lacking in European policy circles.
• The ECB still does not want to purchase large amounts of
government securities, thus acting as the purchaser of last
resort, and thus insuring sustainable interest rates for all
eurozone sovereign debt.
• Eurozone politicians, including UK ones, still believe TINA; that
austerity policies are the only possible solution; that more
restrictions on fiscal deficits will do the trick; that more
« Maastricht-type » rules will solve their economic problems.
• They believe that deficit reduction will increase confidence and
hence will stimulate the economy (a possible effect noted by
Keynes himself).
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What will be the impact of the financial crisis
on economics at large?
• In the short run, many more students should take economics,
trying to understand what has happened.
• It is unlikely that economics students will be provided with any
convincing answer. As a result, in the medium run, there should
be even less students than before in (orthodox) economics
department as students will be disillusioned.
• Government employers are themselves disillusioned with
economics, as the financial crisis has demonstrated the futility of
economic advice and theories.
• In the long run, economics departments may become like
departments of philosophy, theology, or ancient greek.
• They might be supplanted by fields such as public policy, public
affairs, international affairs, public administration, or others (C.
Goodwin 2000).
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What will be the final impact of the crisis on
academia? Three possibilities
• Mainstream macroeconomics will become ever more entrenched in
its models and assumptions : the New consensus model, which is a
variant of the real business cycle model with some rigidities, will be
slightly amended, banks and behavioural economics will be added,
and all other approaches will still be dismissed.
• A second possibility, least likely, is that there will be more tolerance
with respect to other theories, even if it does not incorporate the
intertemporal utility maximizing representative agent with rational
expectations, but only as long as the theories are formalized in
some way.
• A third possibility is that macroeconomics will be split into two parts:
one presumed to be valid in normal times, which will correspond to
mainstream macro, and another one, which will be valid in
depression times.
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A dual macroeconomics
• Richard C. Koo wrote a book, The Holy Grail of
Macroeconomics: Lessons from Japan’s Great Recession,
2007.
• His argument is that mainstream theory (profit-maximization) is
valid in normal times, but that it is not in depression times (debtminimization): the yin and the yan.
• A similar dual macroeconomics is proposed by DeLong and
Summers (2012), and also by Paul Krugman (Depression
Economics)
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Koo’s dichotomy
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DeLong and Summers’ dichotomy
• In depression times or severe downturns:
– Absence of supply constraints;
– Monetary policy is constrained by the zero lower bound;
– The fiscal multiplier is positive, possibly as high as 1.5;
– There are hysteresis effects: higher actual output will raise
potential output or even the growth rate of potential output
(cf. Leon-Ledesma and Thirwall 2002 CJE): high rates of
utilization generate high rates of investment.
– Fiscal expansion will be self-financing under very weak
conditions, i.e., the debt ratio will not rise in the future (cf.
Abba Lerner’s functional finance).
• But in normal times, the fiscal multiplier is zero!
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Any other change in macroeconomics?
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Change of the benchmark economy (supply-side growth model);
Focus on credit rather than on money;
Rejection of the money multiplier story;
Rejection of the HPM-Money-Prices relationship;
Revision of the principal-agent approach;
Revision of « rational » behaviour and « efficient markets »:
Minsky’s euphoria;
• Revision of the negative effects of moderate inflation;
• Reconsideration of leverage, risk premia.
• Positively-sloped AD curve, negatively-sloped MP curve
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Falling wages with an upward-sloping
AD curve
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Fiscal expansion with a downwardsloping MP curve
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Conclusion: Are we all Keynesians?
• The financial crisis will provide more room for
dissenters in macroeconomics.
• But it is unlikely to improve the fate of heterodox
dissenters, including post-Keynesians or Marxists,
within departments of economics
• However the standing of heterodox dissenters may
improve in departments other than economics (social
sciences, public administration, etc.)
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