Keynes and the crisis

Robert Skidelsky thinks our crisis revives Keynes’s thinking:

What was left out of the mainstream economics of his day, and its “post-Keynes” successor, was the acknowledgement of radical uncertainty. “The outstanding fact,” he wrote in his magnum opus, The General Theory of Employment, Interest and Money (1936) “is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made…we know very little about the future”.

Ignorance of the future leads to waves of irrational exuberance and panic. And when panic sets in, there’s a flight to cash and an unwillingness to lend so great that, in Skidelskly’s words:

that there may be no automatic barrier to the slide into depression, unless a government intervenes to offset extreme reluctance to lend by huge injections of cash into the economy.

This raises (at least) three issues.
1.Is a flight to cash really a cause of a downturn, or a symptom of it? Keynes wrote:

A more typical, and often the predominant, explanation of the crisis is, not primarily a rise in the rate of interest, but a sudden collapse in the marginal efficiency of capital. (General Theory ch 22)

The marginal efficiency of capital, stressed Keynes, depended upon “animal spirits” as much as real factors such as the causes of actual profits. However, this suggests that Keynes, like Marx, saw crises as originating in the “real“ economy - and in attitudes thereto - more than the financial system. Which means it's not clear that our current crisis is especially "Keynesian."
2. Why is radical uncertainty confined only to the private sector? If governments know no more than the private sector, they’ll be unable to prevent depression because they’ll no more see it coming than will the private sector. The best governments can do then will be to ameliorate the recession once it’s begun. But as Keynes himself acknowledged, slumps often tend to correct themselves eventually anyway.
3. Are injections of cash really the solution? If governments can’t see downturns coming, they might not be. Again, Keynes was explicit here.

With markets organised and influenced as they are at present, the market estimation of the marginal efficiency of capital may suffer such enormously wide fluctuations that it cannot be sufficiently offset by corresponding fluctuations in the rate of interest.

As injections of cash work by reducing interest rates, this means they are not the solution. Instead, Keynes had another:

The duty of ordering the current volume of investment cannot safely be left in private hands.

Now, by all means argue whether Keynes was right on this. But please don’t think Keynes thought booms and slumps could be prevented merely by pulling fiscal and monetary policy levers.

Comments

[anotherplanet]

"... as Keynes himself acknowledged, slumps often tend to correct themselves eventually anyway."

But, in the long run...

[MattYoung]

"The duty of ordering the current volume of investment cannot safely be left in private hands."

OK, using the arguments originally posted, this is wrong,very wrong. Do I need more arguments?

[Dipper]

off topic - Chris you have asked on a number of occasions whether Risk Managers were stupid, bankers stupid etc, and I've been trying to find the right way of explaining the pressures on bankers. Fortunately I've found this coment by a Tim West on Marginal Revolution that expresses it perfectly:

"One thing that I think gets left out is that it's not just a matter of understanding risk at the top of the management chain.

For any publicly held firm, if you can't persuade your shareholders that the risk is not worth the gains, you either join the risk takers or get kicked out. Given the difficulty of educating such a varied class (and that the indications of risk were fairly ambiguous), it was nigh impossible to avoid joining the risk-taking train even if there were severe doubts."

[Dipper]

sry Tom West - silly mistake

[Bob B]

Everyone to his/her own and for several reasons, I rather prefer this recent piece on Keynes in the FT by Ed Crooks:
http://www.ft.com/cms/s/0/a754a046-9c79-11dd-a42e-000077b07658.html

Doubtless, readers will make up their own minds anyway.

[Toronto realtor]

I am not so educated in economic theory, but there is written "The duty of ordering the current volume of investment cannot safely be left in private hands." How this can be done without using the fiscal and monetary tools, like budget deficit or lowering the interest rate? And the traditional libertarian comment - how the government can know more about the "right time to invest" than the private sector?
I believe Keynes' thoughts have been strongly presented in most of the world's governments. Politicians have always tried to "buy" economic growth...
Take care
Julie

[dearieme]

Perhaps it's time to revive the distinction between Keynes and the Keynesians?

[Brian Lee]

If we are sharing interesting sources on Keynes, I'd like to add - to the superb works by Skidelsky - the books by Donald Moggridge (especially his bio of Keynes) and Donald Markwell's book on "John Maynard keynes and International Relations: Economic Paths to War and Peace". Understanding what Keynes actually thought and why is important before deciding its contemporary and future relevance (which I thnik is very great, BTW).

[iron pimp hand]

It's hard to understand what Skidelsky since, as he half acknowledges in the article, keynes never really went away. All that really happened was the slight modification of having central banks slam on the breaks when it looks like inflation might become a problem.

Unless he thinks that it might be a good idea to nationalise investment then I cant see what insight of keynes approach to the trade cycle we are supposedly overlooking.

[Bob B]

"Perhaps it's time to revive the distinction between Keynes and the Keynesians?"

A goodly suggestion but as Greg Mankiw points out somewhere, it's often not clear what Keynes really meant and he was rather apt to endorse sympathetic but conflicting intepretations of his General Theory.

Hicks on: Keynes and the Classics hugely influenced student textbook presentations but its keynesian model is essentially a comparative-static presentation whereas the role of expectations are fundamental in Keynes's General Theory. Where are these expectations supposed to come from - are they exogenous to the model or endogenously determined?

If exogenous then post hoc the General Theory can explain away any macroeconomic events depending on what exogenous expectations are assumed in the analysis.

If endogenous then we enter the (dubious IMO) territory of rational expectations theory which is claimed by many of its exponents to re-establish Classical economics and its policy conclusions.

These are deep waters in which there has been much paddling.

[Bob B]

Is S&M not going to comment on the letter to the Telegraph by 16 "leading" economists? Quote:

SIR - Further to your interview with Alistair Darling (October 19), we would like to dissent from the attempt to use a public works programme to spend the country's way out of recession. It is misguided for the government to believe that it knows how much specific sectors of the economy need to shrink and which will shrink "too rapidly" in a recession.
Thus the government cannot know how to use an expansion in expenditure that would not risk seriously misallocating resources.

Furthermore, public expenditure has already risen very rapidly in recent years, and a further large rise would take the role of the State in many parts of the economy to such a dominant position that it would stunt the private sector's recovery once recession is past.

Occasional economic slowdowns are natural and necessary features of a market economy. Insofar as they are to be managed at all, the best tool is monetary and not fiscal policy. It is inevitable that government expenditure and debt naturally rise in a recession but planned rises in government spending are misguided and discredited as a tool of economic management.

If it is believed that this recession has features that demand more active fiscal policy, which is highly disputable, taxes should be cut. This would allow the market to determine which parts of the economy shrink and which flourish to replace them.

Notice there are apparently no reservations at all about pouring billions of public money into the retail banks in Britain to prop them up, public guarantees for bank deposits or reining back the Competition Commission from investigating the acquisition of HBOS by Lloyds TSB. I wonder why?