Maynard Keynes was not a God, not even a Son of God, as so many of his immediate disciples appear to have believed. Like everyone else, he was just a human being. Unlike his disciples, however, Keynes was really smart, with a flexible mind that adjusted rapidly to changes in the economic environment. Unlike his disciples, Keynes regularly left his academic cloisters at Kings College to engage significantly in the real world. He did not dwell monk-like, exclusively in the unrealistic world of a cloistered intellectual prison. So Keynes was well aware that general price levels move up and down in response to economic circumstances, sometimes violently so. How could anyone with eyes not be so aware, living, as he lived, through the volatile years book-ended by the two Great Wars?
The much dimmer bulbs that worshipped at his Shrine do not appear to have embraced that knowledge, or at least must have suppressed it because it did not fit well into the mechanistic figments that captured their fevered minds. For the early disciples – Alvin Hansen, John Hicks, Paul Samuelson – the macro-economy was a peculiar laboratory, an environment in which all prices, be they wages, product prices or interest rates, were always rigid downwards, irrespective of the level of aggregate demand, an environment in which economies more or less were permanently under-employed, and where, therefore, inflation safely could be ignored. In such a world, aggregate demand alone drove the level of activity in the macro-economy. Aggregate supply was some passive agent, a 45 degree line in real income-real expenditure space, responding phantom-like to changes in demand.
Thus was born the notion of the inverted L; thus were countless numbers of economic majors crucified on (St. Paul) Samuelson’s Keynesian Cross; thus were the same countless legions indoctrinated into the curious cult of an IS-LM world, a world in which everything is real, where real and nominal values are identical, and where there is no role for price as an adjustment mechanism.
I often reflect sadly on how many of the minds of the more inquiring freshman must have became distraught as they fought to reconcile the two halves of Samuelson’s introductory text, the one (microeconomics) where prices played a key equilibrating role and the other, macroeconomics, where they played no role whatsoever. No wonder that so many so-called cutting-edge economists appeared to verge on the borderline of schitzophrenia, as they moved from microeconomic to macroeconomic analysis.
Well, it turns out that the IS-LM cult of hydraulic Keynesianism was perfectly adapted to the notion that a fiscal stimulus is the only mechanism capable of moving an under-employed economy to full employment. For, with interest rates inflexible downwards, the economy is locked in a liquidity trap and money does not matter; one cannot push on a string. Even if one can push slightly on a string – let us not be too observant since a modicum of modesty is quite becoming – investment will not respond much, if at all, to interest rate adjustments.
Thank God, therefore, for Big G, the Holy Grail of the Keynesian Religion. Fire the fiscal furnace, raise taxes as necessary, and rely on the balanced budget multiplier to do the job. And since we Saltwater Economists worship FDR, and are enamored of big government, what’s not to like in this Brave New World? In the famous words of Harry Hopkins, FDRs loyal spokesman (and closet communist): ”We will tax and tax, and spend and spend, and elect and elect”. (Well, in retrospect, as Massachusetts recently has demonstrated, maybe not always elect and elect!)
I have labeled this column, Why Obama’s Stimulus Package Has Failed, notwithstanding the thrust of the column itself, because I am supremely confident that you, dear reader, will see through the fraud that was perpetrated upon an unwary Western World. That the fraud lasted some 15 years, before it was exposed for what it is, is testament to the fact that we are all human beings, and that we are all capable of suspending reason when confronted by arguments from people that we are taught to revere.
In any event, in tomorrow’s column, I shall dissect the Keynesian cult in terms of its much superior, if still flawed successor, New Keynesian economics…