‘K’ for Keynesian Economics

From the NZ Initiative:

Keynesian Economics owes its name to a problematic economic theory, put forward in the late 1930s by a brilliant but mercurial English economist with a genius for advocacy and rhetoric, Lord John Maynard Keynes.

Keynes took so many positions on so many issues during his career that it became accepted wisdom, as Winston Churchill once observed, that if you asked two economists for a view you would get three opinions, two of them from Mr Keynes. More reliably, one of his eminent contemporaries, Sir Alex Cairncross, once remarked that Keynes would be “longest remembered for his ideas” but who “never said the same thing for long.”

Keynesian theory contentiously proposes that slumps and recessions are caused by a slump in total spending in the economy. A recession allegedly results because producers respond by reducing output and employment rather than prices and wages. This is because it is hard to reduce money wage rates in the short-term.

The posited drop in output reduces real incomes which further reduces spending, aggravating the recession. Adherents of this theory, Keynesians, call this additional decline a multiplier effect.

The original slump in spending may occur because consumers started saving too much, and spending too little. Keynesian economics refers to slumps due to under-consumption as ‘the paradox of thrift’.

Alternatively, investment spending may slump because investors irrationally lose confidence, or ‘animal spirits’.  

Keynes’ remedy was for governments to increase government spending and/or to print money in order to lower interest rates and simulate investment spending. The spending boost would have a multiplier effect on national income.

Politicians would not even have to worry much about the quality of the spending. Paying people to dig holes and fill them in again could be a fine thing. Keynes himself suggested burying gold bars at the bottom of a disused mine. Money spent excavating the useless mine would boost national income.

This theory is popular with governments because it supports government deficit spending and printing money in economic downturns, while not imposing any real offsetting discipline during upturns.

Keynes’ impatience to alleviate today’s slump by such means meant discounting the risk of causing more or bigger future slumps from public debt crises and/or the need to curb inflation. His ‘in the long run we are all dead’ riposte to those who pointed out that slumps were self-correcting in time came to epitomise his side of that debate.

Keynes is dead, but public debt crises live on.

I think what has happened in Europe shows the problems of following Keynes’ advice for too long.