why keynesianism failed

7/31/2019 Why Keynesianism Failed

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Why KeynesianismWhy Keynesianism

FailedFailedVictor V. Claar, Ph.D.Hope College

Acton UniversityJune 11, 2008


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Remarks based on . . .Remarks based on . . .

Chapter 7 of

Economics inChristian

Perspective:Theory, Policy andLife Choices

by Victor V. Claar

and Robin J. Klay.IVP Academic, 2007.


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John Maynard KeynesJohn Maynard Keynes

British economist, 1883-1946

Fatherand namesakeof Keynesianmacroeconomics

Began with his 1936book, The GeneralTheory of Employment,

Interest, and Money


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Pre-KeynesianPre-KeynesianMacroeconomicsMacroeconomics

Classical MacroeconomicsThe first classical macroeconomists

worked primarily in the 18th and 19thcenturies

Included

Adam Smith David Ricardo J.S. Mill


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The Classical ViewThe Classical View

Markets work well (Smiths invisiblehand)

Economies fluctuate, and growth

rates will both rise and slow overtime

Government intervention cannot

improve upon the spontaneousordering of markets in theirmovements of resources from less-

valued to more-valued uses


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Doubt Shadows ClassicalDoubt Shadows ClassicalMacroMacro

Great Depression,1929-39

In 1933, the US

economy operatedat about 70percent ofcapacity

25 percentunemployment inthe same year


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Extreme pessimism about the self-correcting power of market forces

State ownership and planning beganto look increasingly attractive as analternative

While classical macro suggested thedepression would end, it offered noquick fixes


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Keynesian EconomicsKeynesian Economics

Stresses the inherent instabilityofan market economy, and the needfor active policy intervention to

achieve . . .

Full employment of resources

Sustained growth


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The intuition

Recession and high unemploymentare due to insufficient spending inthe private sector by:

Firms, on new capital and equipment

Consumers, on goods and services


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The remedy

The appropriate role of government

is to step in and shore up the gap inspending, using deficit financing ifnecessary

That is, if people are hurting today,and we have the power to relievetheir suffering through policy, then

we must do so


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Obvious Keynesian DownsidesObvious Keynesian Downsides

Critics of Keynes knew such actions while pain-reducing in the short-run, would inevitably lead to two

longer-term macro problems: Inflation

Slower rates of long-term growth

Keynes had already admitted asmuch in his Tract on MonetaryReform (1923), but In the long run

we are all dead (p.65).


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Inertia of Keynesian ThoughtInertia of Keynesian Thought

Gained inertia, and by the 1950s hadevolved into the mainstream inmacroeconomic thought

Major Keynesian figures includeJohn Kenneth Galbraith (Harvard)

James Tobin (Yale)

Famous misquoting of Milton Friedman in

Time:We are all Keynesians now. (Dec. 31,

1965)


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But Keynesianism Has FailedBut Keynesianism Has Failed

Keynesianpolicy recommendationshave proved to be bad advice

Further, Keynesianism has failed asan accurate macroeconomic model

So why has it failed on both counts?Lets look at each


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Why Keynesianism FailedWhy Keynesianism Failed

Keynesian economics is bad policyadvice because of Crowding out

=> Slower long-term growth ofthe economy

A poor mix of goods during recession,and excess capacity in some industriesafter the recession ends

Potentially poor timing of actions


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Why Keynesianism FailedWhy Keynesianism Failed

Keynesian economics oversimplifiesmacroeconomic dynamics

In the Keynesian view, it should bepossible to reduce unemployment byincreasing government spending ongoods and services (and/or increasing

the money supply)=> there should be an empiricallyobservable tradeoff betweeninflation and

unemployment


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The Phillips CurveThe Phillips Curve

This expectedinverserelationshipbetweenunemploymentand inflationrates is named

for NewZealandeconomist A.W.Phillips

Th B kd f h PhilliTh B kd f h Philli


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The Breakdown of the PhillipsThe Breakdown of the PhillipsCurveCurve

Inflation and unemployment rates in the U.S.,

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Unemployment Rate (%)

InflationRate(%)


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The Breakdown of the PhillipsThe Breakdown of the PhillipsCurveCurve

What had the Keynesians missed?

Simply put, for active policy to beeffective, it must be unanticipated

When Keynesian-style policy actions areanticipated, people take actions that

frustrate the policymakers intentions

The policy ineffectiveness proposition


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The Policy IneffectivenessThe Policy IneffectivenessPropositionProposition

Keynesians believed they could stimulatedemand for good and services, and thatfirms would then hire, for example, moreworkers at an unchanging wage rate

But if workers anticipate such actions,and understand that they create inflation,theyll begin asking for higher wages

Faced with higher labor costs, firms wontbe able to hire back workers and increaseoutput after all


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Why Did Keyness Ideas CatchWhy Did Keyness Ideas CatchOn?On?

1. Very bad, never before seen, economictimes

2. Politicians embraced Keynesian ideasquickly because they promised a silverbullet, and also gave them anotherargument for why we need them

3. Sir John Hicks interpreted the GeneralTheoryfor the profession, and later

confessed he may have misunderstood


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Why Did Keyness Ideas CatchWhy Did Keyness Ideas CatchOn?On?

4. The trend increased the mathematicalrigor in economics probably a usefuldevelopment on balance, though theKeynesian models lacked seriousmicrofoundations

5. It wasnt until the start of the 1940s thatearly monetarists began to realize thatmoney was an active factor in thedownswing of the early 1930s

6. Keyness peers were either too easilyswayed or not vocal enough in their

reservations


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Has Keynes SufferedHas Keynes Sufferedan Ideological TKO?an Ideological TKO?

In the 1970s we got in serioustrouble by being good Keynesians when we increased the money

supply in response to a slowdowncaused by OPEC oil shocks

=> rapid inflationary spirals

What are we doing today as oilprices rise? Have we learned our

lesson?


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What is the motivation behind thestimulus checks we are receiving in theU.S.?

One could argue that it is a supply-sideeffort if one believes that governmentspending will fall (i.e., that it reallyis atax cut)

But otherwise, this is a Keynesianattempt to use government spending to

purchase more good and services; but atleast we are decidin what to bu on the


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Basic Information on the Stimulus PaymentsUpdated April 17, 2008

You've heard about it. Now find out how to get yours.

What is it? It's an economic stimulus payment that more

than 130 million households will receive starting inMay. It's not taxable, and it won't reduce your 2007 or2008 refund or increase the amount you owe whenyou file your 2008 return.


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ConclusionConclusion

Has Keynesianism failed?

Yes

Is it still alive and well as a policycrutch?

Yes

why keynesianism failed

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