Category Archives: Keynesian Economics

A Keynesian Opportunity Missed. Did We Take Low Interest Rates for Granted? – NY Times. 

The era of superlow interest rates, which began in 2008, will draw to a close this year if, as expected, the Federal Reserve lifts rates to fend off inflation from tax cuts and spending increases under a Trump administration.

The end of rock-bottom rates represents a huge missed opportunity for generations of Americans. Congress could have — and should have — used those near-zero rates to borrow money to rebuild the country’s decrepit infrastructure, which would have sped up the recovery by creating jobs and set the stage for growth long into the future.

That chance was squandered. After Republicans won control of the House in 2010, they managed to shift the debate from economic-recovery spending to deficit reduction. They did this despite evidence that the still-weak economy required more, not less, federal aid, and even threatened to default on the national debt unless federal spending was slashed. In 2013 and 2014, the budget was cut so deeply that the government sector subtracted from economic growth. In 2015, the government added nothing to growth. In 2016, it added a smidgen.

New York Times

Keynes Reborn – Koichi Hamasaki. 

Large public debts are not always bad for an economy, just as efforts to rein them in are not always beneficial.

The focus on a balanced budget in the United States, for example, has led some elements of the Republican Party to block normal functions of state and even federal authorities, supposedly in the name of fiscal discipline. Likewise, the eurozone’s recovery from the 2008 financial crisis has been held back by strict fiscal rules that limit member countries’ fiscal deficits to 3% of GDP.

Contrary to popular belief, aggregate demand and the price level (inflation) are not dictated only – or even primarily – by monetary policy. Instead, they are determined by the country’s net wealth and the liabilities of the central bank and the government.

When government deficits are lower, investing in government debt becomes more attractive. As the private sector purchases more of that debt, demand for goods and services falls, creating deflationary pressure. If the central bank attempts to spur inflation by expanding its own balance sheet through monetary expansion and by lowering interest rates, it will cause the budget deficit to fall further, reinforcing the cycle. In such a context monetary policy alone would not be adequate to raise inflation; fiscal policy that increases the budget deficit would also be necessary.

John Maynard Keynes’ The General Theory of Employment, Interest, and Moneywhich argued for active fiscal policies, was published in 1936. Forty years later, a counterrevolution took hold, reflecting sharp criticism of fiscal activism. After another 40 years, Keynes’ key idea is back, in the form of the FTPL (fiscal theory of the price level). This may be old wine in a new bottle, but old wine often rewards those who are willing to taste it.

Project Syndicate 

How New Keynesian Economics Betrays Keynes – Roger E. A. Farmer. 

Classicals, Keynesians, and Bastard Keynesians. 

Macroeconomics is a child of the Great Depression. Before the publication of Keynes’ book, The General Theory of Employment, Interest and Money, macroeconomics consisted primarily of mon­etary theory.

Economists were preoccupied with price stability, as we are today, but the idea that government should control ag­gregate economic activity through active fiscal and monetary policy was absent.

There is no self-correcting market mechanism to return the boat to a safe harbor. We must rely on political interventions to maintain full employment. That is the essential insight of Keynes’ General Theory.

Hicks embraced the Keynesian idea that mass unemployment is caused by insufficient aggregate demand, and he formal­ized that idea in the IS- LM model.

The program that Hicks initiated was to understand the connection between Keynesian economics and general equi­librium theory. But, it was not a complete theory of the macro­economy because the IS- LM model does not explain how the price level is set. The IS- LM model determines the unemploy­ment rate, the interest rate, and the real value of GDP, but it has nothing to say about the general level of prices or the rate of inflation of prices from one week to the next.

To complete the reconciliation of Keynesian economics with general equilibrium theory, Paul Samuelson introduced the neoclassical synthesis in 1955. According to this theory, if un­employment is too high, the money wage will fall as workers compete with each other for existing jobs. Falling wages will be passed through to falling prices as firms compete with each other to sell the goods they produce. In this view of the world, high unemployment is a temporary phenomenon caused by the slow adjustment of money wages and money prices. In Samuelson’s vision, the economy is Keynesian in the short run, when some wages and prices are sticky. It is classical in the long run when all wages and prices have had time to adjust.

In Keynes’ vision, there is no tendency for the economy to self- correct. Left to itself, a market economy may never recover from a depression and the unemployment rate may remain too high forever. In contrast, in Samuelson’s neoclassical synthe­sis, unemployment causes money wages and prices to fall. As the money wage and the money price fall, aggregate demand rises and full employment is restored, even if government takes no corrective action. By slipping wage and price adjust­ment into his theory, Samuelson reintroduced classical ideas by the back door— a sleight of hand that did not go unnoticed by Keynes’ contemporaries in Cambridge, England. Famously, Joan Robinson referred to Samuelson’s approach as “bastard Keynesianism.”

The New Keynesian agenda is the child of the neoclassical synthesis and, like the IS- LM model before it, New Keynesian economics inherits the mistakes of the bastard Keynesians. It misses two key Keynesian concepts: (1) there are multiple equilibrium unemployment rates and (2) beliefs are funda­mental. My work brings these concepts back to center stage and integrates the Keynes of the General Theory with the mi­croeconomics of general equilibrium theory in a new way.

THE ECONOMIC CONSEQUENCES OF THE PEACE by JOHN MAYNARD KEYNES, C.B. Fellow of King’s College, Cambridge – Introduction. 

A warning for our times. 

The writer of this book was temporarily attached to the British Treasury during the Great War and was their official representative at the Paris Peace Conference up to June 7, 1919; he also sat as deputy for the Chancellor of the Exchequer on the Supreme Economic Council.

He resigned from these positions when it became evident that hope could no longer be entertained of substantial modification in the draft Terms of Peace.

The grounds of his objection to the Treaty, or rather to the whole policy of the Conference towards the economic problems of Europe, will appear in the following chapters.

They are entirely of a public character, and are based on facts known to the whole world.

J.M. Keynes. King’s College, Cambridge, November, 1919.



The power to become habituated to his surroundings is a marked characteristic of mankind. Very few of us realize with conviction the intensely unusual, unstable, complicated, unreliable, temporary nature of the economic organization by which Western Europe has lived for the last half century.
On this sandy and false foundation we scheme for social improvement and dress our political platforms, pursue our animosities and particular ambitions, and feel ourselves with enough margin in hand to foster, not assuage, civil conflict in the European family.

Moved by insane delusion and reckless self-regard, the German people overturned the foundations on which we all lived and built. But the spokesmen of the French and British peoples have run the risk of completing the ruin, which Germany began, by a Peace which, if it is carried into effect, must impair yet further, when it might have restored, the delicate, complicated organization, already shaken and broken by war, through which alone the European peoples can employ themselves and live.
Perhaps it is only in England and America that it is possible to be so unconscious.
In continental Europe the earth heaves and no one but is aware of the rumblings. There it is not just a matter of extravagance or “labor troubles”; but of life and death, of starvation and existence, and of the fearful convulsions of a dying civilization.

In this lies the destructive significance of the Peace of Paris.
If the European Civil War is to end with France and Italy abusing their momentary victorious power to destroy Germany and Austria-Hungary now prostrate, they invite their own destruction also, being so deeply and inextricably intertwined with their victims by hidden psychic and economic bonds.

The British people received the Treaty without reading it. But it is under the influence of Paris, not London, that this book has been written by one who, though an Englishman, feels himself a European also, and, because of too vivid recent experience, cannot disinterest himself from the further unfolding of the great historic drama of these days which will destroy great institutions, but may also create a new world.


1919 – Keynes predicts economic chaos

At the Palace of Versailles outside Paris, Germany signs the Treaty of Versailles with the Allies, officially ending World War I. The English economist John Maynard Keynes, who had attended the peace conference but then left in protest of the treaty, was one of the most outspoken critics of the punitive agreement. In his The Economic Consequences of the Peace, published in December 1919, Keynes predicted that the stiff war reparations and other harsh terms imposed on Germany by the treaty would lead to the financial collapse of the country, which in turn would have serious economic and political repercussions on Europe and the world.

In January 1919, John Maynard Keynes traveled to the Paris Peace Conference as the chief representative of the British Treasury. The brilliant 35-year-old economist had previously won acclaim for his work with the Indian currency and his management of British finances during the war. In Paris, he sat on an economic council and advised British Prime Minister David Lloyd George, but the important peacemaking decisions were out of his hands, and President Wilson, Prime Minister Lloyd George, and French Prime Minister Georges Clemenceau wielded the real authority. Germany had no role in the negotiations deciding its fate, and lesser Allied powers had little responsibility in the drafting of the final treaty.

The treaty that began to emerge was a thinly veiled Carthaginian Peace, an agreement that accomplished Clemenceau’s hope to crush France’s old rival. According to its terms, Germany was to relinquish 10 percent of its territory. It was to be disarmed, and its overseas empire taken over by the Allies. Most detrimental to Germany’s immediate future, however, was the confiscation of its foreign financial holdings and its merchant carrier fleet. The German economy, already devastated by the war, was thus further crippled, and the stiff war reparations demanded ensured that it would not soon return to its feet. A final reparations figure was not agreed upon in the treaty, but estimates placed the amount in excess of $30 billion, far beyond Germany’s capacity to pay. Germany would be subject to invasion if it fell behind on payments.

Keynes, horrified by the terms of the emerging treaty, presented a plan to the Allied leaders in which the German government be given a substantial loan, thus allowing it to buy food and materials while beginning reparations payments immediately. Lloyd George approved the “Keynes Plan,” but President Wilson turned it down because he feared it would not receive congressional approval. In a private letter to a friend, Keynes called the idealistic American president “the greatest fraud on earth.” On June 5, 1919, Keynes wrote a note to Lloyd George informing the prime minister that he was resigning his post in protest of the impending “devastation of Europe.”

“If we aim at the impoverishment of Central Europe, vengeance, I dare say, will not limp. Nothing can then delay for very long the forces of Reaction and the despairing convulsions of Revolution, before which the horrors of the later German war will fade into nothing, and which will destroy, whoever is victor, the civilisation and the progress of our generation.”

This Day In History 

Keynesian economics: is it time for the theory to rise from the dead? – Larry Eliot. 

Lessons were learned from the 1930s. Governments committed themselves to maintaining demand at a high enough level to secure full employment. They recycled the tax revenues that accrued from robust growth into higher spending on public infrastructure. They took steps to ensure that there was a narrowing of the gap between rich and poor.

The period between FDR’s second win and Donald Trump’s arrival in the White House can be divided into two halves: the 40 years up until 1976 and the 40 years since.

Keyne’s lessons were forgotten. (Hans: after the assault on western economies by the offspring of Saudi Arabia’s oil embargo of 1973: Hyper Inflation and the mistaken conviction that Keynesian economics was to blame.) Instead of running budget surpluses in the good times and deficits in the bad times, UK governments ran deficits all the time. They failed to draw the proper distinction between day-to-day spending and investment. In Britain, December 1976 was the pivotal moment. Matters came to a head in early December when a divided and fractious cabinet agreed that austerity was a price that had to be paid for a loan from the International Monetary Fund, which was needed to prop up the crashing pound.

Subsequently there was a paradigm shift. Labour had been reluctant converts to monetarism; the Thatcherites who followed were true believers. Controls on capital were lifted, full employment was abandoned as the prime policy goal, trade union power was curbed, taxes for the better off were cut, inequality was allowed to widen, finance waxed as manufacturing waned.

The Guardian