The Godley–Tobin lecture*: Keynesian economics – back from the dead?
Robert Rowthorn
Keywords: macroeconomics; Keynesian economics; Keynes; MMT
Published in print:Jan 2020
Category Research Article
DOI:https://doi.org/10.4337/roke.2020.01.01Pages:1–20
Download PDF (230.2 KB)
This paper surveys some of the main developments in macroeconomics since the anti-Keynesian counter-revolution 40 years ago. It covers both mainstream and heterodox economics. Amongst the topics discussed are: New Keynesian economics, Modern Monetary Theory, expansionary fiscal contraction, unconventional monetary policy, the Phillips curve, hysteresis, and heterodox theories of growth and distribution. The conclusion is that Keynesian economics is alive and well, and that there has been a degree of convergence between heterodox and mainstream economics.
Download PDF (230.2 KB)
This paper surveys some of the main developments in macroeconomics since the anti-Keynesian counter-revolution 40 years ago. It covers both mainstream and heterodox economics. Amongst the topics discussed are: New Keynesian economics, Modern Monetary Theory, expansionary fiscal contraction, unconventional monetary policy, the Phillips curve, hysteresis, and heterodox theories of growth and distribution. The conclusion is that Keynesian economics is alive and well, and that there has been a degree of convergence between heterodox and mainstream economics.
1 INTRODUCTION
When Thomas Palley asked me to give this year's Godley–Tobin Lecture, he suggested that I might present my views about modern developments in macroeconomics. At first, I baulked at the idea of covering such a vast field, but then I decided it would be an interesting challenge.
To the extent that there is one, the underlying theme of my lecture is that, since the initial anti-Keynesian counter-revolution 40 years ago, Keynesian economics has made something of a comeback. It would be an exaggeration to say that ‘we are all Keynesians now’, but surveys indicate that many leading economists in the USA and the UK have Keynesian sympathies (CFM 2014; IGM Forum 2014).
2 BACKGROUND
Forty years ago macroeconomics was dominated by Keynesians. Many of their views could be traced back to Keynes, although there had also been various innovations by authors such as Alvin Hansen, John Hicks, Abba Lerner and William Phillips. The defining features of Keynesian economics included a rejection of Say's law: the notion that supply creates its own demand; the paradox of thrift whereby an attempt to save more may result in less total saving because of its negative impact on aggregate income; a clear distinction between saving as abstention from consumption and investment as expenditure on productive capital; the view that saving and investment are brought into equality by variations in aggregate income.
Keynesians believed that a capitalist economy is crisis-prone and in the absence of an external stimulus may get stuck in a prolonged depression. They believed that conventional monetary policy is ineffectual in such a situation – ‘like pushing on a string’ – and that fiscal policy (tax cuts, more government expenditure) is a more effective way to promote recovery. This was probably their most important tenet. Some Keynesians believed that persistent unemployment is explained by the (inescapable) downward rigidity of money wages. Others disagreed. Some Keynesians believed in the existence of a stable trade-off between unemployment and inflation (the Phillips curve). Some believed in the importance of dynamic returns to scale (Verdoorn's law, learning by doing). Like Keynes himself, many stressed the importance of radical uncertainty in economic behaviour as opposed to quantifiable risk which is such a prominent feature of modern dynamic stochastic general equilibrium (DSGE) models.
By the late 1960s, and especially during the oil crisis of the 1970s, governments were finding it difficult to reconcile full employment with low inflation. This failure led to a backlash against Keynesian economics and ensured a hearing for economists who rejected much of the Keynesian heritage. These were known as the ‘New Classical economists’ – not to be confused with Neoclassical (Hoover 1988).
The main theoretical innovations of the New Classical economics were: the Lucas critique, microfoundations, time inconsistency and rational expectations. I should like to discuss these topics in depth, but there is no time.
When Thomas Palley asked me to give this year's Godley–Tobin Lecture, he suggested that I might present my views about modern developments in macroeconomics. At first, I baulked at the idea of covering such a vast field, but then I decided it would be an interesting challenge.
To the extent that there is one, the underlying theme of my lecture is that, since the initial anti-Keynesian counter-revolution 40 years ago, Keynesian economics has made something of a comeback. It would be an exaggeration to say that ‘we are all Keynesians now’, but surveys indicate that many leading economists in the USA and the UK have Keynesian sympathies (CFM 2014; IGM Forum 2014).
2 BACKGROUND
Forty years ago macroeconomics was dominated by Keynesians. Many of their views could be traced back to Keynes, although there had also been various innovations by authors such as Alvin Hansen, John Hicks, Abba Lerner and William Phillips. The defining features of Keynesian economics included a rejection of Say's law: the notion that supply creates its own demand; the paradox of thrift whereby an attempt to save more may result in less total saving because of its negative impact on aggregate income; a clear distinction between saving as abstention from consumption and investment as expenditure on productive capital; the view that saving and investment are brought into equality by variations in aggregate income.
Keynesians believed that a capitalist economy is crisis-prone and in the absence of an external stimulus may get stuck in a prolonged depression. They believed that conventional monetary policy is ineffectual in such a situation – ‘like pushing on a string’ – and that fiscal policy (tax cuts, more government expenditure) is a more effective way to promote recovery. This was probably their most important tenet. Some Keynesians believed that persistent unemployment is explained by the (inescapable) downward rigidity of money wages. Others disagreed. Some Keynesians believed in the existence of a stable trade-off between unemployment and inflation (the Phillips curve). Some believed in the importance of dynamic returns to scale (Verdoorn's law, learning by doing). Like Keynes himself, many stressed the importance of radical uncertainty in economic behaviour as opposed to quantifiable risk which is such a prominent feature of modern dynamic stochastic general equilibrium (DSGE) models.
By the late 1960s, and especially during the oil crisis of the 1970s, governments were finding it difficult to reconcile full employment with low inflation. This failure led to a backlash against Keynesian economics and ensured a hearing for economists who rejected much of the Keynesian heritage. These were known as the ‘New Classical economists’ – not to be confused with Neoclassical (Hoover 1988).
The main theoretical innovations of the New Classical economics were: the Lucas critique, microfoundations, time inconsistency and rational expectations. I should like to discuss these topics in depth, but there is no time.
READ ON
- Appreciation of the Keynesian synthesis was enhanced by the events of the last decade. The global financial crisis highlighted the fragility of financial markets and the capriciousness of animal spirits. The depth of the downturn pointed to the value of not just automatic stabilizers but also discretionary fiscal policy as tools of macroeconomic management. Keynesian models and not their New Classical challengers provided the practical analytical framework for policy design. Models of the anti-Keynesian effects of fiscal consolidation received little support from actual consolidation experience. The secular-stagnation debate that followed the crisis lent legitimacy to the view that policy-makers with fiscal space were wise to use it.
Full Text
1 INTRODUCTION
A symposium with the title ‘Keynesian economics – back from the dead?’ begs two questions. Does everyone mean the same thing when they say Keynesian economics? And who says it died in the first place?
My own interpretation of Keynesian economics derives from two sources. The first is James Tobin – appropriately for a symposium organized around the Godley–Tobin Lecture – from whom I took graduate macro- and monetary economics. Tobin's definition of Keynesian macroeconomics, as he taught it or at least as I learned it, was Hicks's IS–LM model augmented with a financial sector distinguishing assets with different durations and risk characteristics, where asset demands were specified consistently and subject to explicit stock–flow relationships and adding-up constraints (see Tobin 1969; Brainard and Tobin 1968).
The second source was discussions and debates with Alec Cairncross, with whom I collaborated in the 1980s. Alec and I had friendly disagreements about how to model monetary and fiscal policies in the three devaluations of sterling about which we were writing. 1 Specifically we disagreed about whether monetary policy was still effective in an environment of low interest rates, or whether the economy was entirely dependent on fiscal policy for impetus under such circumstances. Having been one of the co-authors of the Radcliffe Report (Radcliffe Committee 1959), Alec doubted the existence of a stable link between monetary policy and economic activity in the presence of low interest rates, and for that matter in a variety of other circumstances. I explained what I had learned at the knee of Tobin: that monetary policy, by altering relative supplies of different financial assets, as in the case of Operation Twist, the Federal Reserve's early 1960s experiment, could still influence relative returns, portfolio allocations, and investment and other spending decisions. Alec looked at me and responded, ‘Well, Keynes didn't see it that way when I was at Cambridge in the 1930s.’ That put an end to the matter.
A cat can't change its stripes. I will therefore argue that Keynesian economics in the sense of IS–LM augmented by a fully specified financial sector never died, although it may have gone into hibernation. If anything, its influence, intellectually and over policy, increased as a result of the global financial crisis. In contrast, the Keynesian argument that monetary policy has no impact on economic activity, in general and specifically at the zero lower bound, suffered a mortal blow as a result of this recent history. This particular aspect of Keynesian economics is not back from the dead. The 2008–2009 financial crisis and the policy response were just the last nails in its coffin.
- Central banks have recently pushed interest rates below zero. This was done after some considerable time with interest rates being near zero and unemployment remaining very high in many countries. The hope was that negative rates would reinvigorate monetary policy and rescue countries suffering from high unemployment and slow growth. This paper argues that negative rates are not an effective solution to the problems of high unemployment and economic stagnation, and that this policy proposal fails to understand both the nature of negative interest rates and how far interest rates might be pushed below zero percent. Rates a little bit below zero are possible because of insurance and carrying costs. Anything substantially below this would result in considerable economic harm that would exceed any economic benefits from the lower rates. This being the case, fiscal policy must be the policy of choice in difficult economic times.
Full Text
1 INTRODUCTION
Macroeconomics today is quite unlike macroeconomics in the past, particularly regarding interest rates. Homer and Sylla (2005) proffer no instances, throughout 5000 years of human history, of nominal interest rates going negative, although the Swiss National Bank did push rates on foreign deposits below zero in the 1970s to prevent capital inflows and currency appreciation. Yet shortly after the last edition of their classic work was published this was no longer true. During the Great Recession, central banks lowered interest rates below zero on bank reserves as a way around the zero lower bound (ZLB). Furthermore, $11.7 trillion of negative-yield sovereign debt has circulated, including $7.9 trillion of Japanese securities and more than $1 trillion of French and German securities (Durden 2016).
This paper examines whether negative interest rates can help developed nations solve their current macroeconomic problems. It answers ‘no’ because there are limits to how far rates can be pushed below zero, and because, at some point, negative interest rates do more harm than good. We proceed as follows. Section 2 provides a brief history of negative interest rates. Section 3 explains why rates cannot be pushed very far below zero. Sections 4 and 5 explain why interest rates a bit below zero cannot solve serious macroeconomic problems. Section 6 concludes by arguing for a revitalized fiscal policy.
No comments:
Post a Comment