Friday, September 12, 2014

How Keynes Became A Dirty Word

Noah Smith understands that Keynes was not a socialist and that his ideas emerged during a period of high unemployment in which alternatives to free market capitalism were gaining credibility.  Keynes proposed some ideas to increase employment in order to preserve capitalism.  Somehow Keynesian ideas have become associated with socialism.  He attributes this primarily to a book written by Hayec who argued that government intervention into the economy puts us on a slippery slope to totalitarianism.  Smith then tells us that many conservative economists helped to develop the Neo-Keynesian approach to macroeconomic theory.  Neo-Keynesian theory is actually closer to the monetarist theories of Milton Friedman than it is to what Keynes wrote about.  It has nothing to do with socialism.

Smith is clearly correct about Neo-Keynesian theory as it is practiced today.  It has nothing to do with any form of socialism.  He is also correct when he states that is has little to do with many of the ideas that Keynes wrote about.  Keynes believed that the economy was inherently unstable and that it could come into equilibrium below the level required for full-employment.  He proposed ways in which the government should intervene in the economy in order to promote full-employment.  Those ideas run counter to the assumptions of rational expectations theory and the real business cycle that came out of the Chicago School of economics.  They assume that the economy is inherently stable, and that it is basically self-correcting.  It may be subject to exogenous shocks but prices will adjust and keep the economy on its long term trend.  Furthermore, efforts made by government to adjust the economy will fail because rational agents will change their behavior in response to actions taken by government.  The real battle within macroeconomics today has less to do with Hayec's debate with Keynes than it does to the rise of the Chicago School and the ideas of Robert Lucas.  That battle is invisible to most Americans.  Its a lot easier to provide an idea with a bad name than it is to understand the idea.

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