Thursday, September 18, 2014

Why Keynes' Advice To The MacMillan Committee Was Rejected

The MacMillan Committee was formed during the Great Depression to discuss policies that might improve the employment situation in England.  Keynes told the committee that the government should increase its spending in order to compensate for the decline in private spending.  His advice was rejected.  A book about Keynes was recently published which explains why his advice fell on deaf ears. This article draws a parallel to the current situation in the eurozone.

Keynes had written a popular book which was critical of the Versailles Treaty. That placed him outside of the establishment, but his presentation was less coherent than it might have been because it conflicted with his argument against the Versailles Treaty and a return to the Gold Standard.  The Committee believed that an increase in government spending would "crowd out" private spending.  Its members could not understand why wages did not deflate in response to the labor surplus.  That would make English products more competitive and restore employment.  Britain had already agreed to return to the gold standard and it was not interested in currency deflation which would also have the effect of reducing the cost of British exports.  Wage deflation was its preferred policy but wages were "sticky".

Five years later, Keynes wrote his General Theory which made a case against wage deflation and a more coherent argument for an increase in government spending during recessions.  Support for his theory increased after WWll when government military spending lifted the US economy out of recession.  It has fallen out of favor in recent years, and a new orthodoxy has replaced it in the eurozone which is similar to the situation that existed in England during the Great Depression.  The euro functions like the gold standard.  Nations in recession cannot deflate their currencies to become more competitive.  The alternative forced upon them is to deflate wages.  That is not politically easy and it has the effect of reducing domestic demand.  It is supported, however, by a powerful ideology which is insensitive to the available evidence.  Eurozone unemployment remains high, and price levels are well below the target inflation rate of 2%. 

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