Economic Depression - Keynes' Keys - Should the survivor expire on a heap of gold?
Nobel Laureate, Paul Krugman said in 2006, "Over the past 70 years The General Theory has shaped the views even of those who haven't heard of it, or who believe they disagree with it. A businessman who warns that falling confidence poses risks for the economy is a Keynesian, whether he knows it or not. A politician who promises that his tax cuts will create jobs by putting spending money in peoples' pockets is a Keynesian, even if he claims to abhor the doctrine. Even self-proclaimed supply-side economists, who claim to have refuted Keynes, fall back on unmistakably Keynesian stories to explain why the economy turned down in a given year."
Noted Economist, Gregory Mankiw says, "If you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than a half-century ago, his diagnosis of recessions and depressions remains the foundation of modern macroeconomics. His insights go a long way toward explaining the challenges we now confront. According to Keynes, the root cause of economic downturns is insufficient aggregate demand. When the total demand for goods and services declines, businesses throughout the economy see their sales fall off. Lower sales induce firms to cut back production and to lay off workers. Rising unemployment and declining profits further depress demand, leading to a feedback loop with a very unhappy ending.
The situation reverses, Keynesian theory says, only when some event or policy increases aggregate demand. The problem right now is that it is hard to see where that demand might come from."
To-day and presumably for the future the schedule of the marginal efficiency of capital is, for a variety of reasons, much lower than it was in the nineteenth century. The acuteness and the peculiarity of our contemporary problem arises, therefore, out of the possibility that the average rate of interest which will allow a reasonable average level of employment is one so unacceptable to wealth-owners that it cannot be readily established merely by manipulating the quantity of money. So long as a tolerable level of employment could be attained on the average of one or two or three decades merely by assuring an adequate supply of money in terms of wage-units, even the nineteenth century could find a way. If this was our only problem now-if a sufficient degree of devaluation is all we need-we, today, would certainly find a way.
"Archaic language", says Krugman, "but he was describing a situation very much like the one we face now."
Now all the politicians all over the world, who dare to talk of economy, are all Keynesians, more Keynesian than Keynes himself as Marx said, "I am not a Marxist. I am Marx". And Keynes was not a Marxist as he once told Bernard Shaw, "My feelings about Das Kapital are the same as my feelings about the Koran. I know it is historically important and I know that many people, not all of whom are idiots, find it a Rock of Ages and containing inspiration. Yet when I look into it, it is inexplicable to me that it can have this effect. Its dreary, out of date, academic controversialising seems so extraordinarily unsuitable as material for the purpose. But then, as I have said I feel the same about the Koran . How could either of these books carry fire and sword round half the world? It beats me."
Is the Indian virtue of thrift a vice in these troubled times? Keynes explained the paradox of thrift in a speech over BBC in 1931, "For take the extreme case suppose we were to stop spending incomes, and were to save the lot. Why, everyone would be out of work. And before long we should have no incomes to spend and the end would be that we should all starve to death." And if wages are repeatedly cut in a depression, the last man will die on a heap of gold.
The natural response of individuals in such a depression is to increase their savings. And collectively this is a disaster. One man's saving is another man's reduced income. Therefore extra borrowing by government, if it encourages more output, can be self-financing in increased revenue. The key is aggregate demand . Normally it is possible to influence this by changes in interest rates to stimulate spending. But there is a level below which interest rates cannot go and at that point monetary policy is powerless. And even if interest rates are lowered it may not have any effect if people cannot or will not borrow. Keynes' revolutionary solution was that at this impasse aggregate demand can only be boosted by the Government borrowing more, either to spend directly on economically useful public works or to give to others to spend via tax cuts and other measures.
The impasse is a waste. Keynes had predicted that
1. The economic system is naturally prone to periods of depression.
2. When these periodically occur as they must, they are not necessarily automatically self-correcting.
3. Such depressions are not the result of choices by individuals.
4. Individuals en masse can become trapped in a depression which is in no one's interest, but which, as individuals, no one can counteract.
Even war could pay for itself as Keynes said in a 1939 article, "How the War could pay for itself".
All the economists (and we have an economist as PM and FM) know Keynes but can they follow him mutatis mutandis?