Living in the Age of Keynes
Since 2008 we are supposed to have seen ‘The Return of the Master’. In truth he never went away. We’ve been living in the Age of Keynes for decades
In 1935 John Maynard Keynes wrote to his friend George Bernard Shaw: “I believe myself to be writing a book on economic theory which will largely revolutionize, not I suppose at once but in the course of the next ten years – the way the world thinks about economic problems.”
That book, The General Theory of Employment, Interest and Money, published the following year, would go on to fully realise Keynes’s expectations. After World War Two, following Keynes’s analysis, policy makers and economists around the world used fiscal and monetary tools to pursue the goal of ‘full employment’. Keynes gave his name to both the economics and the age itself.
It is conventionally said that this Keynesian Age was brought to an end by the Stagflation of the 1970s. To the extent that responsibility for ‘economic management’ was simply transferred from politicians with primarily fiscal tools to central bankers with monetary tools this can be argued. But there is another sense in which we never left the Age of Keynes.
The first substantive chapter of The General Theory is chapter two, ‘The Postulates of the Classical Economics’. Here Keynes ridicules a set of beliefs which he ascribes to an ill-defined group of ‘Classical economists’. For these Classicals income was either spent on consumption or saved. These savings, as capital, were invested with the two quantities, savings and investment, being equilibrated by the interest rate. As Keynes’s Classical mentor Alfred Marshall put it:
“[I]t is a familiar economic axiom that a man purchases labour and commodities with that portion of his income which he saves just as much as he does with that he is said to spend. He is said to spend when he seeks to obtain present enjoyment from the services and commodities which he purchases. He is said to save when he causes the labour and the commodities which he purchases to be devoted to the production of wealth from which he expects to derive the means of enjoyment in the future.”
Keynes, by contrast, saw no such essential unity between savings and investment. In The General Theory he wrote that the “decisions which determine Saving and Investment respectively are taken by two different sets of people influenced by different sets of motives, each not paying very much attention to the other”.
It was possible, Keynes argued, that investors driven by mercurial “animal spirits” could become so pessimistic that the Marginal Efficiency of Capital (the expected return on their investment) could plunge below the interest rate (the cost of funding that investment) so that no investment would take place. The Marginal Efficiency of Capital could, indeed, sink so low that nominal interest rates couldn’t offset it, giving rise to the ‘liquidity trap’ and monetary impotence. Marshall’s link would be broken and aggregate demand would fall.
For Keynes, the way to guarantee the continued investment which not only guaranteed aggregate demand in the present but also increased prosperity in the future, was for the government to underwrite the profitability of investment by acting as spender of last resort, via fiscal stimulus, to prop up the Marginal Efficiency of Capital.
This was the polar opposite of the Classical view. Whereas Keynes believed that spending made you rich enough to save, the Classicals believed that saving made you rich enough to spend. Though Keynes would have agreed with the father of the Classicals, Adam Smith, that “Consumption is the sole end and purpose of all production”, they took totally different routes to get there.
This stems from a striking difference in attitudes to saving. Adam Smith, anticipating Marshall, wrote, “What is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too; but it is consumed by a different set of people...by labourers, manufacturers, and artificers”. Keynes, by contrast, said that “whenever you save five shillings, you put a man out of work for a day”.
Is it Smith or Keynes’s attitude towards consumption and saving which animates western policymakers today? Since 2008 we are supposed to have seen ‘The Return of the Master’. In truth he never went away. We’ve been living in the Age of Keynes for decades.
John Phelan is a Contributing Editor for The Commentator and a Fellow at the Cobden Centre. He has also written for City AM and the Wall Street Journal Europe. He blogs at Manchester Liberal and Tweets @TheBoyPhelan
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