This blog is about the Great Recession, the imbalances which led to it, the use of Keynesian principles by governments of all nations to prevent a deep implosion and how and why the Keynesian mini-revolution didn’t last long. Suddenly, nobody is asking Are We Keynesians Now? and the economics profession has lost lines of communications with governments. Like a Guns N’ Roses song that goes
What we’ve got here is failure to communicate, some men you just can’t reach.
[originally from the 1967 movie, Cool Hand Lake]
Will it take another crisis to revive Keynesianism? While, the author is a die-hard Keynesian, he believes that fiscal policy alone cannot resolve the crisis. Governments are aware of this but government officials give only vague replies when taken to task.
The blog in general is/will be about an approach which has roots in the New Cambridge approach to studying economies and how it can be applied to find political economic solutions to put the world in a sustainable path of growth and achieve full employment. It is also about about the Post-Keynesian theory of Endogenous Money and the Stock Flow Coherent Approach. Using the blogosphere as a medium to satiate my crave to put forth my understanding of how economies work, I aim to make a difference. Post-Keynesians emphasize that monetary economies function differently from the chimerical neoclassical story and money cannot but be endogenous. I plan to take the reader into how the monetary and financial system works, the role of various sectors (individuals and institutions) in a demand-led process, their behaviour and what can be done to reverse sectoral imbalances that have built up.
Why Keynesianism was short-lived in the Great Recession is a difficult question to tackle in a single post. Before the 1970s, for many years, the world was run using Keynesian principles and suddenly it fell apart. To me, the situation right now is very reminiscent of what went on during the 70s and the 80s (I am not that old!).
Francis Cripps wrote this in a 1983 article What Is Wrong With Monetarism [1]
The conclusion which has to be drawn is that, if a modern economic system is to function properly, a mechanism is required for the management of aggregate demand. Now it happens that the need for management of aggregate demand within a closed national economy can be met rather easily. It is easily met because national economies have an institution called the state which is unique in that it has virtually unlimited powers of credit creation or borrowing (or would have within a closed national economy). Keynesians gave up at this point, thinking that once the need for demand management had been pointed out, and the possibility for demand management by a national government had been understood, the problem of demand management was solved once and for all. Unfortunately, there is no such thing as the state in the contemporary international economy at the international level and the absence of the state as such at the international level is, I believe, a sufficient explanation of why the world economy has run into serious problems of recession …
… The important point is rather that in an international economy the possibilities of national demand management are strictly limited. They are limited by problems of balance of payments adjustment and international finance. Governments that wish to regulate national demand so as to sustain full employment run into problems of increasing trade deficits and, in economics with liberal exchange regimes, loss or confidence and outflows of capital. It is actual or potential balance of payments crises which have been decisive in breaking the habit or Keynesian demand management at the national level. Many national governments are still trying but they are trying under difficulties and they are frightened of balance of payments problems that would result if they tried too hard.
Further, as Francis Cripps concluded, in that brilliant article,
… [U]ntil the economists in our society get around to tackling this problem, we risk being stuck with periods of long recession, even if we are occasionally and accidentally favoured with periods of world boom.
In the book From Keynesianism To Monetarism: The Evolution Of UK Macroeconometric Models [2], Peter Kenway writes:
… There is, however, a greater sense in which the development of the Cambridge Group in that period is more important than the model that came to represent them. That sense stems from the historical significance of those ideas…. the ideas were therefore more ‘anti-Keynesian’ than ‘Keynesian’… what makes the anti-Keynesian views of the 1970s Cambridge Economic Policy Group so significant is that they grew out of the very heart of Keynesianism itself …
… On the one hand, as far as the goals it espoused are concerned, of full employment, of steady growth and of government’s responsibility to pursue these ends, the Group’s commitment to Keynesianism never wavered. But on the other hand, as far as the practice of Keynesianism was concerned, and especially the conceptualization of the reasons for the increasing and evident failure of that practice, the Policy Group not only was part of, but in some respects actually led the revolution against Keynesianism in the UK …
So the Keynesians completely failed to understand the “balance of payments constraint” and imbalances in the external sector is one kind of sectoral imbalances.
Sectoral Imbalances are of many kinds. The US private sector ran deficits for a long time (the “Un-Godley Private Sector Deficit”) and this led to the financial crisis and the Great Recession. Frequently, you hear about the shift in the distribution of income and this can also be studied with the Sectoral Balances Approach. Central bankers and policy makers have also realized that global imbalances are unsustainable.
This blog is about how to achieve sustainable growth in the short, medium and the long run and in the author’s opinion can come about only if international policies are coordinated. Policy coordination is not a new concept but for many years before the crisis, imbalances were allowed to continue even though many policy makers took notice of this. In my opinion, these were allowed to continue because the implicit assumption was that “market forces” will work toward resolving the imbalances. What is needed is a “grand bargain” as Mervyn King put it in early 2011. And it should come with an orientation toward fiscal expansion.
When the world entered a period of catastrophe, governments took action and turned Keynesians overnight. So the G-20 made this statement in the Summit on Financial Markets and the World Economy in 2008:
Use fiscal measures to stimulate domestic demand to rapid effect, as appropriate, while maintaining a policy framework conducive to fiscal sustainability.
to prevent a bigger implosion and later in the 2011 summit
Our aim is to promote external sustainability and ensure that G20 members pursue the full range of policies required to reduce excessive imbalances and maintain current account imbalances at sustainable levels.
However, the G-20 summit participants and the IMF seem to bring about the reversal of imbalances via fiscal contraction – as if there is no negative effect of the latter on domestic and world demand!
Wynne Godley and Francis Cripps [1] described confusions in the policy makers’ minds wonderfully in the Introduction of their 1983 book Macroeconomics
Our objective is most emphatically a practical one. To put it crudely, economics has got into an infernal muddle. This would be deplorable enough if the disorder was simply an academic matter. Unfortunately the confusion extends into the formation of economic policy itself. It has become pretty obvious that the governments of many countries, whatever their moral or political priorities, have no valid scientific rationale for their policies. Despite emphatic rhetoric they do not know what the consequences of their actions are going to be. Moreover, in a highly interdependent world system this confusion extends to the dealings of governments with one another who now have no rational basis for negotiation.
How did Wynne think the world needs to run? In a 2005 Levy Institute publication wonderfully titled The United States And Her Creditors: Can The Symbiosis Last? [3], he and his collaborators wrote:
A resolution of the strategic problems now facing the U.S. and world economies can probably be achieved only via an international agreement that would change the international pattern of aggregate demand, combined with a change in relative prices. Together, these measures would ensure that trade is generally balanced at full employment…Those hoping for a market solution may be chasing a mirage.
To conclude, the “infernal muddle” as described by Godley and Cripps in describing how economies work in Economics has been terrible for world demand (except in periods of expansion through unsustainable private sector deficits which end in crises). My blog aims to bring forward ideas in Monetary Economics and how it can be used to achieve active management of economies rather than leaving the task to “market forces”. I am inspired by the 2008 Levy Institute publication A Crisis That Conventional Remedies Cannot Resolve [4] and this is the subtitle of my blog. In the paper the authors argued passionately – in their own words:
In this paper we argue, as starkly as we can, that the United States and the rest of the world’s economies will not be able to achieve balanced growth and full employment unless they are able to agree upon and implement an entirely new way of running the global economy.
My blog aims to follow their footsteps in making the case for concerted action.
References
- Francis Cripps – What Is Wrong With Monetarism, pp 55-68, Monetarism Economic Crisis And The Third World, ed. Karel Jansen, Frank Cass, 1983. Link
- Peter Kenway – p 92, From Keynesianism To Monetarism: The Evolution Of UK Macroeconometric Models, Routledge, 1994 (2011 reprint). Link
- Wynne Godley, Dimitri Papadimitriou, Claudio Dos Santos and Gennaro Zezza – The United States And Her Creditors: Can The Symbiosis Last?, Levy Institute Strategic Analysis, September 2005. Link
- Wynne Godley, Dimitri Papadimitrou and Gennaro Zezza – Prospects For The United States And The World – A Crisis That Conventional Remedies Cannot Resolve, Levy Institute Strategic Analysis, December 2008. Link