For the past year, Duncan Brack and Ed Randall, authors of the Dictionary of Liberal Thought, have kindly agreed to let us publish extracts on Lib Dem Voice. Last month’s instalment was John Maynard Keynes; this month, Keynesianism. You can read previous chapters on LDV here. The entire book is available on Amazon here and can also be bought at the Westminster Bookshop.
A school of economic thought inspired by the work of John Maynard Keynes, especially his General Theory of Employment, Interest and Money. Keynes’s challenge to the ideas underpinning classical and neo-classical economics, and in particular to the proposition that market economies would always find an equilibrium consistent with the highest possible level of economic output, became the foundation for macroeconomics, and Keynesian ideas came to underpin the economic policy of Western governments for the three decades following the Second World War.
In the General Theory, first published in 1936, John Maynard Keynes (q.v.) challenged the majority of his peers in the economics profession, who had steadfastly rejected his notion that there was any need for a branch of economics that distinguished between the behaviour of individual economic actors and the operation of the economy as a whole.
Keynesians generally support the following three propositions: (a) aggregate demand plays a central role in determining the level of real output; (b) economies can remain for a long period in a state where there is substantial under-utilisation of both capital and labour; and (c) government, principally though not exclusively through its fiscal policies, can influence aggregate demand and thus help bring about significant reductions in unemployment.
Keynesianism came to dominate economic policy-making after 1945 when the reflationary actions of the US government, principally designed to boost the production of munitions and weapons, appeared to confirm Keynes’s theoretical arguments about the fundamental importance of government taking the initiative in overcoming failures in aggregate demand. The general acceptance of the three Keynesian propositions seemed to have been confirmed when Richard Nixon observed that ‘we are all Keynesians now’. However, critics of Keynesianism, most notably the American economist Milton Friedman (q.v.), began a counter-revolution in economic thought that attracted political leaders and economic policy-makers from the mid-1970s onwards, including James Callaghan and Margaret Thatcher in Britain, whose statements and policy decisions appeared to reject all or part of Keynesianism.
British economic policy-makers were confronted in the 1970s by ‘stagflation’: low or no growth accompanied by inflation. This was taken as evidence that Keynesian policies for combating unemployment could no longer be expected to work. Friedman argued that government action to boost demand in order to reduce unemployment below its ‘natural rate’ was counter-productive: it would simply raise inflation and add to inflationary expectations in economies.
The counter-revolutionary policy prescriptions offered by Friedman and his colleagues were tested (some say to destruction) in Britain, where the Conservative governments of the 1980s adopted a monetarist strategy. They failed, however, to produce either the stable monetary environment or the economic recovery that had been expected. Friedman himself declared, in June 2003, that ‘use of the quantity of money as a target has not been a success … I’m not sure I would as of today push it as hard as I once did’.
Keynesianism has enjoyed something of a revival since the 1980s, although it has undergone considerable development and reformulation in an effort to integrate Keynes’s theoretical ideas about the operation of the economic system as a whole with classical and neo-classical ideas about the behaviour of individual consumers and producers. In particular, Keynesians have accepted that while human beings are not perfectly rational, human behaviour sufficiently approximates rational behaviour – of the kind hypothesised by economists – so that it is possible to develop models of the economy that can handle long lags between changes in output, employment rates, inflation and interest rates.
Some Keynesians have tried to take account of the growth of international trade and increasing economic interdependence in their economic theorising, and to make the case for internationally coordinated economic policy treating the whole world as a single global economic system. Whether their economic and political ambitions have any real prospect of success is arguable. Perhaps the most important element of the Keynesian legacy is the conclusion that market economies are inherently unstable and that there can be no guarantee that they will, unaided, find a balance that makes full use of the economic resources, including labour, that are available to them. What Will Hutton has described as Keynes’s ‘very shocking’ finding – that capitalist economic systems are inherently unstable – is rightly regarded as a watershed in the development of economic thought.
• Will Hutton, The Revolution That Never Was: An Assessment of Keynesian Economics (Vintage, 2001)
• John Maynard Keynes, The General Theory of Employment, Interest and Money (1936)
• Charles P. Kindleberger, Keynesianism vs Monetarism (Routledge, 2005)
The Dictionary of Liberal Thought is one of the many titles available from the Liberal Democrat History Group. Find out more about them on their website.