Friday, August 19, 2011

Defending Keynes

I'm quite certain that Stephen Moore has studied economics more than I have, and understands much of it better. I'm also certain that, on most economic topics, we agree. And this is a good piece.

Stephen Moore: Why Americans Hate Economics
How did modern economics fly off the rails? The answer is that the "invisible hand" of the free enterprise system, first explained in 1776 by Adam Smith, got tossed aside for the new "macroeconomics," a witchcraft that began to flourish in the 1930s during the rise of Keynes. Macroeconomics simply took basic laws of economics we know to be true for the firm or family—i.e., that demand curves are downward sloping; that when you tax something, you get less of it; that debts have to be repaid—and turned them on their head as national policy.

As Donald Boudreaux, professor of economics at George Mason University and author of the invaluable blog Cafe Hayek, puts it: "Macroeconomics was nothing more than a dismissal of the rules of economics." Over the years, this has led to some horrific blunders, such as the New Deal decision to pay farmers to burn crops and slaughter livestock to keep food prices high: To encourage food production, destroy it.
But as much as I've criticized Keynesian economic policy over the years (and as much as I expect to in the future), there are a couple of points that are worth making in defense of Keynes himself (though not necessarily those who want to implement Keynesian stimulus today).
  1. Keynes "witchcraft" consisted of the observation that demand creates its own supply. Classical economics observed the converse, that supply creates its own demand. In the long-term, the classical formulation seems to be correct. However, as Keynes famously noted, "in the long term, we're all dead." The notion that ten years from now, the economy will have rebounded and produced a long-term expansion is of little solace to an unemployed man with a hungry family. And there is both logic, and some truth, to Keynes theory that the government could stimulate demand, and thus mitigate some of the worst problems of the business cycle. So, while Keynsian policies don't work in the long term, there can be times and mechanisms where they are not a terrible idea.
  2. Keynes didn't have the past fifty years of Keynesian experimentation to look back on when he was formulating his theories.

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