I’m reading The Seven Fat Years by Robert L. Bartley, the Pulitzer-Prize-winning former editor of The Wall Street Journal. This book was published over 25 years ago but is an appropriate read in the light of the upcoming federal tax cuts.
I was struck by a section in the book where Bartley tells of the consensus among his intellectual peers that John Maynard Keynes “was dead.” Keynes is the early 20th-century economist who provided an intellectual-sounding gloss for popular but poverty-inducing borrow-and-spend budget policies. He actually died in 1946, but the belief system he inspired became entrenched in US and UK governments into the 1970s.
Oh, but that Keynesianism would die! It and socialism are powerful addictions, and they cause otherwise very smart people to speak nonsense, as Larry Summers did last week on television. Given that Summers’s advice led to the worst economic record of any president and distortions in the health-care industry so vast the private health insurance market has nearly collapsed and true unemployment stayed above 10% for over seven years (while unregulated markets continue to offer better and cheaper goods and services every year), it might be wise to do the opposite of anything Summers suggests.
Below are, in order, (a) a clip of Bartley introducing The Seven Fat Years, from a 1992 interview on C-SPAN, (b) the section from the book entitled “Keynes is Dead,” (c) a clip of Larry Summers explaining where he got his Keynesian belief system, and (d) Friedrich Hayek telling an interviewer that Keynes “knew very little economics.”
I love Bartley’s description of the Keynesian magical multiplier as a “mythical creature” “solemnly taught to innocent sophomores.” It was heavily invoked in the last administration and proven (once again) to be a purely political device, not economic. About the Hayek comment, I mention it in The Wiring Diagram but only now have I found a copy where the audio is clear (hat tip, Malthus0 on YouTube).
Keynes Is Dead
This was in fact the title of a Journal editorial in January 1977. It opened with a remarkable summary by Prime Minister James Callaghan, head of Britain’s Labor government:
We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you, in all candor, that that option no longer exists, and that insofar as it ever did exist, it only worked by injecting bigger doses of inflation into the economy followed by higher levels of unemployment as the next step. That is the history of the last twenty years.
The simultaneous stagnation and inflation of the 1970s had not only bewildered policymakers, but had ruptured the prevailing consensus of the economics profession. Since Keynes, the centerpiece of economics was “the multiplier.” By running a deficit, the government “injected” money into the economy, and as this injection rippled through the economy it produced a far larger boost in Gross National Product. So if the economy needed a boost, run a bigger deficit, even if that meant hiring workers to dig holes and fill them back up.
Indeed, basic economics texts taught about a mythical creature called the “balanced budget multiplier,” with magical powers to transmute a bigger government into a healthier economy. If the government spent an extra $20 billion and raised taxes $20 billion, all of the spending would be consumed, and some of the taxing would come out of savings rather than consumption. So on net, consumption would increase, and be multiplied into a bigger GNP. This was solemnly taught to innocent sophomores by professors who later ridiculed the Laffer curve.
The question, everyone at Michael 1 [a restaurant where Bartley would meet fellow economists] understood, was: Where does the government get this money it “injects” into the economy? Well, it borrows it. But if you borrow from Peter to pay Paul, what is there to be multiplied? And anyway, if someone “saves” by stuffing dollar bills into a mattress, the Federal Reserve can simply print up some more dollar bills. And if, more likely, someone “saves” by putting money in a bank, the bank will lend it to someone to “consume.” What is it that Lord Keynes was trying to say, anyway?
This was supposed to be explained by Sir John Hicks’s IS-LM model, and augmented in practice by the inflation-unemployment trade-off of the Phillips curve. But when the 1970s dealt more inflation and more unemployment simultaneously, the whole Keynesian universe imploded.
None of this should be taken as disparagement of Lord Keynes; the diners felt reverence was due. In the midst of a Great Depression, it was plausible to believe that there were pools of idle savings that might be tapped by government borrowings. But in the inflationary climate of the 1970s, idle money would waste away. Savers, banks, borrowers all rushed to convert it into interest-bearing instruments, or better, real assets such as gold or real estate.
“If Lord Keynes were alive today, he would no doubt be back at the drawing boards,” our January 1977 editorial said. “As Oxford economist Walter Eltis has pointed out, through most of Keynes’ life the gold value of the pound was precisely where Sir Isaac Newton had fixed it a century and a half before. If we had Lord Keynes today, surely he would have something instructive to say about an age of inflation. ”
In 1983, The Economist ran a centenary edition on Keynes. The contribution from F . A. Hayek read in part:
It will not be easy for future historians to account for the fact that, for a generation after the untimely death of Maynard Keynes, opinion was so completely under the sway of what was regarded as Keynesianism, in a way that no single man had ever before dominated economic policy and development. Nor will it be easy to explain why these ideas rather suddenly went out of fashion , leaving behind a somewhat bewildered community of economists who had forgotten much that had been fairly well understood before the “Keynesian Revolution.”
During this crucial period I could watch much of this development and occasionally discuss the decisive issues with Keynes, whom I in many ways much admired and still regard as one of the most remarkable men I have known. He was certainly one of the most powerful thinkers and expositors of his generation. But, paradoxical as this may sound, he was neither a highly trained economist nor even centrally concerned with the development of economics as a science, tending to regard his superior capacity for providing theoretical justifications as a legitimate tool for persuading the public to pursue the policies which his intuition told him were required at the moment.
Keynes never recognized that progressive inflation was needed in order that any growth in monetary demand could lastingly increase the employment of labour. He was thoroughly aware of the danger of growing monetary demand degenerating into progressive inflation, and toward the end of his life greatly concerned that this might happen. It was not the living Keynes but the continuing influence of his theories that determined what did happen. I can report from first-hand knowledge that, on the last occasion I discussed these matters with him, he was seriously alarmed by the agitation for credit expansion by some of his closest associates. He went so far as to assure me that ifhis theories, which had been badly needed in the deflation of the 1930s, should ever produce dangerous effects he would rapidly change public opinion in the right direction. A few weeks later he was dead and could not do it.
Summers on Friedman:
Hayek on Keynes: