Keynes: The Return of the Master [Paperback]

Given that macroeconomists have been thinking about the world's economy since the late eighteenth century, an impartial observer could be forgiven for assuming that the field had reached some kind of a consensus in over 200 years.

They couldn't be more wrong.

The twentieth century saw a great tug-of-war between two separate schools of thought. In the blue corner, stand the economists who see the economy as a well oiled machine, instantly responding to exogenous shocks by reaching a new satisfactory equilibrium -- the classical economists and their latter day equivalent, the rational expectations crowd and real business cycle theorists.

In the red corner, stand Keynes and his myriad followers. When puzzling over the Great Depression, Keynes created a new model of macroeconomics: which stressed the imperfections and frictions in the economic machine that could keep the economy in an unsatisfactory rut for years. These frictions allowed for a role for government: to expand the money supply, cut taxes, and increase spending in the face of recession. Much of this has become modern-day common sense policy, but he was opposed by President Hoover in the U.S., and the British Treasury who insisted that a balanced government budget laid the best foundations for growth.

Sounds familiar?

Robert Skidelsky traces out this theoretical tug-of-war, and explains how the current crisis calls for, "Keynes: The Return of the Master". He also explains how this war was an overtly political one. The modern day economists who wanted to overturn Keynes were mostly conservatives with an innate distrust of government. The modern day neo-Keynesians, such as Nobel prize winners George Akerlof and Joseph Stiglitz, are largely liberals, who emphasise that markets have imperfections and failures as well as governments.

This short book is all about Keynes's ideas, and their enduring relevance in the 21st century. For a biography of Keynes the man, try Peter Clarke - Keynes.

Robert Skidelsky is right : we need to restore Keynesian economics to the current debate. Lord Skidelsky has contributed immensely with his monumental three volume biography of Keynes (`Hopes Betrayed', `The Economist as Saviour', and `Fighting for Freedom'). In this shorter book he summarises aspects of Keynes' economic theory. He attacks neo-classical economic theory's assumptions of rational expectations, real business cycle theory, and efficient market theory. He highlights inescapable, irreducible uncertainty as the key Keynesian diagnostic of economic behaviour, leading to Keynes' theory of `Liquidity Preference' whereby actors hold money to allay uncertainty, and thus reduce effective demand, leading to macroeconomic recession. He correctly points out that philosophically this diagnostic of irreducible uncertainty challenges the established Newtonian paradigm.

But more importantly he argues the practical superiority of Keynes over monetarist economics. As an economic historian, Skidelsky does this in his core chapter 5 by seeking to demonstrate that the global economy performed better under the Keynesian Bretton Woods period of 1951 to 1973, than under the monetarist free market `Washington Consensus' which replaced it. At this point Skidelsky's admitted lack of economic training and of the mathematical skills he too easily derides weakens his point. He interprets the graph on page 117 of world real GDP growth as two points of high average growth under Bretton Woods and low average growth under the Washington Consensus. A visual and econometric best line fit of this data would show a growth line declining from 1960 to 1985 and then rising, which would undermine this particular aspect of Skidelsky's argument.

He emphasises liquidity preference theory which may have addressed the 1930s depression, but does not figure in explaining the current recession, where, on the contrary, households are high in debt rather than in savings. He misses Hicks' `false trading' interpretation of Keynes, whereby actors seeking a market clearing price trade experimentally at other prices, leaving some actors short of market clearing income. He relies to some degree of Leijonhufvud's information failure exposition of Keynes but does not expound this fully.

The main conclusion should be that it is Keynes' tool kit, rather than any specific Keynesian policy which needs restoring. Keynesian methodology would be to apply the tool kit differentially to specific situations. Three core Keynesian ideas of relevance today are i) the need for effective demand in the economy to purchase full employment output ii) the realisation that wages are not just a cost of production but also a major component of this demand iii) the definition of money as a virtual artefact, which can be created and destroyed and does not need to be balanced.

Skidelsky traces the current recession in standard terms. US banks made excessive house purchase loans to households unable to repay. This drove an asset bubble which burst when the mortgage backed derivatives were traded in a nervous unregulated market. But the best interpretation of the current recession, using the Keynesian toolkit, is that advanced by Thomas Palley in an article Skidelsky quotes briefly on page 178. Palley's argument in his `America's Exhausted Paradigm : Macroeconomic Causes of the Financial Crisis and Great Recession' is that real wages have failed to keep pace with productivity, leading to deficient consumer demand, a gap which has been made up by consumer credit which then becomes un-repayable. Palley's policy solution is to raise real wages. I agree with Palley's analysis, but suggest that advancing technology makes a reduced wage component of GDP inevitable, so that a citizen's income is the only workable solution.

Skidelsky ends by calling for a wider university macroeconomics programme to include history and philosophy. Agreed, but the Oxford PPE degree supposedly already offers this, and half the UK cabinet, including the Prime Minister, have taken this degree, without apparently realising the Keynesian diagnostic?

Think of the current recession as the mother of all hangovers. The World economy has been partying insanely for the best part of a decade - busily borrowing, spending, investing and speculating without real regard to what economists like to call 'the fundamentals'. In other words by failing to address the risk attached to a given activity in relation to a possible return; institutions and individuals have spent money to no good purpose whilst at the same time racking up huge debts. Hence the big headache the morning after.

So,Governments, businesses and me if not you, have been binging on cheap credit. Eventually, the party has to stop when the money runs out. The waiter of doom presents his bill. Governments who have run big budget deficits have racked up massive interest charges on loans face huge problems as do the citizens in their care. Governments like Greece are faced with debt default, firing civil servants, begging from the European Central Bank or World Bank,cutting back on services and raising taxes. Their citizens are faced with higher unemployment, wage cuts, inflation and failing public services. Businesses find profit margins squeezed, reduced sales revenues and rising input costs. It's a big mess and possibly it's going to get messier before much longer. But what to do about it?

After a period of heavy indulgence its fairly normal for the patient to go on a diet - lose a bit of weight and generally reform previous bad behavior, at least for a while ,until normal vigor is restored. 'Keynes -Return of the Master' is a detailed analysis of why the market cannot be left to itself to clear the debris up the morning after the economics party is over.

Markets according to 'libertarian' economists function well, providing their are left alone by government. Unemployment high?:wage rates fall, employers take on more staff-end of problem. Over supply of goods and services?: prices fall, demand picks up-no problem. In other words markets will adjust and eventually confidence, investment and spending power will return to the market and all will be well. Keynes saw things differently. The market can and will fail. In fact the natural state of the market is not full employment and full use of resources. In fact markets have pronounced weaknesses. Prices and wages are 'sticky downwards'. The herd mentality of investors,consumers and businesses mean that they will not act 'rationally' - that's why 'asset bubbles' form. Worse still,no one can be certain of the future. This is fundamental. If you can't predict the future then you can't put a price on risk. if you could, interest rates would have been a lot higher in the USA and Europe a lot sooner and the easy credit to the Sub- Prime market would never have happened.Keynes was arguing for governments to provide the missing spending power that occurs during recessions in order restore markets, create employment and prosperity. Keynes was not a socialist- he was however a moralist. For him, one of the purposes of economic management was to create wealth, opportunity and well being but not just for the elite but for all citizens.

This is highly readable account of the age old Monetarist v Keynesian debate.There is some technical matter to attend to but not enough to cause indigestion to the non- specialist. It's also a biography. Keynes was definably what used to be called a 'man of parts'. A brilliant author and debater, a key government adviser from the end of the First World War onwards, a hugely successful on occasion) investor as well an original thinker of almost unparalleled depth and breadth. He may not be currently fashionable , but his influence is every where and given the depth of problems that Western economies are facing right now, it may not be long before his name is again center stage for policy makers.

The aspiring economist will gain from this book is the chance to enter the debate: Is changes in money supply more important than changes in savings and investment stimulating growth, Should governments spend and tax to adjust for cyclical changes in the economy- if so does this imply that economists should accept a moral responsibility to 'price in' the effects on society of policy changes? Does the emphasis on mathematical analysis in Economics ignore the stumbling block that is 'uncertainty' in assessing risk? Economics invites discussion, opinion and dispute. Read this book and get stuck into some fascinating issues

Question: If Keynesian economics was so 'useful' why did people like Margaret Thatcher and Ronald Regan drop it for the 'Free Market'approach?

Topics covered: Great Depression, current economic situation : causes , effects and policy strategy. Looks in detail at the strengths flaws in the Monetarist /Free Market models in comparison to Keynesian analysis and policy prescriptions. Also an in-depth examination of Keynes view of markets suggesting that governments need to regulate 'Animal Spirits' and be ready to step in when the economy starts to get out of kilter. Also interesting there is an interesting study of Keynes views on Ethics and Economics with reference to G.E Moore which may be useful many Philosophy students.

Type of Read: Appropriate adjectives: Enjoyable, challenging and rigorous. The author has the happy knack of presenting complex arguments in a clear and absorbing fashion, no attempt at 'dumbing down' here. Students of Politics, Economics and History would find 'The Return of the Master' a compelling read. Even if you think you know your 'Keynes', be prepared to have your understanding enriched. Recommended? You bet