How do we compare Keynesian and modern economics?

Over at policy.net, Chris Trotter states (ht Rates Blog):

Keynesian economics was never more than the rational response of decent and compassionate men to the human cost of economic management when reposed in the hands of the avaricious and the uncaring

This is an incredible mis-representation of “Keynesian economics” – however, it is also an incredibly common mis-representation.

Among many on the left and right of the political spectrum there is a belief that Keynesianism is left-wing macro-economics and modern economics (which people attribute to Friedman – even though in general terms his ideas only apply to monetary policy, not the whole shabang). However, as CPW once said to me, the correct comparison is not one of political ideology, but one of science – Keynes was like Newton, while Lucas/Friedman/the crew are like Einstein.

How?

Keynes unambiguously founded macroeconomics in the way we understand it today. There were a number of previous authours who discussed large scale ideas in a holistic sense (eg the business cycle) but Keynes was the first person to really treat the macro economy in the aggregate sense we now view it.

Contrary to popular belief, Keynes did understand the importance of restraining inflation, and held parts of classical economics as true (for many years he was a strong defender of classical economics) – but he was also a man of the times. He was writing during the Great Depression, and he noticed mass unemployment which classical economics was unable to explain. By describing how “demand” could function in the aggregate economy, he helped guide policy in a way that would help it out of the depression – but contrary to the name he gave his book this was no “general theory”.

However, the economics profession worked on the basis that this was a general theory, and built an idea of how the aggregate economy worked with no regard to the very real limits that exist inside any economy. The 1970s saw these limits become apparent, and through Lucas and Friedman we realised that we needed a better way to explain economic activity when taking into account the “supply” of resources.

The mistake that our discipline made was relying to heavily in unexplained empirical relationships – in other words we had taken on a heavily holistic method which provided us with “forecasts” but with no understanding to base these on. Since then, the application of microfoundations has allowed us to create a fuller picture of the aggregate economy, and as a result has given us a better idea of the outcomes from certain policies. Ultimately, this has made economics strong as a descriptive discipline.

But monetary policy?

Modern economics gives us a frame that we can view monetary policy through. We know what “inflation” is, what the costs are, what the trade-offs are, and what inflation targeting does.

Most economists determination to fight inflation does not stem from a “policy position (which) merely displays the naked greed of the farming and importing sectors” as Mr Trotter states – it actually stems from a belief that the costs of allowing inflation to rise exceed the benefits for our society as a whole.

The political divide amongst economists is not Keynesian vs modern, it is left vs right, just like the rest of society.

Furthermore, why does a lower interest rate policy suit the poor more than the rich? Higher interest rates knock does stock prices, reduce asset values, and delays investment.

I suspect that the class war argument based on traditional Keynesianism stems from a lack of understanding about economics and economic history.

  • Kimble

    Trotter is a hater, not a thinker. Dont expect a reasoned response from him. More likely you will just be attacked.

  • “Trotter is a hater, not a thinker. Dont expect a reasoned response from him. More likely you will just be attacked.”

    That’s fine with me – at least I’ve got to put my point of view down 🙂

  • John

    I studied economics about 30 years ago and I remember Keynes and his equations that showed how G could be increased to get people working etc, but apart from that my understanding is so so. I do appreciate tho the corrosive effect of inflation on my savings and the shift in wealth when we have house price inflation.

  • You cannot have your cake and eat it too.  You cannot eat your wife and fu©k her too.  You cannot fu©k your life and save it too.JeanBaudrillardJean Baudrillard

  • goonix

    Insightful analysis there.

  • IRS

    Pussy rules the world.MadonnaLouiseVeronicaCicconeMadonna Louise Veronica Ciccone

  • Kimble

    wicked cool haiku’s

  • “Insightful analysis there.”

    “wicked cool haiku’s”

    Indeed, it is amazing how insightful this spam can be 😛

    Hi John

    “I remember Keynes and his equations that showed how G could be increased to get people working etc”

    Keynes didn’t really have many equations – a lot of the theoretical work was done by other people eg. the Hicks-Hansen model (IS/LM):

    http://en.wikipedia.org/wiki/IS/LM_model

    However, it is even debatable whether these models even represented what truly mattered about what Keynes stated.

    My impression of the General Theory was that it took a string of observations about human behaviour, aggregated them, however it did not do so clearly. Fundamentally, the book could be interpreted in many ways – something that made it difficult for people to form a “general theory” from.

    Ultimately, its a bit like physics. We can’t have a “general theory” until we understand all the little bits fully enough – if we ever do 😛

  • SPP

    Donald and I were jazz fans in high school. We were outcasts. We were the poor, sad kids who brought Sarah Vaughn records to their first junior high school party. That kind of stuff warps you for life.WalterBeckerWalter Becker, of Steely Dan, on he and co-member Donald Fagin’s being disliked

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