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Brooks Wilson's Economics Blog: A Book Review by Mankiw

Thursday, September 24, 2009

A Book Review by Mankiw

The Great Depression was the most traumatic economic event in U.S. history.  Production declined 30 percent and unemployment reached 25 percent.  As the length of the depression grew, some economists began to doubt the soundness of Classical economic models that predicted that a market economy would quickly return to full employment in response to an economic downturn.  John Maynard Keynes was the economists whose theories appealed most to doubting economists.  He believed that market imperfections slowed wage and price adjustments, thus slowing or possibly stopping market readjustments. He believed that the government, through increased deficit spending and to a lesser degree easy money policies could speed economic recovery.  His theories became a paradigm or school of thought known as Keynesian economics.  Keynes is considered to be the father of macroeconomics and though his theories have been largely replaced in the literature by more mathematically sophisticated and better empirically supported theories, his insight that market imperfections can slow economic recovery and that the government can hasten recovery remain central components of many models. 

Robert Skidelsky, an historian, has completed a three volume biography of Keynes that Gregory Mankiw reviews for the Wall Street Journal in "Back in Demand."  Mankiw observes that the historical background in the book is engaging and interesting but that the author simplifies competing economic ideas sometimes to the point of absurdity.  Skidelsky calls for a revival of Keynesian In part, Mankiw writes
In "Keynes: The Return of the Master," Mr. Skidelsky makes the case for Keynes—not only for his place in the history of economic thought but also for his relevance today. To understand the global economic crisis of the past year, he says, we need more unadulterated Keynes.
Certainly, some economists have called for a rebellion against current paradigms and a renewal of Keynes.  The call for a revival of Keynesian thought and the title of the book has a Star Wars feel to it.  That's the way I see the sometimes hostile debate between Keynes' supporters and those who believe his theories are outdated.  It should be noted that a great number of economists who believe Keynesian economics is outdated believe that he made significant contributions that have been assimilated into the scientific collective (sorry to mix Star Wars and Star Trek metaphors) All economists view Keynes as the first Force in macroeconomics, but was he the part of the dark side?

Mankiw describes three viewpoints on Keynes.  The first views Keynes as the Force.

To admirers, Keynes was nothing short of the savior of the capitalist system. His "General Theory of Employment, Interest and Money" (1936) proposed a diagnosis and remedy for the calamity known as the Great Depression. According to Keynes, economic downturns are not a fundamental indictment of the market economy. Rather, recessions and depressions arise from insufficient aggregate demand. A smart government can remedy the problem with its monetary and fiscal policy—say, by printing up some money and spending it. Once the right policies are put in place, the thinking goes, the world is safe again for free markets.
The second views Keynes as part of the dark side of the Force.
To detractors, Keynes was an economist whose reach exceeded his grasp: He tried to replace classic economic principles with new ones of his own, but what he offered was vague and incomplete. Keynes's many followers have tried to give his theory analytic rigor, but with only limited success. Despite these intellectual deficiencies, the detractors say, Keynesians recklessly push their ideas in the political arena, where they often lead to high inflation and excessive budget deficits. The fiscal policy of the Obama administration is a case in point. When the White House pushed for a massive increase in infrastructure spending to create jobs, it was taking a page from the Keynes playbook.
The third views Keynes as a flawed theorist, an Anakin Skywalker, who was both good and bad.
Which brings us to a third group of macroeconomists: those who fall into neither the pro- nor the anti-Keynes camp. I count myself among the ambivalent. We credit both sides with making legitimate points, yet we watch with incredulity as the combatants take their enthusiasm or detestation too far. Keynes was a creative thinker and keen observer of economic events, but he left us with more hard questions than compelling answers.

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