Why Keynes is important today
By Peter Temin and David Vines
October 28, 2014 – Institute for New Economic Thinking
Macroeconomists have been notably unhelpful
in explaining and recommending policies since
the global financial crisis of 2008.
How could this have happened?
Since John Maynard Keynes created macroeco-
nomics in the 1930s, the field has grown to be
half of all introductory courses in economics
and has become well represented and respected
among academic economic publications.
Keynes was considered helpful in the “Golden
Age of Economic Growth” after the Second
World War, but he is largely ignored now that
we have recreated conditions similar to the
Great Depression in many countries.
Keynesian analysis was abandoned in the tur-
bulent 1970s that signaled the end of rapid eco-
nomic growth. Macroeconomics reconstituted
itself as the study of economic growth. Build-
ing on pioneering work by Frank Ramsey and
Robert Solow, macroeconomics became the
study of long-run economic growth. It also be-
came the complement of economic develop-
ment, which focused on empirical works and
policies of developing countries.
Modern macroeconomics flourished in its pur-
suit of the secrets of long-run economic growth,
but it neglected short-run economic problems.
In the long run, prices are flexible, and the
growth of the economy is determined by the
growth in the ability to supply goods and ser-
vices. But in the short run prices are not flexi-
ble. Growth can be held back because prices are
too high and, as a result, demand is too low.
Keynes made his name by analyzing short-run
problems caused by the stickiness or even ri-
gidity of some important prices. But these
Keynesian ideas were abandoned by modern
macroeconomics.
But not completely. In Lectures on Macroeco-
nomics, the classic 1989 summary of the field
by Olivier Blanchard and Stanley Fischer,
Keynesian models appeared late in the lectures,
in a chapter identified only as “Some Useful
Models.” We strongly suspect that these econ-
omists, now influentially located high up in the
International Monetary Fund and the Federal
Reserve, still regard these models as useful, alt-
hough not describing them as Keynesian.
The fact that these two prominent economists
departed from orthodoxy suggest that they had
in their minds governments that cared for all of
their citizens, following John Rawls’ famous
proposal that we should give care to the most
disadvantaged citizens. Implicit in Keynesian
models is concern for those workers unable to
find jobs and support for the concept of govern-
ment that includes this concern.
What can we gain by calling these models
Keynesian again?
We can see good economic policies in the con-
text of a consistent analysis of the economy.
For example, Keynes’ paradox of thrift showed
that the actions of individuals and economies
are different. If one person wants to save more,
he or she can do so by simply reducing spend-
ing. But if everyone wants to save more, or at
least enough people and business firms to influ-
ence the whole economy, then their collective
reduction in spending reduces national income.
The economy does not save more. Instead pro-
duction and jobs decrease. If everyone tries to
do this in all countries, then global unemploy-
ment emerges, which is an international para-
dox of thrift.
This is where we are now. Many households
have reduced spending because they are trying
to pay off mortgages that now are larger than
the value of their houses. In the United States,
students and ex-students weighed down by ed-
ucational debts also have reduced their con-
sumption. Businesses are accumulating large
amounts of cash and not investing because their
balance sheets are in bad shape as a result of the
decline in the value of their assets—many of
which are the flip side of the same bad mort-
gages that are hurting consumers. And govern-
ments are reducing their spending under the
pressure of austerity programs.
As these large groups in the economy have re-
duced their spending after 2008, national in-
come and jobs have decreased. And as this has
happened in many countries and regions, global
income and employment has fallen with each
country dragged down by falling incomes and
employment elsewhere.
Central banks have moved to stimulate spend-
ing in the face of this attempt to increase sav-
ings by lowering interest rates. They lowered
them to the zero lower bound without having
much effect; the fall in desired savings was too
large. We are in a Keynesian liquidity trap.
Central banks have tried to stimulate spending
by actively increasing the money supply, rais-
ing fears of inflation in many circles. But no in-
flation has resulted as the cash sits idle in cor-
porate coffers. Even at zero interest rates, busi-
ness firms are reluctant to spend!
What to do? Many pundits say we must simply
endure what they call secular stagnation. This
is an unhappy prediction. Much better is the
Keynesian insight that this is the perfect time
for fiscal policy. In the U.S. again, there are im-
mediate needs to repair roads and bridges, re-
build the energy grid, and modernize other
means of travel. Keynesian fiscal policy expan-
sion will benefit the economy in both the short
and long run.
We argue in our new book, Keynes, Useful Eco-
nomics for the World Economy, that these rec-
ommendations can be seen as inferences from
a simple and effective model of the short-run
economy. We show how hard it was for Keynes
to break away from previous theories that work
well for individual people and companies—and
even for the economy as a whole in the long
run—to define the short run in which we all
live. We also stress Keynes’ interest in the
world economy, not just in isolated economies.
After all, the IMF is perhaps the most enduring
remnant of Keynesian thought left today.
Peter Temin is Elisha Gray II Professor Emeritus of Eco-
nomics at MIT and the author of Lessons from the Great
Depression and other books. David Vines is professor of
economics and fellow of Balliol College at the University
of Oxford, and joint editor of a number of books on
global economic governance. Temin and Vines are coau-
thors of The Leaderless Economy: Why the World Eco-
nomic System Fell Apart and How to Fix It.