Essay: Keynes is Back

I have always said that Keynes would live as long as the world needed him. What the world decided, 30 years ago, was that it no longer needed him. The Keynesian revolution had been reduced to a mechanical system for stabilising economies by means of budget surpluses and deficits—more deficits than surpluses, as it turned out, leading to the “stagflationary” crises of the 1970s. Keynes, the theoreticians said, was redundant, having failed to prove that the world needed “Keynesian” policies. The market system was automatically self-correcting; Keynesianism led only to inflation.

And from their point of view, the theoreticians were right. The only acceptable basis of economic theorising is the assumption that human beings are rational maximisers. Grant this, and it follows that the many disturbances to which market economies are prone are the result of outside interferences. For Hayek and Friedman, the culprit was government manipulating the money supply for populist ends. No one who is not an economist believes human nature to be as economics depicts it, yet without its rationality axiom economics could not exist as the science it claims to be.

Keynes’s greatness, indeed his uniqueness as an economist, was that he was more than an economist. As well as being an outstanding theoretician and a great administrator, he was economics’s only poet of human nature. He tried to press his poetry into the service of science and policy. But it did not really fit, as he himself half-recognised. The poetic and scientific parts of his theory were discordant. So the poetry was struck out, and with that, his science also fell. He had never succeeded in showing, the theoreticians said, why rational agents should neglect trades which were to their advantage. Involuntary unemployment is impossible. And once Keynes’s science was gone, there was little, if nothing, left of Keynesian policy. All economies needed was independent central banking, whose principles long preceded Keynes’s economics.

Keynes’s understanding of human psychology in markets had two features, neither of which fits into the paradigm of mainstream economics. The first was inescapable uncertainty. “The outstanding fact,” he wrote in his magnum opus, The General Theory of Employment, Interest, and Money (1936), “is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made.” We disguise this uncertainty from ourselves by assuming that the future will be like the past, that existing opinion correctly sums up future prospects, and by copying what everyone else is doing. But any view of the future based on “so flimsy a foundation” is liable to “sudden and violent changes. The practice of calmness and immobility, of certainty and security, suddenly breaks down. New fears and hopes will, without warning, take charge of human conduct…the market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning yet in a sense legitimate where no solid basis exists for a reasonable calculation.” He saw economics as “one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future.”

In the face of uncertainty, the springs of human behaviour are very different from what economists conceive them to be. “Most… of our decisions to do something positive… can only be taken as a result of animal spirits… If animal spirits are dimmed… enterprise will fade and die” is one famous remark. Professional investment, he wrote, is like “a game of Snap, of Old Maid, of Musical Chairs,” whose object is to pass on the Old Maid—the toxic debt—to one’s neighbour before the music stops. Here is the recognisable anatomy of the “irrational exuberance,” followed by blind panic, which has dominated the present crisis.

The second aspect is what may be called Keynes’s “organicism.” He was an individualist, but in a traditional, almost religious sense—that is, he conceived of individuals as part of a community of value. His unit of analysis is very different from the “methodological individualism” that underpins economic reasoning. The point is difficult to grasp in the abstract, but it can be illustrated in his frequent diatribes against making the balance sheet and considerations of efficiency the sole tests of economic virtue. In the 1930s he praised his own home town, Cambridge, as a place where one could spend an afternoon strolling around “talking to one’s lifelong friends” and shopping in “shops which are really shops and not merely a branch of the multiplication table.” Views like these made him only a qualified supporter of what is now called globalisation.

Keynes would have endorsed the rescue operation mounted by the world’s governments to save the global banking system. As a British patriot he would have been proud that his country had given the lead. But he would have worried about the huge element of uncertainty in the outcome. The government must inject sufficient cash into the system to offset the “propensity to hoard” (liquidity preference in Keynes’s language), so as to bring down the long-term rate of interest. The question is how much is enough. If it is too little, the deflationary tendency, and the slide into depression, may not be arrested; if it is too much, one risks worldwide inflation. No mechanical calculation will give one the right answer; it all depends on the confidence with which the measures are received by the public. At present, we simply do not know; and no “pretty, polite techniques” will give us the answer.