KEYNESIAN ECONOMICS

John Maynard Keynes (1883–1946) was a brilliant, well-born British economist who during the Great Depression laid the foundations for an alternative to classical economics, which dominated economic thought and policy in the Western democracies from the late 1930s through the end of the century. In the public mind, Keynes is most commonly thought of as offering the rationale for a compensatory fiscal policy to regulate the swings of economic cycles. The centrality of his thought is underscored by the efforts of scholars only in the last decade of the twentieth century to evolve what they call a post-Keynesian economics.

In the conclusion to his General Theory of Employment, Interest, and Money (1936) Keynes maintained that "the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else." The twists and turns in the story of the role of Keynesian economics during the Great Depression and its enduring connection to that crisis in the public mind are fascinating and revealing.

Though he became well-known early in the century through his critique of the Treaty of Versailles and considered his major work to be his two volume A Treatise on Money (1930), Keynes is best known for his General Theory, an uncharacteristically turgid and poorly organized tome that explained in highly theoretical language how a calamity such as the Great Depression could have happened and what policies governments might employ in countering the extremes of business cycles.

From the beginning of his career Keynes was keenly interested in the practical world and quick to offer advice to politicians and public officials. He did so frequently and eloquently during the 1920s and the Great Depression. He was particularly concerned about the state of the American economy, which seemed more fragile than the British economy and which was more sharply affected by the stock market crash of 1929.

In April 1931 Keynes made a radio address to the people of the United States, warning that businessmen and financiers were too optimistic and that the Depression could easily last another five years. A month later he came to the United States to deliver a lecture at the University of Chicago in which he argued that in the United States regulation of credit would be more effective than public works spending in countering the Depression. In December 1933 Keynes wrote for the New York Times a somewhat condescending open letter to President Franklin Roosevelt, warning him to avoid such reform measures as those undertaken by the National Recovery Administration, that, as Keynes saw it, were shaking business confidence and thus impeding recovery. In June 1934 Keynes came to the United States again, this time meeting personally with Roosevelt, presenting calculations on the level of spending needed to achieve recovery. Accounts of the meeting suggest that the two were mutually unimpressed.

Clearly, advice from Keynes was abundant. Yet hardly anyone formulating policy at the time was listening. Nevertheless, the essential components of both his analytical framework and policy recommendations were developed independently by administration officials, especially presidential advisors Stuart Chase and Harry L. Hopkins, several of their staff, and Reserve Board Chairman Marriner S. Eccles. All drew from their practical experience, the work of a broad range of economists and advisors, and most importantly, all were pressed by an imperative to respond to the obvious human needs that the crisis engendered. As Eccles later put it, "we came out at about the same place in economic thought and policy by very different roads." Thus, one might be understandably suspicious of Keynes's conclusion concerning the ideas of academics that "the world is ruled by little else."

Nonetheless, Keynesian economics ultimately became, in the minds of some, almost synonymous with the New Deal. Why so? Because Keynes offered a powerful theoretical analysis of the economic conditions underlying the crisis of the 1930s at precisely the moment when Western democracies were desperately in need of an authoritative and coherent explanation of the Depression, and of hope that there was a way out consistent with their ideology.

Of initial concern was the duration and depth of the Depression. Prevailing business cycle theory, offered by eminent scholars such as Jacob Viner and Wesley C. Mitchell, proposed that cycles were an inevitable, even necessary, part of the progression of capitalist economies. During downturns the decline in prices, wages, and interest rates would reach a point where investors could not resist the potential profits these conditions offered and would start borrowing, investing, and propelling the economy back onto an upward trajectory. Similarly, in upturns, high prices, wages, and interest rates would restrict investment and lead to a downturn. The implication for policy was that governments should intervene as little as possible and let "natural" forces right the economy in their own due time. Yet during the Great Depression the downturn went deeper and lasted longer than anyone had imagined, and still no "natural" forces were leading to recovery. It seemed that the economy might not be self-correcting and could reach equilibrium at levels far below full employment and adequate living standards.

The use of public works to offer jobs to the unemployed and build public infrastructures at minimal cost had become legitimized during the 1920s. Herbert Hoover had implemented such programs before leaving office and the policy was continued in the New Deal under Harold Ickes's Public Works Administration. Yet federal spending for relief was regarded by both Hoover and Roosevelt as an expedient to mitigate suffering, a galling necessity (and hence a symbol) of bad times. It was difficult for them to accept spending, other than on well-planned and needed public works, as a deliberate and continuing instrument of economic policy. Moreover, how could one reasonably argue that tax money given back to taxpayers, who would have spent it had the government not taken it in taxes, could provide a stimulus to the economy?

These concerns could be pushed to the background as long as there seemed to be progress, however halting, towards recovery. But when the recession of 1937 struck, the nation was faced with not a Hoover but a "Roosevelt Recession," which had to be addressed. The domestic political implications were clear to New Dealers, but so also were the implications for the worldwide ideological struggle among fascism, communism, and liberal democracy.

As the recession deepened during the winter of 1937 and 1938 there were widespread complaints in the press that the administration was adrift and had no coherent policy, a criticism that could justly be applied to the various pragmatic, need-driven programs of the early New Deal. Secretary of the Treasury Henry Morgenthau, Jr., urged a return to a balanced budget. Eccles, Hopkins, and others urged a resumption of spending. The president finally resumed spending, but only after being presented with arguments that the policy was consistent with American historical experience and with liberalism, and that the resulting growth would bring in enough to pay back the deficits incurred.

That decision was announced in April 1938. By August there were clear signs of recovery and it was assumed by all that the renewed spending program had caused the recovery. But by the time the recession struck, the General Theory was being read and avidly embraced by young American economists within and outside of the administration. Several addressed the recession crisis by restating Keynes's ideas in a brief, accessible manifesto, An Economic Program for American Democracy, published in November 1938. The book was, in effect, a simplified, policy-oriented, Americanized distillate of Keynes's General Theory. It immediately became a best seller. Eccles was so impressed with its argument that he used his personal funds to buy copies for every member of the U.S. Congress. The Washington Star called it "the first authentic attempt to tell compactly and in simple language the complete economic and social ideology of the New Deal." The Boston Globe concluded that "for the first time the effects of haphazard spending and investment policies of the New Deal are dispassionately analyzed and given academic sanction."

Of course, as economists and other policy makers were beginning to understand, the base of that academic sanction was Keynes's General Theory. In it Keynes provided elaborate explanations for why it was possible for the economy to reach equilibrium at levels well below full employment. His analysis of "liquidity preference" explained that in some circumstances potential investors might wish to retain rather than invest their resources. Thus, contrary to classical economic theory, interest rates could fall to zero without attracting new investment. His description of the "propensity to consume" explained what proportion of incomes citizens would, under various circumstances, re-inject into the economy through consumption. His "multiplier" concept borrowed from economist R. F. Kahn to offer clearer answers to the question of how much stimulus would be given by a specific amount of public investment as it moved through the economy. The multiplier concept offered the possibility of predicting levels of increased economic activity and tax yields, and thus assurance that an invigorated economy could eventually pay the deficits such investment created.

None of these ideas appeared early enough in analytical form to affect New Deal policy, including even the resumption of spending in 1938. They did, however, as the Boston Globe reporters understood, provide academic sanction and legitimization of that policy. Informed observers quickly came to conflate Keynesian economics and the later New Deal. As Eccles put it, New Deal policies, now bolstered by Keynes's academic sanction, offered "some assurance that we can go forward in the future."

Keynes, the economic theorist, had little direct influence on the formulation of policy. The world, in fact, was ruled by others. But his work suggested that the United States was on the right path and thus brought hope and promise to a generation of young academics disheartened by the ideological choices that leaders of Italy, Germany, Spain, and Japan had made in their efforts to cope with the Great Depression. As the United States spiraled into recession in 1937, Western civilization seemed to hang in the balance. And in the minds of those persuaded by Keynes, the "academic scribbler," by explaining what was happening, had tipped that balance in the direction of the liberal democracies. Having thus grasped a hand of rescue at so critical a time, it is understandable that over six decades later Keynesian economics continued to be the predominant paradigm for economic thought and policy in much of the world, including even most societies that had once embraced fascism and Marxism.

KEYNESIAN ECONOMICS

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