Re-embracing K e ynes Scholars, A dmirers and S ceptics in the A ftermath of the C risis

1. Re-embracing KeynesScholars, Admirers and Sceptics in the Aftermath of the Crisis Maria Cristina Marcuzzo Sapienza,Università di Roma

2. Return to Keynes • 2008-9 crisis has seen an upsurge in the wave of references to Keynes • Which aspects of Keynes’s analysis and recommendations do economists wish to see accepted and implemented and which are still rejected and misunderstood? • “Is the return to Keynes” plea matched by original research into his work? • In the face of unqualified admirers and sceptics alike, scholarly investigation into Keynes’s writings more than ever is called for.

3. Aggregate demand and deficit • Standard “return to Keynes” argument: more important to address a failure in aggregate demand than to worry about the size of the government deficit • Opposition to this view: 1) Cato Institute Manifesto: 237 signatories against “we need action by our government…to jumpstart the economy” (Obama, Jan 2009) 2) Letter to Sunday Times: 20 signatories advocating a more reduction of Britain’s budget deficit “to support a sustainable recovery” (Feb. 2010). 3) G.Osborne (UK Chancellor): fiscal discipline needed to take Britain off “the road to ruin” (Oct 2010)

4. Anti-Keynesian arguments • “Lessons” from history • Hoover and Roosevelt did not pull the United States economy out of the Great Depression in the 1930s. • More government spending did not solve Japan’s “lost decade” in the 1990s. • “Lessons” from theory: • Growth depends on reforms that remove impediments to work, on lower taxes and competition • Empirical studies show that value of public spending multiplier is not large

5. Keynesian counter-arguments • Rejection of the claim that public expenditure crowds out a corresponding amount of private expenditure. • There is no theory to justify the “right” size of deficit nor the amount of government spending. • Unemployment due to insufficient effective demnd, not rigidities in prices and wages. • Restricting the fiscal space (as European monetary system) means imposing a deflationary bias • Crisis in the US: a distribution of income problem, i.e. a private debt which has increased to offset the fall in wages and salaries.

6. Samuel Brittan’s point (FT, 8 Oct 2010) • Impoverished fiscale debate: • Two schools of thought: priority to eliminating current deficit and to curb expenditure vs to protect “public services” at the cost of a slower rate of deficit reduction • Confusion between views on public spending and views on the role of the budget balance in macroeconomic policy. • Logically four, not two positions • Reduce deficit and public spending • Reduce deficit, but keep a high proportion of public spending • No urgency to cut deficy and public spending • No urgency to cut deficit, but lower public expenditure and lower taxes

7. Paul Krugman’s point (NYT, Nov 3, 2010) Vulgata: America went for Keynesian policies Germany chose austerity and Germany did better. Facts: Germany’ s : GDP did not do better

8. Who are the bees and who are the ants? Actual government purchases of goods and services, (excluding transfer payments from the federal government to states), Germany more Keynesian than the United States

9. Shadows of Keynes

10. Keynes’s arguments • Reversal of the causality relation between deficit budgeting, level of income and international confidence in a country. • Public expenditure as a means to reduce unemployment not to adjust supply to the existing level of demand. • “Digging holes in the ground” argument: to illustrate the principle, not to provide a blueprint of “useful” public work schemes • Expenditures on goods which have no useful purposes from the point of view of consumption, may produce effects on income and employment.

11. Paradoxes • “Gold mining, which is just another form of unearthing bottles dug in the ground, or pyramid building had positive effects on income and employment because they yielded fruits that “could not serve the needs of man by being consumed” and therefore do not ‘stale with abundance’” (General Theory). • “Two pyramids, two masses for the dead, are twice as good as one; but not two railways from London to York” (General Theory) • Possibility of increasing the stock of wealth with “useful” forms of loan expenditure is limited, because of decreasing of marginal efficiency of investment and/or marginal utility of useful objects.

12. Failures of Ideas • Modern macroeconomics deals with God-like creatures: they know the statistical distributions of all the shocks that can hit the economy. As a result, they can make scientifically founded probabilistic statements about all future shocks. • The assumptions of rational expectations and efficient markets have created an intellectual framework that blinded economists and policy-makers, preventing them from seeing the bubble and the dangers that these create for systemic stability.

13. Return to another Keynes • Financial crisis has forced us to take on board Keynes’s division of economics between: “the study of those economic activities in which ‘our views of the future are...reliable in all respects’ and the study of those in which ‘our previous expectations are liable to disappointment and expectations concerning the future affect what we do today” (General Theory). • To acknowledge the failure of economics to take uncertainty seriously

14. Notion of Uncertainty • A probability relationship is a rational belief in the conclusion from the knowledge of the premise • The “weight of the argument” expresses the confidence in that probability • Uncertainty is of lack of a probability relationship. It applies to cases in “which no rational basis has been discovered for numerical comparison. It is not the case here that the method of calculation, prescribed by theory, is beyond our powers or too laborious for actual application” (Treatise on Probability). • Keynes’s uncertainty rejects the presupposition that risk can be measured and allocated in such a away as to prevent uncertainty of the outcomes

15. The state of macro is not good: How should it be fixed? • Blanchard (2008): problem can be “fixed” by introducing a more sophisticated explanation of the real and nominal wage rigidities • Dahlem Report (2008):interconnectivity (network analysis); the informational role of financial prices and financial contracts; construction of indicators warning of bubble formation. • Buiter 2009: “behavioral approaches relying on empirical studies on how market participants learn, form views about the future and change these views in response to changes in their environment” • The “return to Keynes” mainly a lip service with very little original work done on those aspects of Keynes which are relevant to the present recession and crisis of economics.

16. What is the return to Keynes about? • The return to Keynes not just about government spending and injection of liquidity, but also: • international cooperation on finance, primary commodities and international payments • coordination and rules in markets and behavior, to fight irrationality and unreasonableness • rational behavior under uncertainty: • rationality bounded by knowledge, judgment and experience.

17. Drivers of the research agenda • In finance: to build on Keynes’s insights: • Unarbitraged margins preventing the law of one price from prevailing in financial markets • The Beauty contest – picking what one thinks others are most likely to think that others think are the best choices • Noise trading: uniformed agents derail the operations of rational agents • Istitutional Reforms: to take action to smooth prices and output of primary commodities and agricultural products which play a crucial role in international trade.(Buffer stocks schemes) • Strong links between fluctuations in prices of primary commodities and agricultural products on the one hand, and financial crisis and structural trade imbalances on the other.

18. Lessons Return to Keynes’s wide range of proposals not simple-minded so-called Keynesian policy. Three broad lessons: • the notion of uncertainty • the economy cannot be managed as an individual business • individual self-seeking behaviour does not guarantee a stable economic order. But: • Scholars and admirers of Keynes have failed to persuade sceptics and opponents

19. Conclusion “A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it” (Max Planck)