Wednesday, February 04, 2009

What J.M. Keynes Should Have Said

I've been utilizing the website RealClearMarkets ever since we entered this era of financial crisis and recession. A lot of the articles that I found on this issue talked about Keynesian economics. The basic idea that I got was that goverment spending can help bring an economy back to prosperity.

You know, I ran into John Maynard Keynes in high school. My psychology teacher had to teach us a unit in consumer education and he showed a lot of tapes from programs that I would think could be found on WYCC-TV. The problem was the theory of Keynes wasn't articulated in a way that I or probably most of my classmates could understand.

Well anyway what does this column from RCM says about Keynes:
For more than seventy years, policy makers have used Keynesian monetary and fiscal policies to control recessions (Keynes 1936). Although these policies are widely perceived to have been successful in stabilising the business cycle, academics gave up on Keynesian theory in the 1970s. The appearance of stagflation led to the adoption of the Phelps-Friedman hypothesis of a natural rate of unemployment, and it caused academics to abandon the Keynesian idea of many steady-state unemployment equilibria (Cross 1995). Mainstream economists adopted an approach in which temporary deviations from the natural rate of unemployment are caused by “sticky prices”.

In a forthcoming book (Farmer 2009), I propose a new paradigm that reconciles Keynesian economics with general equilibrium theory. Unlike existing interpretations of Keynes’ General Theory, my approach does not rely on sticky prices and does not carry the implication that the economy, if left to itself, will return to full employment. The theory implies instead that any level of unemployment can coincide with any rate of inflation.

I will make three related points. First, due to missing markets, labour market clearing may occur at many different unemployment rates, all of which are consistent with steady state equilibrium. Second, aggregate demand determines which of these equilibria will occur. Third, aggregate demand depends not on income, as asserted by simple Keynesian theories, but on wealth. My argument leads me to advocate a different policy from the trillion dollar bailout currently on the table. I argue instead for direct control of the stock market through Fed intervention in a market for indexed securities.
Sounds like the author, Roger Farmer, wants to rework the theory of Keynesian economics. Although reading thru this piece, and I do suggest you read the whole thing, it almost looks like Farmer advocates for greater governmental control of the economy. People are already complaining, well if you watch FOX News Channel, that America is making a nose dive into socialism. Farmer addresses that issue in the very last paragraph.
Capitalism is the single greatest engine of growth ever devised and the free market allocation of capital is superior to any other system known to humanity. If the big three auto makers cannot produce cars that people want to buy – let them fail. If Lehman Brothers made bad investments – let it sink. But do not let every manufacturing firm and every bank fail at the same time as a result of speculative movements in markets that serve no social purpose.
Well that's all fine and good. I've always believed that anyway that companies that engage in bad business should fail. Still I think we should be bothered if government wants to take on more influence in the economy. The fear is once the government gets into something it's very hard to get it back out!

Here's another piece worth your time. Former House Majority Leader Dick Armey advocates for less Keynesian economics and more Hayek. Friedrich Hayek was a practitioner of Austrian economics.

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