KeynesALesson

In looking for potential solutions for our economic woes we could do worse than look back at possibly the greatest modern economist of them all; John Maynard Keynes, the British genius who can show us, from beyond the grave, the route to the Promised Land.

Like all great men, Keynes was capable of mistakes and errors of judgment in many small ways, but was also to make some very wise forecasts that, had he been listened to, could have changed the future of the world. He correctly insisted that the Versailles Treaty at the end of the First World War was too punitive on the defeated nation and would lead to a dreadful reaction by Germany. He was right, the Treaty gave Hitler and his Nazis the argument against this national humiliation as an excuse, which led directly to the Second World War.

According to Keynesian economics the state can, and in my opinion should, stimulate economic growth and improve stability in the private sector - through, for example, interest rates, taxation and public projects. This, in general terms appears to be the course being followed by Gordon Brown in the UK, and now, might well be what the USA does.

In 1936 Keynes published these theories that formed the basis of Keynesian economics in The General Theory of Employment, Interest and Money. In this theory, micro-level actions by individuals and firms can lead to aggregate macroeconomic outcomes in which the economy operates below its potential output and growth.

The majority of Keynes contemporary classical economists had believed in Say's Law, which stated that supply creates its own demand, so that a "general glut" would be impossible.

Keynes argued convincingly that aggregate demand for goods would prove to be insufficient during major economic downturns, and this would lead to unwarranted high unemployment and consequential losses of potential output. He was convinced that government policies should be used as an instrument to increase aggregate demand, thus increasing economic activity and reducing high unemployment and deflation.

Although Keynes's macroeconomic theories were mostly a direct response to mass unemployment in 1920s Britain and in 1930s America they are no less appropriate in today’s situation.

Keynes stated that the solution to economic depression was the stimulation of the economy through a variable use of two approaches; the first of these being a reduction in interest rates and the second, Government investment in infrastructure.

The injection of income results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so forth. The initial stimulation sparks a cascade of events, whose total increase in economic activity results in a multiple of the original investment.

A central conclusion of Keynesian economics is that in some situations, no strong automatic mechanism moves output and employment towards full employment levels. This conflicts with other economic theories, which assume a tendency towards equilibrium. The 'neoclassical synthesis', combines Keynesian macro concepts with a micro foundation, the conditions of General equilibrium allow for price adjustment to achieve this goal.

In the corridors of power of Whitehall were many bureaucrats who either didn’t understand or appreciate the financial genius of Keynes.

Perversely Keynes never saw his ideas fully utilized in his own country. Instead it was President Franklin Roosevelt who partially bit this bullet in his effort to get America out of the Great Depression.

More strangely it was the UK that came out of that depression first, in about 1935, and it was not due to any of the Keynesian ideas, but more the result of the UK being de-coupled from the gold standard, that up to then had meant that there was literally gold held centrally in exchange for every pound or dollar.

America’s economic salvation was a mixture of FDR led intervention by big government in addition to the country meeting the huge production demands of the Second World War.

Keynes himself, worn out by his efforts on behalf of the world economy at Breton Woods, and more particularly that of his own country, was to die within one year of the end of the war after successfully raising a huge loan from America to rebuild England from its near bankruptcy. Keynes was a liberal, not socialists, and perhaps this was humorously proven by his last words; when asked whether there was anything he regretted, he answered, “I should have drunk more champagne.”

Whichever way we find our way through this period of economic turmoil it will all be OK as long as we remember to revert to less government intervention the very minute we can, so we can all drink a little champagne again.