14 June 2011
I have long suspected that very few people actually read Keynes's General Theory. But today I am led to wonder whether anyone at all has seriously read Keynes in decades.
The reason for my doubt is an article by James K. Galbraith, Why not Keynes? in The American Conservative magazine.
Galbraith laments that the ideas of Keynes, which seemed set for a new revival just three years ago, are again on the retreat. And for this he blames the "False Keynesians", such as Lawrence Summers and others who occupied high office in the Obama administration. They supported a "stimulus" but one so small that it had no effect at all.
"People who actually read and understood Keynes never came close to power," says Galbraith.
This is a pretty damning statement. The implication, of course, is that Galbraith has both read and understood Keynes.
But has he?
This is what he says later in the article, while complaining that it is the outdated ideas of David Ricardo and Adam Smith that dominate policy-making today:
"The rabbit in Ricardo's hat was the nature of money in his time-- mainly coins and paper backed by gold and silver. The quantity of money thus didn't fall in a glut, and its purchasing power would rise as prices fell. Consumption and investment would take up the slack.
"But we no longer live in that world. In our credit-money economy, purchasing power goes away when banks stop lending, and the money stock falls."
I am, of course, completely in agreement with Galbraith that in today's economy, the money stock falls when banks stop lending.
But Galbraith is terribly in error when he thinks that this was Keynes's understanding.
I suggest that he take up The General Theory and skim through it quickly. To begin with, he should ask himself why Keynes, writing several years after the start of the Great Depression which was characterised by the failure of hundreds of banks, did not have a word to say about bank failures, bank rescues or indeed about banks at all.
The answer is that Keynes did not ascribe any importance to banks. In his model, money consists entirely of currency, exactly as in the Ricardo that Galbraith excoriates. Keynes believed that the quantity of money was fixed and could be changed only by the monetary authority.
Here are a few quotes to prove that.
".. money has, both in the long and in the short period, a zero, or at any rate a very small, elasticity of production, so far as the power of private enterprise is concerned, as distinct from the monetary authority; -- elasticity of production meaning, in this context, the response of the quantity of labour which a unit of it will command. Money, that is to say, cannot be readily produced; -- labour cannot be turned on at will by entrepreneurs to produce money in increasing quantities as its price rises in terms of the wage-unit. In the case of an inconvertible managed currency this condition is strictly satisfied. But in the case of a gold-standard currency it is also approximately so, in the sense that the maximum proportional addition to the quantity of labour which can be thus employed is very small, except indeed in a country of which gold-mining is the major industry.
"Now in the case of assets having an elasticity of production, the reason why we assumed their own-rate of interest to decline was because we assumed the stock of them to increase as the result of a higher rate of output. In the case of money, however -- postponing, for the moment, our consideration of the effects of reducing the wage-unit or of a deliberate increase in its supply by the monetary authority -- the supply is fixed." (Chapter 17)
"Moreover it is impossible for the actual amount of hoarding to change as a result of decisions on the part of the public, so long as we mean by 'hoarding' the actual holding of cash. For the amount of hoarding must be equal to the quantity of money (or -- on some definitions -- to the quantity of money minus what is required to satisfy the transactions-motive); and the quantity of money is not determined by the public." (Chapter 13)
I can quote other chapters and verses but there are limits to what can be inflicted on a general reader.
The absence of banks is the central error of Keynes. The moment banks are introduced into the equation, the entire Keynesian structure -- the speculative motive for liquidity preference, the liquidity trap, the idea that recessions are caused by a failure of aggregate demand -- collapses as I have shown in John Maynard Keynes and the dog that did not bark and Paul Krugman and the liquidity trap