| The IMF has just published its World Economic Outlook, in which it says all is well, me hearties, and will be for another two years at least, who knows. This reminded me of an essay of the same name by John Maynard Keynes called "The World's Economic Outlook", written in May 1932. |
| The problem was the opposite then""over-condensation, if you like, as opposed to over-heating. But the consequences would be the same. |
| So Keynes posed the problem thus: "...to-day the primary problem is to avoid a far-reaching financial crisis ... Can we prevent an almost complete collapse of the financial structure of modern capitalism?" |
| According to him the problem lay in banks having lent too much and governments having borrowed too much and asset prices going down, down, down as people started selling more and more and more. The margins, he said, had "run off". |
| He also wrote that there was "no financial leadership left in the world and profound intellectual error as to causes and cures ... It is, indeed, in the United States itself that this has proceeded to the most incredible lengths..." |
| He went on to paint the bleakest of pictures about what is coming but then, being fair-minded, presented the other side of the picture as well. "The outstanding ground for cheerfulness lies, I think, in that the system has shown already its capacity to stand an almost inconceivable strain." |
| He also said that it was very public-spirited of Britain to go off the gold standard because had it not done so, the problems would have been much worse. "Great Britain's action has had two signal consequences," wrote Keynes, because it slowed down the general deflationary tendencies and it made "a very considerable proportion of the world" come together under the sterling. |
| But there was a problem. The US and France, along with some smaller economies, never went off the gold standard. This meant there were two international mediums of exchange, just as we have now, that is, dollars and euros. However, the reduction of pressure on gold would, he said, "undermine and eventually destroy the creditor position of the two leading creditor gold countries". Substitute dollars for gold and we know what will happen to East Asia and China. |
| France, he said (as entirely as befits a Briton), would get the chop first. In the US, it would take a little longer. "A point will surely come when the current release of gold from India and the mines will exceed the favourable balance of the gold countries." Substitute China for India and dollars for gold, and we know what might happen. |
| He said this would reverse the ongoing deflation but the more important thing was whether this would happen "before financial organisation and the system of international credit break under the strain". He hoped it would, and exhorted financial purists to give up the idea that governments should spend only on war. Instead, he said, we should be "ready to spend on the enterprises of peace..." |
| He also said that it was the US that had to solve its own domestic problems first, adding that he didn't think this would happen. "I even fancy that, far from the US giving the example, she will herself have to wait for stimulus from outside." |
| As can be seen from this and other writings by Keynes, his worldview was shaped by the persistent fear of deficient aggregate demand. The question is: is this view valid any longer? Have not a whole lot of things, not least of which is the discarding of his own barbaric relic, gold, not to mention technology rendered deficient aggregate demand on a global scale obsolete? |
| If we see Keynes as a product of his times, whose major political agenda was to keep Communism at bay""remember barely 15 years had passed since the Bolshevik revolution""the emphasis on not allowing demand to fall so that unemployment would be minimal, is understandable. |
| But although times have changed, Keynesianism still rules the roost as a way of looking at the world economy, namely, through the prism of demand. Certainly, finance ministers (through fiscal policy) and central bank governors (through monetary policy) approach the economy from the demand side. |
| Policy is thus limited by the way the economy is seen by two generations of policy managers brought up on Keynesian orthodoxy with, no doubt, the occasional heckle from Friedmanians. But as Alan Greenspan's different kinds of "landings" and "steps" reveal, monetary policy is turning out to be a blunt instrument. Do what you will, demand refuses to abate. Allowing for local blips, it does not seem likely to abate in the foreseeable future, thus turning the problem on its head. |
| This brings me to the central question: has the time come to view the macroeconomy differently, that is, not through the demand prism alone? Has the Keynesian deficient demand obsessed system of thought gone past its expiry date? |
| Is not the issue one of managing global excess demand against a backdrop of near full-employment global output, excess liquidity and numerous, mutually inter-convertible, financial assets? Is the current theoretical framework equipped to handle all this? |
| Perhaps it is. But someone still needs to revisit the deficient demand theory. Or will it take a world-class crisis, of the opposite sort to what Keynes had in mind, for that to happen? |
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