Never has a book on economics been so anticipated.
John Maynard Keynes’s “The General Theory of Employment, Interest and Money” was published 75 years ago today. Back then, there were queues outside the Economists’ Bookshop in Houghton Street, London. Opening hours had to be extended to deal with the rush of those eager for an alternative to policies that had ruined the global economy.
The impact on the field of economics wasn’t unlike that on the scientific community when Charles Darwin published “On the Origin of Species” in 1859. Just as with Darwin’s book, Keynes’s shook the foundations of economic orthodoxy and had profound effects on his profession. The main thrust of Keynes’s work was also met with outright denial from his peers, including close colleagues, who reduced his theory to what one described as “diagrams and bits of algebra.” Above all, they denied the centrality of his theory of the rate of interest.
This “bastard Keynesianism,” as British economist Joan Robinson called it, subverted and continues to block the Keynesian revolution both in vision and in method. Monetarists were concerned with the quantity of money. Keynes’s overwhelming concern was with the rate of interest on money. He argued that monetary policy should always support the private and public economy, stimulate it, and prevent recession.
Safe and Risky
The centerpiece of his policy prescription was to sustain low rates of interest across the spectrum of loans: short- and long-term, real, safe and risky. Countering determined efforts to undermine these policy goals, Keynes used his position at the Treasury and the Bank of England, and his influence with U.S. President Franklin D. Roosevelt, to make this vision a reality. Interest rates were forced down from 1932; the bank rate was set at 2 percent until 1951.
To achieve this goal, which he argued was essential to sustained investment, growth and full employment, Keynes rejected the liberal-finance model based on deregulated international-capital flows. Instead he constructed a managed-finance model relying on domestic credit and restricted flows of international capital. From the end of the World War II until the 1970s, finance was managed, and low rates of interest prevailed. But with the celebrated move to free markets, this approach to finance was also rejected.
For the 30 years since 1980, policy has supported liberalized, deregulated credit creation and capital flows. Since the Golden Age of 1950 until 1973, the borrowing costs for U.S. and U.K. businesses, adjusted for inflation, have doubled to about 6 percent, according to data assembled by Geoff Tily, author of the 2010 book “Keynes Betrayed.”
Under liberalization, high rates of interest have been accompanied by the unsustainable growth of credit. This led to a series of excessive expansions and debt inflations and then severe contractions and debt deflations, beginning on the periphery of the global economy before spreading to Japan and South East Asia.
The contrast between the Golden Age and the Age of Liberal Finance has at root this upward shift in the rate of interest. In the U.K., unemployment averaged about 2.5 percent in the Golden Age and close to 8 percent afterwards. Economic growth in the U.K. and the U.S. averaged 0.5 percent higher per year during the Golden Age than in the liberal-finance era, according to their respective National Accounts authorities.
The global economy was finally ruined in 2007-09 as the financial system in the U.S. and Europe imploded under the weight of accumulated private debt. Subprime borrowers were the first to buckle under the weight of “dear money” -- costly, unpayable debts. The widespread belief that it was low interest rates that caused the credit crisis is indicative of how far economists have strayed from Keynes’s theory and analysis.
Equally, the idea that interest rates are now substantially lower, stems from a focus on policy rates while the high, real rates paid by consumers and businesses are ignored. To reduce real rates of interest for both industry and consumers requires the full embrace of Keynes’s approach to the global system: a coordinated effort to reverse financial liberalization.
Only with finance restrained can there be prospects for public and private-sector expansion. Keynes’s “General Theory” -- not the “Keynesian” theory of textbooks and conventional wisdom -- offers the same way out of today’s crisis as it did in the 1930s. But the economics profession must begin a reappraisal of his central contribution to monetary theory.
And just as with “On the Origin of Species,” society must reconsider conventional wisdom and reconcile itself to the extent and scope of Keynes’s vision.
(Victoria Chick is emeritus professor of economics at University College London and a co-founder of Prime -- Policy Research in Macroeconomics. Ann Pettifor is a director of Prime and co-author of “The Economic Consequences of Mr. Osborne.” The opinions expressed are their own.)
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