Keynes’ comeback

More than half a century after his death, British economist John Maynard Keynes is back in vogue. Can Keynesian economics pull the world out of its slump?

Who was John Maynard Keynes?

The 20th century’s guiding light of liberal economic theory. Born in 1883, Keynes was educated at Eton and Cambridge, and became a prolific writer on subjects ranging from philosophy to probability. He joined the British Treasury during World War I, representing it in negotiations in Versailles over the treaty that ended the war. His experience in Versailles led him to write The Economic Consequences of the Peace, in which he condemned the onerous reparations imposed on Germany and sagely predicted the ruin that loomed ahead for Europe. Such unconventional views left him out of political favor for much of the 1920s. But the market crash of 1929 increased demand for his theories—and counsel—on both sides of the Atlantic. In 1936, he published his magnum opus, The General Theory of Employment, Interest, and Money, which for decades exerted a profound influence on economic thinking and practice.

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What was the core of his economic theory?

Disputing the classical free-market belief in an “invisible hand” that guides economies in a natural cycle, Keynes viewed recessions and depressions as symptoms of economic distress that must be treated. He also challenged the prevailing view that governments should always strive to balance budgets. Keynes said the proper response to economic slowdowns was to boost demand in the marketplace, and if the private sector was not investing sufficiently to create demand—as was the case throughout the 1930s—then government should fill the void by spending. It mattered not whether the government was building trains or pyramids—the point was to create jobs so citizens would have more money in their pockets, which would increase demand for goods and services and propel the economy forward.

Did this theory get a real-world test?

Yes. It was called the Great Depression. With the country’s economy in collapse, President Roosevelt followed Keynesian principles by spending heavily on public-works projects. In response, unemployment rates slowly declined through the 1930s, and the economy began to revive. But it wasn’t until the largest public-spending program of all—World War II—that the Great Depression came to an end. After the war, most mainstream economists were more or less “Keynesians.” Time magazine wrote in 1965 that Keynes’ ideas had become so widely accepted “that they constitute both the new orthodoxy in the universities and the touchstone of economic management in Washington.”

Why did Keynes fall out of favor?

In the 1970s, global economic distress defied a lot of Keynesian thinking. Keynesian models projected that the ills of inflation and unemployment had an inverse relationship—if one was high, the other would be low. Government could supposedly keep both at modest levels by adjusting both monetary policy (interest rates and the money supply) and fiscal policy (taxation and spending). But in the 1970s, unemployment in the U.S. hit 8 percent and was accompanied by 16 percent inflation. Inflation in the U.K. and Japan rose even higher, and out-of-control government spending was blamed. Keynesian theory lost its mojo, replaced by the conservative policies identified with economist Milton Friedman. While Keynes emphasized demand, Friedman stressed adjustment of interest rates and the money supply as the primary lever of economic policy. Rather than trying to micromanage the economy, Friedman said governments should lower taxes, lower interest rates, and get out of the way, letting the pursuit of wealth drive a return to economic health.

Why is Keynes suddenly back?

Because of the mess we’re now in. In the current economic crisis, monetary policy has been pushed to its limit. The interest rate charged to lenders is near zero, but lending remains stalled and economic activity has plummeted along with employment. With no tools left in the monetarist kit, many economists favor a government boost to aggregate demand—just as Keynes would have advised. That’s the idea behind the $787 billion stimulus package.

How will the stimulus work?

It will spend billions on public-works projects, health care, education, law enforcement, and other programs in an effort to create jobs and put money in people’s pockets. The key goal is to goose consumer spending and counter the effect that Keynes called “the paradox of thrift.” If everyone tries to save money in an economic downturn, the reduction in spending only accelerates the spiral. With a burst of public spending, the White House hopes to break the cycle and restore confidence, the key psychological factor that Keynes called the “animal spirits.”

Will it succeed?

Nobody knows. Economics can be mystifying. Back in the Great Depression, Keynes said, “We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand.” Eighty years later, the experts’ collective understanding of economies is greater than it was in Keynes’ hour of despair. But while the White House can point to broad support for the stimulus among economists, not everyone thinks it will work. Critics contend that government spending is inherently wasteful and that the resulting deficits will suppress private investment by driving up interest rates. They prefer balanced budgets, and their lower risk of inflation, saying that such sound policies will lead to a recovery—perhaps not immediately, but in the long run. To such critics, Keynes once famously said, “In the long run, we are all dead.”

Keynes’ bohemian side

Keynes was at home among the rarefied Bloomsbury set, the collection of artists and intellectuals that cohered in pre–WWI London. He appreciated Bloomsbury’s disdain for convention—he had a lengthy and fairly open homosexual affair with painter Duncan Grant before the war. But despite his bohemian tendencies, he found no attraction in radical politics. Squarely labeling himself a “bourgeois economist,” he used his financial acumen to amass a fortune, including one of the world’s great collections of 20th-century art. Keynes married a popular Russian ballerina, Lydia Lopokova, in 1925; the couple had no children. As a don at Cambridge, he influenced a generation of young intellectuals, establishing himself as one of the most formidable minds of the century. “Every time I argued with Keynes,” said philosopher Bertrand Russell, “I felt that I took my life in my hands and I seldom emerged without feeling something of a fool.”