"How I Became A Keynesian"

Most of you may not have heard of Richard Posner. Richard Posner is a judge, and an Economic Law professor at the University of Chicago (which is a hardcore subscriber of the neo-classical school of economics). Posner is considered to be one of the best economic minds at the school, and he was also a subscriber of the classical theory. I say he was because he no longer subscribes to that theory.

In an editorial in The New Republic titled How I Became A Keynesian, Posner details his experience in reading "The General Theory" and how he decided to shift from a classical point of view to a Keynesian point of view (Full Disclosure: As it should be quite obvious from my previous posts, I subscribe to the Keynesian theory). The article itself is excellently written and provides very good insight into why a Keynesian approach is more valid than the neo-classical approach. I recommend reading the article to get the full idea of what he's saying, as it is extremely well written, organized, and clear. I've highlighted a few points here, along with my analysis of them:

1. Keynes states that during a boom, risk estimation is quite low, but that during a bust, nearly everything becomes risky and "entrepreneurs droop." Posner states that this idea is both true and irrational, something that classical economists wouldn't be able to comprehend. If you look at current crisis, this is incredibly true. During booms, money flies everywhere, and the riskiest of propositions get taken up. As Jon Stewart put it during his interview with Jim Kramer, "In what world is 36-1 a good decision?" This is a rationale idea, that no one will take that bet. However, during an upswing, people don't view risky propositions as risky, and therefore would be willing to take that very irrational bet.

2. Keynes claims that "consumption is the sole end and object of all economic activity." Keynes was not interested in consumption itself, but more so how much of their income people allocated to it. Posner here begins to talk about the effect of "hoarding," and how it can lead to economic trouble. He states that while it's true that savings = investment, most of the time peoples savings are hedges against uncertainty and doesn't actually promote growth. Therefore, it's important to distinguish "Active investment (investment that happens immediately, like firms buying machines)" from "Passive investment (investment that takes a while, like saving money for later, unknown uses)." Keynes, therefore, says that the goal is to increase active investment, as this money will circulate through the economy (read the article to see how, as going into how would just be redundant). Therefore, consumption (actively buying goods and services), becomes the engine of the economy. This is radically different from what neo-classicals claim, which is that savings (or thrift/hoarding) is the engine of the economy.

3. This idea of consumption being the main engine of the economy leads Posner to claim that people can save with no intention of spending. Rationally, there is no reason to this, however Keynes tends to deal with the irrational as well. Posner states that people may save for all sorts of psychological reasons (bequeath a fortune, build up reserves). This type of saving is technically investment, but it is passive investment and doesn't actually help stimulate the economy. Therefore, this type of savings with no plans to spend actually hurts the economy, and can lead to recessions. Paul Krugman (another Keynesian economist) in his book "The Return To Depression Economics" claims that "Recessions are caused by people holding money." This is essentially what Keynes and Posner are talking about here. Holding money means less consumption which means less income (as people's income tend to depend on how much of their product other people buy) which means less growth which means less saving (This is known as the paradox of thrift).

4. Next, Posner talks about uncertainty in the markets. Because savers/investors don't know how their money will be used, there are times when they will be less likely to take chances and invest, which will lead to a higher interest rate (people who invest will want to be paid more for their money). These high interest rates will discourage active investment, and lead to passive investment, which as we've already discussed harms the economy.

5. There is an assumption among economists that by getting rid of the minimum wage, we can get rid of unemployment. The idea is that by letting wages to fall, people who would be willing to work at a lower wage would be able to. Unfortunately, this would obviously reduce incomes, leading to deflation, which can be deadly to people who have debt (which is just about all of us). Also, there are differences in skill levels of workers. A worker who is more productive is more likely to get a job than one who is less. Therefore, there CAN be involuntary unemployment that is unrelated to the business cycle, something that is impossible in the classical theory.

6. This leads us to Keynes's main idea, and one that Posner advocates for in his article. He says that when this happens, it is up to the government to invest, driving up demand. They can do this by lowering interest rates (Which the Fed does) and they can spend on public projects. As Posner says in his article, when the government buys a highway, they do so from a contractor who buys the materials, hires workers, and those people all buy things, letting the money cycle through the economy, leading to an upswing. However, this government spending does more, which is build confidence. It shows that the government is there to help business, and therefore, businesses will start to invest. In the Keynesian theory, confidence is key when it comes to stimulating consumption and investment.

Posner's shift has come at a time when it seems that everyone is moving to the Keynesian school, as typically happens during economic downturns. What's interesting to me is why people flee the Keynesian school once upswings happen. The most recent economic collapse can be linked to deregulation, a highly classical theory. I'm not advocating socialism, which seems to be the rallying cry of conservatives when it gets to the talk of government oversight. I'm talking about regulating the economy, re-instituting the Glass-Steagal act (which will be another blog at a future date), and making sure that the next upswing doesn't come in the form of a bubble, which has happened in the last two upswings (Tech and Housing). Keynes was not a socialist, and therefore, those who subscribe to his school of thought, like Posner, are not either. Instead of focusing on long run plans, the theory states that we should focus on the short run.

After all, as Keynes so eloquently put it, "In the long run, we're all dead."



-The Economist