Keynesian Revolution in Economics - Essay Example

of the of the Keynesian Revolution in Economics Introduction This paper is intended to discuss key aspects of Keynesian revolution in economics. This paper will attempt to find out what historical conditions was it attempting to address and what problems was it directed towards in economic theory It also looks at the prevailing tradition in economic theory which it borrows from and what traditional economic doctrines did it challenge In what way did psychology play a role in Keynes explanation of economic activity Thesis Statement A large part of new Keynesian economics is trying to explain why firms set and adjust prices over time in the way they do. Firms in a perfectly competitive environment don't have any choice over what their prices are going to be. Competitive firms are price takers. If you want to even talk about firms setting prices you have to talk about firms that have some ability to do so, and those are firms that have some market power: they are imperfectly competitive. Key Aspects Keynesian Revolution The Keynesian heritage in terms of both theory and policy is now open for debate. What went wrong with Keynesian economics in recent decades, or, for that matter, from the beginning Is there any other method which can help us to resolve more effectively and efficiently the many problems which are menacing the foundations of Western society What is wrong with the alternative of Marxian economics as applied in the Socialist countries, which also harbor a plethora of unresolved problems Is the thinking of our time upside down, or are we using the wrong approach - both in the West and the East - and therefore cannot resolve the pending problems These are some of the leading questions to be answered during the rest of the twentieth century. First, he broke the prevailing conventional wisdom of the past, i.e. the classical economics and method of reasoning, and brought for debate a new economic vision where government intervention becomes a part of and a major rule in the economic system. This was a new economic philosophy in contrast to the classical view where government intervention in a free society was conceived as an exception to the rule or not needed at all, according to the formula of laissez-faire or "hands-off policy". Second, he was able to develop new tools of analysis like the multiplier theorem, the consumption function or the paradox of thrift - all devised to prove that his new economic philosophy based on the concept of active and permanent government intervention was necessary and workable. Third, he was able to induce a large number of his peers in the economic profession to accept and follow his method of approach and the overall conceptualization, even though this was a sort of inverted type of analysis when compared with classical economics, as will be shown later. The fact of the matter remains that his influence upon the thinking of his time was tremendous and unprecedented. Indeed, no other economist since Adam Smith enjoyed the opportunity to see that during his lifetime his ideas have conquered the world. This was a performance which raised Keynes to the status of the most influential economist of the twentieth century. A new composite method of approach: equilibrium vs. disequilibrium Classical economists were deficient in two major areas, one theoretical and the other practical. Their great performance was the study of stable equilibrium in theory where they found natural laws. This direction culminated with the formulation of the Walrasian theorem of general equilibrium. However, they were deficient in not having studied with the same diligence and attention problems of disequilibrium which were closer to the existing economic and financial conditions of their time. In other words, they were not aware of the existence of a gap between the harsh and unstable realities staring them in the face and the conceptual construction of an economics of stable equilibrium with natural laws valid only under the assumption of most ideal conditions, non-existent at the time. Such a unique performance could not have come except from a man of extraordinary intellectual background. No one has described his personality in more glowing terms than his old friend, colleague and former student, Professor E.A.G. Robinson of Cambridge University, England, who wrote in 1946 shortly after Keynes' death: "He (Keynes) was an optimist in the sense that he believed that very many of the world's evils were remediable, if only the obstacles of human stupidity could be removed; he hated stupidity with the passionate, emotional hatred of one who believed that it was depriving the human race of so much that was most valuable. He was an idealist in the sense that it mattered to him deeply and immediately what was the fate of mankind; he was not prepared to tolerate wrong in the present in the belief that it might ultimately be mitigated" (Heilbroner, 112). After some reluctance in the 1920s, his own country and the rest of the free world finally gave heed to his theories and followed his new ideas and propositions, supposedly to make a better world. During the 1950s and early 1960s Keynesian economics reached a position of almost absolute monopoly in the market of economic ideas and nobody dared to question it. And even if someone did, with the exception of a well-known economist like John Kenneth Galbraith, his product was not published. The Keynesian euphoria in politics reached a peak when a conservative President of the United States, Richard Nixon, declared publicly in 1969 upon the advice of his experts that "we are now all Keynesians". (Patinkin, 7) What followed after the Great Depression until the 1970s was the application of such policies based in principle on the same new economic philosophy of active government intervention as formulated by Keynes. What are the end results by 1976 Before the 1930s modern capitalism seemed to be plagued with problems coming from the private sector of the economy. Four decades later, having applied Keynesian policies, we have ended with the welfare state which gives evidence of even more difficult problems in the area of the public sector, respectively government business and finances. Obviously, over this span of time there was no clear-cut improvement since we moved from one set of disequilibrium (in the private sector) to another set of even more complicated disequilibrium (in the public sector). Indeed, if we now (in 1976) consider what is happening in Great Britain, France, Italy and the USA as well as the rest of the free world, we can clearly distinguish a widening gap between what the Keynesian doctrine had promised and what was achieved in practice. The Keynesian heritage in terms of both theory and policy is now open for debate. (Patinkin, 7) Classical economists further failed to investigate systematically the practical side of the issue, namely, the empirical conditions and the institutional set-up necessary for the realization and maintenance of an economic order based on a system of free markets with equilibrium prices and optimum use of available resources (natural and human). What went wrong with Keynesian economics in recent decades, or, for that matter, from the beginning Is there any other method which can help us to resolve more effectively and efficiently the many problems which are menacing the foundations of Western society What is wrong with the alternative of Marxian economics as applied in the Socialist countries, which also harbor a plethora of unresolved problems Is the thinking of our time upside down, or are we using the wrong approach - both in the West and the East - and therefore cannot resolve the pending problems These are some of the leading questions to be answered during the rest of the twentieth century. (Robert, 89) For the sake of the argument regarding the validity of Keynesian economics, it is encouraging to see that another great living economist, the Nobel Laureate Sir John Hicks, in a recently published book acknowledges in a friendly way that there is a crisis in Keynesian economics, which he describes thus: "There can yet be no doubt that the boom (of the 1950s and early 1960s) was associated in the minds of many with the Keynesian policies; so when at some date in the late sixties (varying from country to country), the boom itself began to falter, the authority of the policies that were supposed to have let it inevitably begin to be called in question. Instead of producing real economic progress, or growth, as they had for so long appeared to do, they were just producing inflation. Something, it seemed clear, had gone wrong. What was it The purpose of the monetary and economic dialogue with Keynes in this contribution fits very well with the characterization of Sir John Hicks in the last sentence: "We have to start all over again." Certainly Keynesian economics alone cannot save the Western world from another potential debacle reminiscent of the 1930s, and this time perhaps even more complicated. I might say that the incentive to conduct such a dialogue was sparked when this author was reading another most enlightening article by Hicks in which, back in 1937, he diagnosed Keynesian economics as the "Economics of Depression or Slump Economics" (Heilbroner, 121). Keynes made a great discovery, namely of a conflict between the goal of stability of prices and the goal of stability of exchange rates during the era of the modern gold standard before 1914. This was indeed a masterful observation at a time when the rest of the profession thought that the system in question as a whole, before World War I, was stable. As Keynes reported, it is historically true that at that time governments had "plumped for stability of exchange as against stability of prices" and had "'submitted to the social consequences of a change of price level for causes quite outside" of the country. If there were nothing to be added to the above observation Keynes would be right in drawing the conclusion that whenever faced with a conflict between the two goals, it is the one on price stability and not on the stability of exchange which is to be preferred in the national interest. Fortunately, there is more to be said about this issue, and an alternative exists when the conflict in question is avoided. But in order to see the alternative we must apply the new composite approach of equilibrium versus disequilibrium. Keynes missed the other most important implication - that the existence of such a conflict was a signal or a characteristic of disequilibrium conditions in the economy. If so, then under conditions of stable equilibrium the two goals are consistent with each other, are realized at the same time without government intervention. The real problem therefore was not to take the correctly observed conflict as an immutable phenomenon - as Keynes did - but rather to search further and discover the real nature of the disequilibrium under the aegis of a presupposed stable gold standard. Conclusion One could easily draw the conclusion from this article that what Keynes constructed was in reality not a general but rather a partial theory of disequilibrium of the capitalist system during a depression. The reference to Freud cannot help to resolve the argument scientifically since Freud was concerned with abnormal psychology, while gold was always desired by normal and not abnormal people. Works Cited Heilbroner, Robert; William Milberg. The Making of Economic Society. (12th Edition). Prentice Hall. (December 22, 2006). Patinkin, D (1996), "Keynes' monetary thought. A study of its development", History of Political Economy, Spring, Duke University Press, Durham, NC, Vol. 8 No.1, pp.7. Robert L. Heilbroner. The Worldly Philosophers: The Lives, Times And Ideas Of The Great Economic Thinkers. Touchstone. (August 10, 1999) Robinson, E.A.G, Keynes, J.M, in Lokachman, R (Eds), Keynes' General Theory. Reports of Three Decades, St Martins Press, New York, NY, pp.39. (1883-1946) Read More