Monetary Central Planning and the State, Part 17: Keynesian Economic Policy and Its Consequences

In a famous lecture entitled “National Self-Sufficiency” delivered in Dublin, Ireland, in April 1933, John Maynard Keynes renounced his previous belief in the benefits of free trade. He declared, “I sympathize … with those who would minimize rather than those who would maximize economic entanglement between nations…. Let goods be homespun whenever it is reasonably and conveniently possible; and above all, let finance be primarily national.”

He remained loyal to his new allegiance to economic protectionism when he published The General Theory of Employment, Interest and Money in 1936. In one of the concluding chapters, he discovered new value in the 17th- and 18th-century writings of the mercantilists and their rationales for government control over and manipulation of international trade and domestic investment.

But Keynes also expressed another sentiment in that 1933 lecture:

“We each have our own fancy. Not believing we are saved already, we each would like to have a try at working out our salvation. We do not wish, therefore, to be at the mercy of world forces working out, or trying to work out, some uniform equilibrium according to the ideal principles of laissez faire capitalism.”

Keynes was convinced that left to itself, the market economy could not be trusted to ensure either stable or full employment. Instead, an activist government program of monetary and fiscal intervention was needed for continuing economic prosperity. If this also required a degree of state planning, Keynes was open to that kind of direct social engineering as well. A letter that Keynes wrote to Austrian economist Friedrich A. Hayek in 1944 is often quoted. In it Keynes said that he found himself “in a deeply moved agreement” with Hayek’s arguments in The Road to Serfdom. But less frequently mentioned was what Keynes went on to say in that same letter:

“I should say that what we want is not no planning, or even less planning, indeed I should say that what we almost certainly want is more. Moderate planning will be safe if those carrying it out are rightly oriented in their own minds and hearts to the moral issue. Dangerous acts can be done safely in a community which thinks and feels rightly, which would be the way to hell if they were executed by those who think and feel wrongly.”

Of course, the question is, Who determines which members of the society think and feel “rightly” enough to qualify for the power and authority to plan for the rest of us? And how is it to be ensured that such power does not fall into the hands of “those who think and feel wrongly”? Furthermore, on what basis can it be presumed that even those who claim to be “rightly oriented in their own minds and hearts” could ever possess the knowledge and ability to plan some proposed, desirable economic outcome for society?

Yet, as a number of commentators have pointed out, Keynes had no doubts about either his “rightness” or competency in claiming such an authority or ability. He belonged to a British elite that viewed itself as superior in practically every way from the other members of the society. As Keynes’s sympathetic biographer Roy Harrod explained, “He was strongly imbued with … the idea that the government of Britain was and could continue to be in the hands of an intellectual aristocracy using the method of persuasion.” And as the American Keynesian Arthur Smithies also pointed out, “Keynes hoped for a world where monetary and fiscal policy, carried out by wise men in authority, could ensure conditions of prosperity, equity, freedom, and possibly peace.”

As we have seen (see “Monetary Central Planning and the State, Part XVI, April 1998), Keynes argued that the fundamental problem with a laissez-faire market economy was that as incomes went up over time, the saved part of that income would grow proportionally. Individuals were habituated and socialized into having certain types and amounts of consumer wants. When these tended to be satisfied, consumers ran out of things to demand, both in the present and the future. As a result, that would limit the amount of their growing fund of savings for which there would be private investment demand.

With a psychological limit on the propensity to consume, and investment demand restrained by limited investment opportunities for future profits, savings in the society would accumulate and go to waste. Since workers were presumed to be unwilling to accept any significant downward adjustments in their money wage demands because of “money illusion,” total, aggregate demand for goods and services in the economy would be insufficient to profitably employ all those willing to work at the prevailing, rigid money wages on the market.

In Keynes’s mind, the only remedy was for the government to step in and put the unused savings to work through deficit spending to stimulate investment activity. What the government spent those borrowed funds upon did not matter. Even “public works of doubtful utility,” Keynes said, were useful, as long as they put people to work. “Pyramid-building, earthquakes, even wars may serve to increase wealth,” as long as they create employment. “It would, indeed, be more sensible to build houses and the like,” said Keynes, “but if there are political or practical difficulties in the way of this, the above would be better than nothing.”

Nor could the private sector be trusted to maintain any reasonable level of investment activity to provide employment. The uncertainties of the future, as we saw, created “animal spirits” among businessmen which produced unpredictable waves of optimism and pessimism that generated fluctuations in the level of production and employment. Luckily, government could fill the gap. Furthermore, while businessmen were emotional and short-sighted in their fears and their erratic investment behavior, the state had the ability to calmly calculate the long-run, true value and worth of investment opportunities “on the basis of the general social advantage.”

Indeed, Keynes expected the government to take on “ever greater responsibility for directly organizing investment.” In the future, said Keynes, “I conceive, therefore, that a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment.” As the profitability of private investment dried up over time, society would see “the euthanasia of the rentier” and “the euthanasia of the cumulative oppressive power of the capitalist” to exploit for his own benefit the scarcity of capital. This “assisted suicide” of the interest-earning and capitalist groups would not require any revolutionary upheaval. No, “the necessary measures of socialization can be introduced gradually and without a break in the general traditions of the society.”

This did not mean that the private sector would be completely done away with. Through its monetary and fiscal policies, the government would determine the aggregate level of spending in the economy, and then private enterprise would be allowed to operate in directing resources for the manufacture of the various individual goods to be sold on the market.

The role of fiscal policy was for the government to run deficits and inject a net increase of spending into the economy by borrowing the unused savings that accumulated as idle cash or as unspent hoards of money. The key, in Keynes’s view, was for the government to increase spending enough that prices in general in the economy would rise. “The expectation of a fall in the value of money [a rise in prices] stimulates investment, and hence employment” because it would raise the profitability of prospective investments.

Why would rising prices stimulate investment profitability? Because, in Keynes’s view, workers’ “money illusion” worked both ways. Just as workers would not accept cuts in their money wages with a fall in prices, workers would not generally demand an increase in their money wages when there was a rise in prices. “A movement by employers to revise money-wage bargains downward,” said Keynes, “will be much more strongly resisted than a gradual and automatic lowering of real wages as a result of rising prices.” Thus, the government’s fiscal stimulus would raise prices in general relative to costs of production (especially the money-wage costs of labor), thus increasing profit margins and creating the incentives for private employers and investors to expand output and rehire the unemployed.

Matching the fiscal stimulus, government was to introduce any required monetary expansion to keep interest rates low. If the government’s fiscal stimulus did succeed in generating greater investment spending in the private sector, it would tend to increase the private sector’s demand to borrow for the financing of expanding production activities. This increased demand to borrow would tend to push interest rates up and dampen some of the private sector business activity the government would try to stimulate. Thus, the government’s monetary authority was to create enough money to satisfy both the government’s and the private sector’s demand to borrow, while keeping interest rates unchanged (or even lowered).

While Keynes was suspicious of attempts to construct statistical models of the economy (indeed, in an article in 1939, he forcefully criticized one of the leading developers of econometric techniques), he clearly believed that it was in the capacity of the government to determine just the right amount of fiscal and monetary stimulus to establish and maintain a fully employed economy.

He also argued that government had to regulate and control a country’s imports and exports for purposes of securing a desired level of domestic production and employment. “It will be essential for the maintenance of prosperity that the authorities should pay close attention to the state of the balance of trade…. For a favorable balance, provided it is not too large, will be extremely stimulating,” Keynes said. As for the effects this would have on international trade, Keynes stated that “the classical school [of economists] greatly overstressed … [the] advantages of the international division of labor.”

For Keynes, therefore, no aspect of economic life would remain unaffected by the activist hand of government. After all, Keynes had said, “We each have our fancy,” and his purpose was to devise the rationale and tools for government “to have a try working out our salvation.”

Categories: Freedom Daily Archive, Monetary Policy