Keynes Re-Engaged

Arindam Banerjee

A book review of ‘Keynesian
Reflections: Effective Demand, Money, Finance and Policies in the Crisis’
edited by Toshiaki Hirai, Maria Marcuzzo and Perry Mehrling, Oxford University
Press 2013.

The global financial crisis of 2008 has dealt a double blow
at the fundamentals of the world economic system, which the latter is still
grappling with. The first blow was to the hitherto unchallenged hegemony of
international finance capital, which rose to global dominance over the
preceding three decades. The collapse of Lehmann Brothers and with it the disappearing
aura of the Wall Street brought into question the deep-rooted confidence of
finance capital. However, in the aftermath of the crisis, one can say that
though Finance Capital is down but not yet out, given that there is an intense
ongoing effort on part of the global financial elites to reinstate the
near-complete hegemony that it enjoyed till the 2008 crash. The ardent push for
austerity in the Euro zone and the more recent militancy of the Republicans,
blocking the US budget, in order to bargain for greater fiscal conservatism,
are cases in point, which reflect this continuous effort of finance capital to
influence policy-making.

The second blow seems to be more decisive in nature. This
has been struck at the base of the commonly held beliefs of the discipline of
economics, largely informed by the neo-liberal doctrine; the very essential
ideological foundation of finance capital. The massive dimensions of the US housing
market collapse and the inability of the mainstream economics practitioners to
predict or even diagnose the same has spelled doubt on much of the teaching and
research in economics that have been carried out by frontier institutions and
universities, particularly in the north but not exclusively so. The celebration
of more and more securitization of assets on the basis of unchanging real
outputs and piling up derivatives on weak asset bases has been brought to a
screeching halt, whereby the discipline is now more critical and apprehensive
of the par excellence financial
models, which have dominated the discourse for nearly three decades.
The neo-classical assumption of full employment is once
again under critical focus. The germane debates during the times of the Great
Depression of the 1930s are being referred back and the search for alternative
paradigms of economics is rejuvenated. The Keynesian thought plays an important
role in this for two reasons. First, it was the theoretical interventions and
policy prescriptions of John Maynard Keynes and his followers that rescued the
world economy from the clutches of the Great Depression. This is not to ignore
the important role that massive fiscal expansion led by war expenditures (prior
to the Second World War) played in this regard. The second reason why Keynesian
policies have to be re-engaged and re-imagined is due to the fact that
neo-liberalism led by the interests of finance capital rose to dominance
precisely by undermining Keynesian policies and building on the latter’s
shortcomings. The New Keynesians are actually closer to the neo-liberals in
their assumptions than Keynes’ original propositions.
In this context, Keynesian
Reflections: Effective Demand, Money, Finance and Policies in the Crisis

(ed. By Toshiaki Hirai, Maria Marcuzzo and Perry Mehrling, OUP, 2013: ISBN
0-19-809211-3) presents as an excellent endeavour to rediscover Keynes, both
the positives of the theory and the negatives of the way Keynesianism was
practiced in policy-making. The collection of articles in the book engages
meaningfully in the central debates of macro-economics and also foregrounds
several paradigms of economic policy-making which were lost due to dominance of
neo-liberalism in the recent past. The discussion of the macro-economic
experience of various countries like Japan, US or India and the wide range of
policies adopted to tackle the crisis also places the discussion in a global
perspective of policy-making.
It’s the Investments!
Practicing Keynesian macro-economics policies has always
been an area of contention. The Patinkin-Meltzer debates on what Keynes meant
when he prescribed that government expenditure, and in general, expenditure,
should increase when an economy is in a depression, is illustrative of this
dilemma. Meltzer’s argued that Keynes was in favour of the investment route in
order to enhance aggregate demand in the economy, especially in one afflicted
by a depression. Patinkin countered this by saying that this interpretation of
Keynes stretches the point too much as it is not possible that private
investments will increase at times when ‘idle factories’ i.e. unutilized
capacities, are plenty in number. Rather, the way an economy can come out of
depression is by increasing consumption levels and the rest would automatically
Such consumption-led growth, often financed by credit and
not through a rise in incomes, results into bubbles based on false expectations
and undervalues risks, thereby becoming an unsustainable proposition. This is
also a recipe for recurrent economic crisis. The experience of the US, since
the 1990s, bears testimony to this prognosis. Backhouse and Bateman in their chapter
engages with this debate using Keynes’ unpublished letter to the Dutch company
N. V. Philips, to which he acted as an adviser during the Depression years.
The company asked for a clarification on Keynes advice to
them that it is only through countercyclical investments that the depression
can be overcome. The company was not convinced that more investments and
addition to manufacturing capacity was a good idea when much of the existing
capacities were already in excess for immediate needs. Keynes in his response (Keynes
Papers, File BM5) reiterated that only through a reduction in the long-term
interest rates and a consequent recovery of investment can the economy emerge
from the crisis. He further clarified that by investment he does not mean so
much of private investment in manufacturing, which was already excess, but
stresses on the requirement for infrastructure investments like ‘building,
transport and public utilities’. He reckoned that even for these investments to
occur, often by the government, the cost of borrowing should be low and high
interest rates in the economy presents as a barrier in this regard.
Infrastructure investments are expected to create jobs
leading to higher aggregate demand and also increase the productivity of
private capital, which in turn further boosts the economy. A monetary policy,
which raises the interest rates during depression and hence the cost of credit,
is therefore not conducive for an economic recovery.
Monetary or Fiscal Policy?
The dominant argument from the Keynesians is however for a
expansionary fiscal policy and not for monetary policy. Kregel makes a
significant intervention in this regard with his examination of whether
monetary policy alone can lead an economy out of crisis. He says that there is
no doubt that monetary policies like the Zero Interest Rate Policy (ZIRP)
adopted by the Japanese Central Bank in the 1990s and the Quantitative Easing
(QE) policy adopted by the US after the financial crisis have their origin in Keynesian
ideas. At the same time, these policies have not been very successful in terms
of orchestrating an economic recovery and therefore the efficacy of these
policies need to be reviewed. Kregel also reminds us that Keynes himself had
also evolved, during the Great Depression years, with regard to his position on
the effectiveness of monetary policies in enhancing investments.
Keynes in his A
Treatise on Money
(1930) had strongly made the argument of why low interest
rates (expansionary monetary policy) are required for dealing with an economic
crisis, elaborated in the last section. The ZIRP and the QE are precisely in
line with that argument. This enthusiasm that Keynes possessed regarding
monetary policy is dampened over the years and his position on this appears to
be more nuanced in The General Theory
written in 1936. In his magnum opus,
he clearly points out that pushing the interest rate down alone may not be
enough to induce lenders and borrowers to transact in the market, given that
the level of ‘trust’ in the economy may be quite low in a depressed economy.
Keynes’ own words put forward the point quite illustratively:
We must also take
account of the other facet of the state of confidence, namely, the confidence
of the lending institutions towards those who seek to borrow from them,
sometimes described as the state of credit. A collapse of the price of equities
[…] may have been due to the weakening either of speculative confidence or of
the state of credit […] the weakening of either is enough to cause a collapse,
recovery requires the revival of both
(emphasis in original)…
” (General Theory, J. M. Keynes, 1936: 158)
Keynes also pointed out that very low interest rates without
a revival in the ‘state of confidence’ can also put an economy in a liquidity
trap where investors prefer to hold money instead of bonds. Kregel argues that
Keynes’ optimism with monetary policy in the Treatise was misplaced and his skepticism expressed later is more
realistic. Specifically, the confidence of investors in the US after 2008 is
down precisely due to presence of large volumes of ‘toxic assets’ in the
markets, which erodes ‘trust’. Even a zero real interest rate in the US for the
last few years has therefore failed to attract higher levels of investment.
In this context, Kregel argues by quoting Keynes that
countercyclical fiscal expansionary policies are more reliable in lifting an
economy out of a depression. A greater role of the government is long due in
tackling the current crisis
[…] am now somewhat
skeptical of the success of a merely monetary policy directed towards
influencing the rate of interest. I expect to see the State […] taking an ever
greater responsibility for directly organizing investment;
” (ibid)
State versus Market: a false binary?
The untenable assumption of neo-classical economics of full
employment in any economy and consequent inflationary tendencies of public
expenditure clearly needs to be debunked in order to formulate policies which
can meaningfully address the ills of a depression. The Keynesian tradition
lucidly does this through the emphasized argument of enhancing aggregate demand
through counter-cyclical expenditures during a slowdown. Much of these
expenditures have to be undertaken by the government, as the above lines from
the General Theory points out. An
economically pro-active State or a ‘Large State’ is therefore unambiguously
required for engineering a fiscal stimulus, contrary to the usual reasoning of
The fact that money and bond markets will not clear on their
own, particularly at times of a recession, is also pointed out through the
Keynesian argument of ‘liquidity trap’, where even at very low interest rates,
investors are more willing hold money than undertake investments. Government
intervention in the bond markets is essential in order to revive the economy
and large scale government borrowing and spending creates the environment where
investments, employment and incomes increase. Wray argues for a ‘Big
Government’ that operates in public interest as proposed by Minsky.
Sen in her piece stresses on the role of private speculators
in the financial and other markets in fuelling economic crises. Speculation has
increased greatly across the globe over the last few decades with increasing
reforms of markets, creation of new commodity future markets and relaxation of
regulations regarding operations in such markets. In the US, the regulations on
banking and particularly the clear separation of banking and financial
operations that were part of the Glass-Steagall Act of 1933 were considerably
watered down since the 1980s. This allowed the participation of banks in more risky
operations like those in the derivative markets. Speculative activities
multiplied manifold and diverted larger proportions of finance away from
productive investments.
Keynes in his policy prescriptions during the Great Depression
had clearly argued that the optimum volume and mix of investment that is
‘socially relevant’ may not be the same as that which maximizes ‘private
profits’. It is therefore natural that in the absence of strong regulations,
there is an amplification of short-term speculation in various markets at the
cost of real economic production. Several authors in the volume argue for
stronger regulations in the financial and commodity futures markets which have
emerged as the sites of big ticket speculation globally. This adds to the reasons
why one should pitch for a ‘Strong State’ that can keep the markets in its
leashes and not get undermined the other way round as has happened under
neo-liberal thinking.
The post-crisis experience in US and the rest of the world
however indicates that even a mammoth financial collapse like the 2008 crisis
does not automatically help to put in place a State that can keep markets under
control. While theoretically neo-liberalism and free market worship may have
suffered a setback, in the domain of policy-making, the dominance of finance
has not ended. This is well-illustrated by the massive bail-out of the Wall
Street after 2008, that essentially amounted to a ‘socialization of losses’; losses
which were caused by the caprices of the bullish CEOs of financial institutions
and their pack of trained speculators.
This experience, along with the clamour for more austerity,
points out that the binary between the State and the Market may not always be
the correct paradigm to start from if one has to remedy the present
crisis-ridden situation. This is more so in a historical context where the
State has primarily acted to facilitate the ‘free market’ and when it grows big
and strongly intervenes, it does so to protect the interests of finance
The real binary may actually be identified if one
investigates the political economy of state policy. The true contradiction does
not lie between the State and the Market but in the social contradiction
between capital and labour. To be more precise, the binary is between finance
capital on one hand, represented by the global financial elites and their
beneficiaries, and the working class, salaried middle classes, petty producers
and the unemployed on the other. The global income distribution has clearly
moved in the favour of the former party. Without a tilt in the balance of power
against the financial elites, there is little chance that the State will
remotely adopt Keynesian or other alternative policies to address the crisis.
In the aftermath of the crisis, there has been myriad
manifestation of class struggles globally, one example of which is the Occupy
Movement in the US. Without increasing pressure on the governments through such
struggles with more clarified objectives, the majority of the population cannot
hope to change State policies in a direction that needs to not only bring
recovery and stability to the economy but also lead to more equitable growth
and distribution of global income and resources. It is beyond doubt that any
social scientist concerned with the current crisis has to engage more
vigorously with the political economy of such a desirable social and economic change.
Arindam Banerjee is Assistant Professor at Ambedkar
University Delhi.
The review was published in The Book Review in 2014.