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Fabricating the Keynesian Revolution: Studies of the Inter-war Literature on Money, the Cycle, and Unemployment
It is a commonly held belief that, in 1936, Keynes' General Theory ushered in a new era in economic thought, with faith in the free market being replaced by reliance on systematic government intervention as a means of keeping the economy on an even keel. This book surveys the writings of a large number of economists in the interwar years and argues that the "Keynesian Revolution" is a myth, and that the "new economics" was a careful and selective synthesis of an "old economics" that had been developing for twenty years or more.
400 pages, Paperback
First published March 28, 1999
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August 11, 2014
This is by far the best book out there tracing the ideas behind the so-called Keynesian Revolution. While not slighting Keynes, and giving full regard to his innovations and contributions, this shows how much of his supposed revolution was already incipient in the work of previous economists. (I apologize but this review will be a little wonky.)
Laidler starts the book with what other researchers have called the "Wicksell Connection," namely, the importance of Swedish economist Knut Wicksell and his 1898 book "Interest and Prices," for a variety of different economists. Wicksell posited that a divergence between the "natural" rate of interest, variously defined, and the actually existing interest rate caused a disturbance in the monetary system that could lead to inflation or deflation, and boom or bust. This insight, or variations of it (for it was not translated or well-known in English until the 1930s) underlay much of the new work on monetary theory in the early 20th century. The Austrians thought such a divergence, say with lower real than natural rates, caused a more "roundabout" method of production and eventually overproduction that lead to depressions. The Swedes soon incorporated faulty expectations in their models and showed how changes in opinions about the future could change output today. The Brits showed how "wage stickiness" against a downward fall in the price level could translate into a fall in unemployment and then a fall in output. Finally, the Americans brought some rigorous empirical data to the story and many, like Paul Douglas at the University of Chicago, emphasized the importance of "underconsumption" in explaining depressions.
So all these went into Keynes 1936 book the General Theory on Employment, Interest, and Prices, but Keynes to added a few important things and clarified much. Most importantly, Keynes's "liquidity preference theory" showed that when a change in the need for holding money due to expectations about the future, say towards more cash because of uncertainty, the price level would not necessarily drop but total income would, since an increase in the demand for money would increase as opposed to decrease the interest rate, and thus cause a further depressing effect on the whole economy.
Two of Laidler's most important contributions should be noted. First is that economist Ralph Hawtrey, famous or infamous as the progenitor of the "Treasury View" that increased public works spending had no effect on the economy as a whole, is shown to be perhaps the most perceptive and far-seeing economist of his time. Laidler demonstrates that Hawtrey only believed public works were ineffective because anything they could do could be done better by the monetary system, and he argued for strong central bank open-market purchases of securities in the Depression to bolster the economy when others were arguing for caution. Laidler also shows that much of what we think of as "Keynesian economics" is really the economics of his followers like John Hicks, who synthesized Keynes theories into the algebra of the IS-LM curves (the equation that showed how interest and savings met the demand and quantity for money). In this, Laidler shows how Hicks and others left out a much of the true Keynesian story, about sharp changes in "animal spirits" or expectations, and about the supposed insensitivity of interest rates to changes. Keynes tendency to eschew mathematics actually allowed the next generation to pluck what they most wanted from him and turn it into their own equations, and in the process ignore much of Keynes's actual work, sometimes for the better and sometimes for the worse.
This book is certainly dense, and it can be hard to follow all the differing theories of a myriad of different economists, especially when their theories are so often confused. But Laidler is the ideal guide through it all: highlighting their inconsistencies, noting their contributions, and adding his own important insights into the evolution of contemporary macroeconomists.
Laidler starts the book with what other researchers have called the "Wicksell Connection," namely, the importance of Swedish economist Knut Wicksell and his 1898 book "Interest and Prices," for a variety of different economists. Wicksell posited that a divergence between the "natural" rate of interest, variously defined, and the actually existing interest rate caused a disturbance in the monetary system that could lead to inflation or deflation, and boom or bust. This insight, or variations of it (for it was not translated or well-known in English until the 1930s) underlay much of the new work on monetary theory in the early 20th century. The Austrians thought such a divergence, say with lower real than natural rates, caused a more "roundabout" method of production and eventually overproduction that lead to depressions. The Swedes soon incorporated faulty expectations in their models and showed how changes in opinions about the future could change output today. The Brits showed how "wage stickiness" against a downward fall in the price level could translate into a fall in unemployment and then a fall in output. Finally, the Americans brought some rigorous empirical data to the story and many, like Paul Douglas at the University of Chicago, emphasized the importance of "underconsumption" in explaining depressions.
So all these went into Keynes 1936 book the General Theory on Employment, Interest, and Prices, but Keynes to added a few important things and clarified much. Most importantly, Keynes's "liquidity preference theory" showed that when a change in the need for holding money due to expectations about the future, say towards more cash because of uncertainty, the price level would not necessarily drop but total income would, since an increase in the demand for money would increase as opposed to decrease the interest rate, and thus cause a further depressing effect on the whole economy.
Two of Laidler's most important contributions should be noted. First is that economist Ralph Hawtrey, famous or infamous as the progenitor of the "Treasury View" that increased public works spending had no effect on the economy as a whole, is shown to be perhaps the most perceptive and far-seeing economist of his time. Laidler demonstrates that Hawtrey only believed public works were ineffective because anything they could do could be done better by the monetary system, and he argued for strong central bank open-market purchases of securities in the Depression to bolster the economy when others were arguing for caution. Laidler also shows that much of what we think of as "Keynesian economics" is really the economics of his followers like John Hicks, who synthesized Keynes theories into the algebra of the IS-LM curves (the equation that showed how interest and savings met the demand and quantity for money). In this, Laidler shows how Hicks and others left out a much of the true Keynesian story, about sharp changes in "animal spirits" or expectations, and about the supposed insensitivity of interest rates to changes. Keynes tendency to eschew mathematics actually allowed the next generation to pluck what they most wanted from him and turn it into their own equations, and in the process ignore much of Keynes's actual work, sometimes for the better and sometimes for the worse.
This book is certainly dense, and it can be hard to follow all the differing theories of a myriad of different economists, especially when their theories are so often confused. But Laidler is the ideal guide through it all: highlighting their inconsistencies, noting their contributions, and adding his own important insights into the evolution of contemporary macroeconomists.
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