Saturday, April 30, 2011

Book Review (#6 of 2011)

The General Theory of Employment, Interest, and Money by John Maynard Keynes. I found this free at Project Gutenberg and is the first ebook I've read exclusively on my iBooks (instead of Kindle & Kindle apps). I decided it would be great to read it since I just finished Wealth of Nations. My highlights and notes are legion, but Apple/iBooks doesn't put them out on a website for easy copy-and-paste like Amazon does.

This review is not intended to be exhaustive, it's just my main take-aways. Like WoN, the GT is a book you read a lot about but really need to read for yourself. In some ways, it's a more difficult read than WoN because some of Keynes' thoughts are underdeveloped and ambiguous. It made me appreciate the Hicks-Hansen IS-LM framework more (particularly with foreign exchange added in later, since Keynes is mainly thinking in terms of a closed economy).

GT needs to be read with a commentary. I used the ever-helpful Ekelund & Hebert textbook, and for the first 12 chapters used commentary from Tyler Cowen (who apparently quit posting after Ch. 12). I didn't have any epiphanies like renowned conservative Judge Richard Posner, who claimed recently reading the book converted him to Keynesianism.

Keynes is primarily dealing with one big weakness in economic thinking: interest rate determination. He explores all historical explanations of interest rates, from Ricardo, Mun, Marshall, Pigou, Wicksell, Von Mises, and many more, and finds them wanting. He contributes his liquidity preference theory to the mix, and shows how that can augment others' previous contributions.

Besides harping on the failure of the classical British school of thought to explain interest rates, he also harps on the classical model's failures in explaining unemployment. Writing from 1936, unemployment had been high for years. His "animal spirits" explanation of fluctuations in Investment is often derided but I don't see how reasonable people could say it's wrong. We've seen 2 very recent examples-- the tech bubble and the housing bubble-- that Shiller and others point out prove Keynes' point.

Even though Keynes blasts his teachers Marshall and Pigou, he also pays tribute to the classical school for its contributions to the world, and his own upbringing. He devotes considerable space in a late chapter, however, to Mercantilists. The free trade arguments of Smith and Ricardo are generally held up as economic Gospel, and as such Mercantilist ideas had been ignored and discarded. Keynes makes the point that the Mercantilists had figured out that by increasing the money supply one could lower interest rates and stimulate the economy-- something the Classical school found abhorrent.

As Milton Friedman later showed, Keynes' biggest problem was his lack of faith in monetary policy to stimulate investment. Everything monetary in Keynes' view revolves around the interest rate. And if the central bank can't get the interest rate low enough to stimulate investment anymore, then you're in the "liquidity trap." This has led to the problematic current thinking of monetary policy being ineffective at the zero lower bound.

Keynes seems to ignore the possibility of creating an excess of money beyond what people want to hold, so that people will eventually spend that money. Output will rise, unemployment will fall, and prices will eventually rise as well. This is why I prefer a Hayek/Sumner idea of a central bank ignoring interest rates and targeting M x V growth instead.

The original sin of Keynesianism is this whole obsession with monetary policy via interest rates. Following that was then Keynes' skepticism of monetary policy to do anything stimulative in his 1936 environment. Which meant that the only other entity left was the government-- hence, he advocated government investment to replace or enhance private investment.

It's not an unreasonable conclusion. If the economy isn't quickly self-correcting and monetary policy is useless, the only way to stimulate investment is to have the government plan to keep it going. Save for a "rainy day" during the boom years, run deficits when the private economy turns downward, and you can keep the party going indefinitely. For Keynes, the trade-off between inflation and unemployment is a long-run one, which Phelps & Friedman later reminded us isn't true.

I liked how Keynes addressed Austrian economic concerns/criticisms at the time. Austrians believe that "malinvestment" is created by keeping interest rates "artificially" low. People wouldn't build houses or purchase other capital equipment if interest rates were higher. But Keynes points out that a) who's to say which investments are mistaken?, and b) by raising interest rates to snuff out the malinvestment, you also snuff out the legitimate investments. Having the government choose investment projects probably wouldn't be any more helpful, but as Skidelsky put it, we can put up with a little bit of government waste if it means getting rid of the waste of human capital that unemployment causes. Keynes solution is to keep the interest rate from rising to prolong the boom indefinitely (and where this fails, enter government investment).

Milton Friedman believed that had Keynes lived longer (to read Friedman and Schwartz's book probably) he probably would have changed his mind about some of his prescriptions, particularly about monetary policy. And Keynes would not have agreed with Keynes' disciples' prescriptions for the U.S. economy in the 60's and 70's. Probably so. But Keynes would have definitely been useful the past few years to remind us that prices aren't going to start really rising until unemployment falls and we get closer to capacity.

Cowen and others point out the numerous errors and mistakes in the GT. That's fine, is there an economic book out there that didn't have errors and mistakes (WoN is full of them)?

But Keynes' contributions in how we think about and teach the macroeconomy are huge. We are indeed all Keynesians now, even though none of us is anymore (Friedman quote again).

I give the book 3.5 stars out of 5. I'm definitely a better macro teacher this semester having read it.

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