What’s Wrong with Keynesian Economic Theory?

That is the title of a new book, edited by Steven Kates. It is published by Edward Elgar ($$$). I am one of the contributing authors.

My essay argues that Keynesians use two very different approaches in marketing their ideas. First, they use a simplistic approach (“spending creates jobs and jobs create spending”) to talk to politicians and the general public. Second, because among trained economists it is indefensible to ignore prices and instead talk about quantities depending on quantities, Keynesians talk in academic circles in an entirely different fashion.

I say that that fatal flaw in both approaches is aggregation–treating the economy as a GDP factory. This makes it impossible for Keynesians (or for macroeconomists in general) to think about the issue of patterns of sustainable specialization and trade. The PSST story is that some patterns of trade become unsustainable as tastes and technology change, and addressing this requires a trial-and-error process to evolve new sustainable patterns.

In terms of policy, the Keynesian assumption that all work is done in the same GDP factory suggests that government can fix a recession without knowing any specifics about the characteristics of unemployed workers. In reality, worker skills are heterogeneous, and there is no guarantee that a fiscal stimulus will be relevant to the workers who are having difficulty adjusting to new circumstances.

I reprise some of these points in Specialization and Trade, which is priced so that an entity other than a library might wish to purchase it.

5 thoughts on “What’s Wrong with Keynesian Economic Theory?

  1. and addressing this requires a trial-and-error process

    I think this is the key part, Arnold, and lots of people don’t get it. Most, if not all, of what government (including the central banks) delay and hinder the beginning and the progress of this trial and error process.

  2. Problem is patterns become unsustainable and are replaced during normal times as more profitable and useful processes are developed. Investment failures do occur but this means the non failures should have been more profitable since they had to compete with the failures for resources. No longer needing to do so means they should grow faster. So those resource prices either don’t fall or don’t fall enough whether due to fixed costs and administrative pricing, increased fear and risk, interest rates too high, or resources too specialized to form a common market so there was no competition between them other than than others that are also failing. Businesses fail all the time, new investment occurs during recoveries and normal times, large scale investment failures are somewhat uncommon, whether driven by scale of the investment or magnitude of the shortfall, whether due to rosy expectations, endless extrapolations, bubbles and manias, or deception and fraud.

  3. I assumed the main problem with Keynesian economics is basically it was written 90 years ago when the captial expenditures per worker is a lot higher. However:

    1) The biggest problem with PSST is basically incredible ‘Creative Destruction’ also creates massive ‘Soical Instability.’ (The Nazis did come from power because booms in German economy….Also might explain a lot of the current popularity of nationalism candidates.)
    2) Isn’t one of the problems today is the sudden shortage of skilled labor, espeically construction? 8 years ago those workers were completely PSST and now there skills are needed. Working class can’t be out of work for 5 – 8 years. (During Keynes time the definition of laid off was manufacturing workers let go for 4 months during slow periods only to be rehired with business pickups.)
    3) Isn’t the threat PSSt why everybody wants to go to college and develop specialized skills? They know working class positions are likely future PSST workers.
    4) And finally, given interest rates are at historical lows in all the developed world for almost 8 years. (Actually they appear to slightly going up the last two months.) Why? There is a AD and AS shortage caused by low birth rates. Tell me how our low wages is going to get families to have more children? Frankly, I am a complete Keynesian/Douthatist economist if they simply increased tax credits for having children.

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