by Mario Rizzo
I have been arguing for some time, both here and elsewhere, that the ideas of John Maynard Keynes after the mid-1930s and into the 1940s are more sophisticated that the prime-the-pump notions of many modern day economists who call themselves Keynesians. Keynes, himself, evolved away from those simple ideas he advocated in earlier years.
The mature Keynes diagnosed the fundamental problem of market economies as the instability of private investment associated with radical uncertainty. Because the future is uncertain, in the sense that investors cannot envisage all of the possible outcomes of their courses of action, including the behavior of other people, they are subject to changes in expectations. This can result in sudden, unpredictable changes in investment behavior. Periodically, for reasons that are not entirely clear in Keynes writings, investor confidence will collapse in part because some investors fear that other investors will be discouraged by future state of the economy. Perhaps the bursting of a bubble will set things off.
In any event, the problem is uncertainty. And the main remedy is the restoration of confidence, not by sweet or inspiring talk, but by ensuring the stability of investment. Keynes thought it would take some form of government control or influence over the majority of investment to stabilize the investment sector and thus the economy. Therefore, the way to avoid slumps (and later inflation) is to stabilize investment through government management. The stimulus that would be generated if private investors were, for some reason, to lose confidence would be derived from the stability the government investment behavior. This behavior would have to be regular, predictable and substantial to be effective. In fact, Keynes believed that this kind of policy would prevent slumps and not cure them once they occurred.
The upshot is that Keynes’s “solution” requires taking at least a medium term point of view. Discretionary start-stop fiscal stimulus tends to create uncertainty and hence is not really stimulative. The mature Keynes was, ironically, concerned about the long-run: the institutional reform of the way investment takes place in a market economy. I do not advocate what he called the “socialization of investment.” But that is Keynes.
My article in the American Enterprise Institute’s online magazine The American deals with this issue.