Keynes lives
By Robert Skidelsky
Financial
Times, August 15 2001 19:06GMT
Lord Skidelsky is professor of political economy at
Warwick university.
The
third volume of his biography of John Maynard Keynes was published in November
The Bank of England cut interest rates this month by a quarter point in response to growing fears of recession. In the US, President George W. Bush’s recently enacted tax package front-loaded tax reductions for the same reason.
All of this sounds rather Keynesian. Yet we are told ad nauseam that Keynes is dead; that economies are inherently stable; that governments should stick to clear rules and avoid monkeying around with the economy as they did in the bad old days. So what exactly is macroeconomic policy trying to achieve nowadays?
Officially, one thing only: price stability. The monetary policy committee has been mandated to keep inflation at 2.5 per cent, overriding any explicit instructions to consider the state of the economy. Yet consider what Sir Edward George, governor of the Bank of England, told the House of Lords select committee on economic affairs: “What we are trying to do all the time is to balance the aggregate demand with the aggregate underlying supply in the economy.” According to Donald Brash, governor of the Reserve Bank of New Zealand, monetary policy should aim at “regulating the level of demand”. This sounds pretty Keynesian to me.
Admittedly, there has been a change of theory. Today the balance between aggregate demand and aggregate supply is measured not by the unemployment rate but by the inflation rate, with unemployment supposed to be at its equilibrium rate - that is, full employment - when inflation has no tendency to go up or down.
This formulation reflects the influence of Milton Friedman. However, it still leaves some room for fine-tuning, though the Bank dislikes the phrase. The MPC makes estimates of both output and inflation over two years. Any expected slowdown in output growth is taken to indicate that inflation will fall below target. The MPC can then lower interest rates to bring inflation back to target over the forecast period. Interest rate policy, in effect, can be set to accommodate (or smooth out) short-run fluctuations in output growth, while maintaining the expectation that demand will come back into line with supply or the inflation rate back to target - once the policy reaction has had sufficient time to take effect.
Fiscal policy’s role in stabilisation policy is now passive. As the economy slides into recession, the budget will automatically go into deficit as revenues fall relative to spending. However, the “sustainable investment rule” does allow for some increased public investment in a downturn.
“Managing demand” is now called “managing expectations”. This minimal Keynesianism reflects both changes in theory and our long experience of the pitfalls of discretionary macroeconomic policy. Whether it will be enough to deal with a serious drop in business or consumer confidence is the big unknown.
Today, uncertainty about inflation is replaced by uncertainty about the exchange rate. When currencies float, as they now do, interest rate policy seems to work, in part, by altering their value. If interest rates are raised to restrain inflation, sterling appreciates in the foreign exchange market; if they are lowered to stimulate demand, the pound falls. Thus there is a simultaneous effect on both domestic and export demand. But no one really knows how large the swings in currency will be or what will be the effect of the swings, or indeed how permanent these effects will be.
The last point is particularly troubling. In a globalised economy the “temporary” loss of competitiveness caused by a strong pound may well be permanent. Manufacturing capacity cannot be turned on and off like a tap. Companies can switch from British to foreign suppliers, or relocate production abroad. Can we be confident that when policy has had time to work itself out, there will not be less capacity and therefore less employment in the economy?
We are told that we cannot have both an inflation target and an exchange rate target. When inflation was the problem, no doubt it made sense to target inflation. But today inflation is low everywhere. Is this because of the policy of central banks? Or is it owed, as some argue, to increased competition in the world economy? If the latter is true, would not a policy of “managing expectations” do better to target exchange rates rather than inflation? That way, we might get the benefits of both low inflation and stable exchange rates - such as we had under the Bretton Woods system, set up in 1944.
There are too many theoretical and practical objections to “switching” targets to make such an approach feasible at present. But the fact remains that our present global economy lacks monetary coherence. I feel sure that Keynes would have been plotting a new, improved Bretton Woods system. He always believed in being five years ahead of the game.
Keynes är stendöd
SvD-ledare 2001-03-22
The enduring legacy of Keynes
The great British economist deserves best to be remembered for
his
doctrine of the macroeconomic risks of oversaving
Samuel Brittan, Financial
Times, November 23, 2000