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On Krugman's Introduction to Keynes's General Theory

March 9, 2006

Among current proponents of activist government, few have greater name recognition than Paul Krugman. While most economists focus on communicating their ideas to their students and peers, professor Krugman has targeted the educated public with his work. This work now includes an introduction to The General Theory of Employment, Interest, and Money, by John Maynard Keynes. Brad Delong has posted an abridged version of this book on his website. Given the reputation of this book and its author a proper introduction should be of great interest to members of the educated public. Unfortunately professor Krugman's introduction is seriously flawed.

One major problem with this introduction is that it perpetuates the mythology of Keynes's influence. According to the mythology popular among Keynesians The General Theory reshaped professional opinion over night. Keynes published his book in 1936. By this time the idea that falling aggregate demand causes depressions was well known and widely accepted. In 1929 a German economist named Lautenbach published a book- Kredit zins Produktion- that was very similar to Keynes's theory. In fact, some German economists accused Keynes of plagiarism . [1]

The "Keynesian Multiplier" was in fact developed by Richard Kahn in 1931. In the same year Herbert Hoover leaned on industrial employers to keep wages high so that workers could spend more. Hoover thought that high consumer demand, combined with government spending on public works, would restore prosperity. In 1932 several professors at the university of Chicago recommended "Keynesian" policies to deal with the Great Depression. The Polish economist Michal Kalecki also anticipated much of what Keynes later wrote, with articles that he published in 1932 and 1935. The Swedish economist Gunnar Myrdal also claims that Swedish economists were familiar with the ideas in Keynes's General Theory before its publication. The proposition that Keynes transformed professional opinion single-handedly does not hold up to scrutiny. While professor Krugman claims that Keynes's General Theory was revolutionary, it actually fit in with much of existing professional opinion.

Professor Krugman also claims that Keynes shaped public policy with his work. The fact of the matter is that Keynes did not go very far in working out the policy implications of "his" theory. Economist Abba Lerner was largely responsible for working out these details. Keynes initially criticized Lerner's recommendations, but reversed his position a month later [2] . Lerner also had a key role in developing other parts of the 'Keynesian' paradigm, both on wages and interest and money demand [3]While Lerner sorted out many of the details of Keynesian theory, Economist John R Hicks developed the standard model for postwar Keynesian economics [4]. The Hicks model consisted of some equations concerning equilibrium of money demand and supply, and equilibrium of investment and saving. The Hicks model of Keynesian economics deviated from what Keynes wrote in his General Theory. The claim that the postwar keynesian paradigm betrayed Keynes' own thinking was made not only by prominent associates of Keynes, like Joan Robinson, but also by Hicks himself-

"The "Keynesian Revolution" went off at half-cock...The equilibrists, therefore, did not know they were beaten; or rather...they did not know that they had been challenged. They thought that what Keynes had said could be absorbed into their equilibrium systems; all that was needed was that the scope of their equilibrium systems should be extended. As we know, there has been a lot of extension, a vast amount of extension; what I am saying is that it has never quite got to the point....I must say that that diagram [IS-LM] is now much less popular with me than I think it still is with many other people. It reduces the General Theory to equilibrium economics; it is not really in time. That, of course, is why it has done so well." (JR Hicks, Time in Economics, in Evolution, Welfare and Time in Economics p. 289-90, 1976)

Hicks came to realize that his IS-LM model was static, while Keynes' theory was dynamic. The postwar Keynesian paradigm also included the Philips curve- a statistical relation between employment and GDP. The fact of the matter is Keynes theory was not new at the time of its publication, and the postwar version that most economists accepted as Keynesian was a version that other economists revised significantly. This revised version extended Keynes' ideas in some respects, but it also deviated from what Keynes wrote in important ways. Yet Professor Krugman defends the equilibrium reinterpretaton of Keynes' General Theory as an accurate interpretation of this book.

Naturally, Krugman's introduction indicates that Keynes's contribution were positive in nature. This is a highly contentious issue. The early Keynesians predicted a return of depression conditions in 1946. They predicted this because the end of the Second World War meant an end to wartime government spending. According to Keynes's theory such a drastic reduction in government spending should cause a depression. This did not happen. This is not the only empirical problem with Keynesian economics. Most politicians have not followed the Keynesian policy of counter-cyclical deficit spending. Before Bill Clinton entered office in 1992, he held a conference at Little Rock Arkansas. The economists there recommended Keynesian deficit spending. He pursued the opposite policy. First he increased taxes (Keynesians recommend tax cuts to stimulate the economy). Later the Republican Congress pressured him to control spending (Keynesians recommend spending increases to stimulate the economy). Of course, some politicians attempt to implement Keynesian policies. During the 1992 election President Bush proposed a increase in the deficit to end the 1992 recession. The Democratic Congress refused to consider this proposal- for obvious political reasons. The Democrats did not want to take a chance on the recession ending soon enough to help George Bush in his reelection bid. Keynes and Lerner were politically naïve. They did not appreciate the potential for politicians to use "Keynesian" policy to help their own political careers [5]. This Naiveté seems to have rubbed off onto professor Krugman. Also, Milton Friedman pointed out years ago that Keynesian policy suffers from long and variable political lags.

Another part of the myth of Keynes's General Theory concerns Keynes's opponents. Professor Krugman claims that the alternative to Keynes's theory was the 'classical' theory concerned with a barter economy, one without money. In reality, Keynes debated FA Hayek during the 1930's. Hayek proposed a monetary theory of the trade cycle, originally developed by Ludwig von Mises. Hayek critiqued Keynes's early work on trade cycles, and prompted Keynes to incorporate capital into his later work (the General Theory). The fact of the matter is that Keynes and Hayek responded directly to each other in discussing both of their ideas on money and the trade cycle. The classical theory of a barter economy that professor Krugman refers to is a straw man. Professor Krugman should know this because he penned an attack on a straw-man version of the Mises-Hayek theory of trade cycles [6].

Professor Krugman correctly points out that Keynes believed that a market economies' automatic tendency to eliminate unemployment works slowly, if at all. The belief is not well founded. Recent work by Harold Cole and Lee Ohanian at UCLA demonstrate that the policies of the Roosevelt administration interfered with recovery from the depression [7]. Richard Vedder and Lowell Galloway did similar work years earlier [8]. Professor Krugman believes that Keynes hit the nail on the head with his analysis, and that we are all Keynesians now. However, the truth of the matter is that professional opinion has been slowly moving against Keynes for decades. Modern Keynesians, or 'New Keynesians' sometimes say that they have more in common with Milton Friedman than John Maynard Keynes [9].

Professor Krugman also claims that no other book has been both as brilliant and as timely. The General Theory had immediate practical relevance! Actually, there have been many such books. Adam Smith's Wealth of Nations was a towering intellectual achievement with immediate practical relevance. Smith critiqued the mercantilist policy of Europe. David Ricardo carried this argument further in his Principles of Political Economy and Taxation. Smith and Ricardo made some mistakes, but they also demolished their opponents, the Mercantilists, on major policy issues of their time. Ludwig von Mises published his brilliant Socialism, an economic and sociological analysis shortly after the Bolshevik takeover in Russia. FA Hayek published his Road to Serfdom during the reign of Stalin and Hitler. Milton Friedman and Anna Schwartz published their Monetary History of the United States just before inflation and stagflation emerged to cast doubt on the Keynesian paradigm. Keynes was neither right about the problem of his day, nor the only one to address policy problems in a timely fashion. Many have done this, and done so better than Keynes.

One final point concerns the importance of ideas. JM Keynes often gets cited for noting that it is the influence of ideas for good or evil, not the power of vested interests, that matters. Keynes did write this, but Lionel Robbins, at the London School of Economics, made the same basic point earlier-

"The policies which at present prevail have been adopted, not because they have been forced on politicians by the masses, but because the masses have been taught to believe them ...The ideas which, for good or bad, have come to dominate policy are the ideas which have been put forward by detached and isolated thinkers ... In the short run, it is true, ideas are unimportant and ineffective, but in the long run they can rule the world." Lionel Robbins, The Great Depression 1934, pp199-200

In short, Keynes's General Theory was a relatively unoriginal book, whose author received undue credit for founding a defective intellectual movement. The ideas attributed to Keynes served to diminish the fiscal discipline of politicians without addressing the real causes of trade cycles. While JM Keynes is an iconic figure to those who embrace activist government, there is no real basis for this honor. Perhaps the most important reason for the perpetuation of the myths concerning Keynes and Keynesian economics is the lack of attention that economists pay to history. Most graduate programs in economics do not offer, let alone require, history of economic thought. Unfortunately, most economists simply ignore the history of their own subject. Fortunately, Economists like Ohanian, Cole, Vedder, and Galloway pay attention to the history of actual economic events. In any case, Professor Krugman's introduction to Keynes' General Theory of Employment, Interest, and Money suffers from a serious lack of historical accuracy.



[1] See Barkain, Avram- Nazi Economics: Ideology, Theory, and Policy, Yale U Press and George Garvey, "Keynes and the Economic Activists of Pre-Hitler Germany," The Journal of Political Economy 1975

[2] See Abba P. Lerner, "Functional Finance and the Federal Debt," Social Research 10 (February 1943): 38-51;

[3] Lerner wrote numerous articles in developing the Keynesian paradigm. See Mr Keynes's General Theory", 1936, International Labor Review, Saving Equals Investment", 1938, QJE, Saving and Investment: Definitions, assumptions and objectives, 1939, QJE, Interest Theory: Supply and demand for loans or supply and demand for cash?", 1944, RES, The Burden of the National Debt, 1948, in Income, Employment and Public Policy, The Inflationary Process: Some theoretical aspects, 1949, REStat, On the Marginal Product of Capital and the Marginal Efficieny of Investment", 1953, JPE, On Generalizing the General Theory", 1960, AER

[4] See Mr Keynes and the Classics: A suggested interpretation 1937, Econometrica

[5] See Nordhaus, William D. "The Political Business Cycle." Review of Economic Studies 42, (1975) 169-190 and Political Cycles and the Macroeconomy, by Alberto Alesina

[6] See web.mit.edu/krugman/www/hangover.html

[7] See http://mises.org/freemarket_detail.aspx?control=515&sortorder=title

[8] See Out of Work, by Vedder and Galloway

[9] See 'New Keynesian Economics' 1991, Mankiw and Roemer eds.

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