What now do we do? With some luck, the economy will “recover” through a return of investment activity to sustainable levels once some capital stocks, like houses, have been worked down. But it will not recover to a strong level of business activity unless something happens to boost innovation. The great question is how best to get innovators humming again through the breadth of the land. Hayek himself said little on innovation. But at least he had an applicable theory of how a healthy economy works.
The Keynesians, sad to say, show no understanding of how the economy works. They think they can lever employment up or down by pushing buttons – as if the economy were hydraulic. They show no grasp of the concepts that would be necessary to restore us to prosperity and flourishing. In an old image that applies well to the posturing of today’s self-styled Keynesians, “the Emperor has no clothes.”
Seems Phelps has become a “supply only matters” guy. But he gets it really wrong at the very start:
Keynes was a close observer of the British and American economies in an era in which their depressions were wholly or largely monetary in origin – Britain’s slump in the late 1920s after the price of the British currency was raised in terms of gold, and America’s Great Depression of the 1930s, when the world was not getting growth in the stock of gold to keep pace with productivity growth. In both cases, there was a huge fall of price level. Major deflation is a telltale symptom of a monetary problem.
Ever since, the followers of Keynes – the Keynesians, as they are called – see every slump as monetary. They suppose that behind the slump is a shortfall of liquidity and a resulting deficiency of ‘effective demand’ – an insufficient flow of money circulating through the affected economy to support the normal level of employment. So they always call for anti-deflation measures – for a “stimulus” to “demand.”
Sounds to me (David Glasner, what do you think?) he´s talking about Cassel and Hawtrey, not the Keynes of the GT.
As Nick Rowe has pointed: “Recessions (or depressions) are always and everywhere a monetary phenomenon”, just like inflation.
But all that is just to allow him to say:
It’s true that such a deficiency of liquidity occurred twice in recent US experience – hence an actual or incipient deficiency of aggregate demand. With the fall of Lehman in 2008, there was a rush to get into liquid assets. So the Keynesians (and everyone else) were right to urge the US central bank – the Fed – to create a massive increase of the money supply. Then, by spring 2010, another deficiency had developed – one of the Fed’s own making.
There was clear evidence of that in the fall of the inflation rate from the customary rate of 2% per annum to 0.9% in half a year’s time. The Fed had to engage in QE2 to get the inflation rate back up to 2% per annum.
These measures served to remedy a deficiency of liquidity and thus to forestall or remove a deficiency of effective demand.
The evidence: Inflation is running at about 2% again. The expected rate of inflation at 1.5% or so. Consequently, we do not have a “deficiency of demand” now!
And then he comes peddling his 1994 book “Structural Slumps”:
So what do we have? We have a structural slump! We are slowly coming out of a structural slump – thanks to structural forces, such as wealth decumulation and a build-up of untried ideas for innovation.
If the present slump is wholly or largely structural, Keynes’s theory of employment, since it’s monetary, does not apply to the slump.
He gets it wrong. The Fed provided liquidity to banks, but did not increase the money supply in order to match the increased money demand. Therefore, the monetary-induced, not structural, slump.
Back in 1985, long before receiving his Nobel, Phelps wrote a great Introductory Text called “Political Economy”. The preface reads:
This book is an introduction to economics for the university student and general reader. The focus, in common with other such texts, is on political economy. Economics arose in response to questions of political interest about the national economy; and though economics has since found other applications as well, it´s vitality and development continue to stem from this central concern. The causes and effects of the way society organizes and regulates its economy – and the resulting debates over instability, inequality, joblessness, inflation, organizational incentives, and the rest – are the main stuff of economics from here to China.