What’s Wrong with Keynesian Economic Theory?

Steven Kates presents his new book What’s Wrong with Keynesian Economic Theory?

It is not hard to see how unlikely it is that a theory that has been examined by economists since first brought into the world in 1936 is utterly wrong in its structure and totally misguided in the advice it gives. But that is how it is. That is what this book is intended to explain. The very concept of aggregate demand was introduced into economic theory by Keynes in his General Theory. It is this that is at the heart of the problem macro now has.

What’s Wrong with Keynesian Economic Theory? is a collection of thirteen articles by economists each of whom had previously written critical articles about Keynesian economics. The authors come from every corner of the non-Keynesian world, and therefore you are guaranteed to like some approaches more than others. But at least it is in print, and there is at least this much evidence that the theoretical case behind public spending and low interest rates to create recovery has its enemies. You would think, given how badly our economies have been performing, that there would be more, but such it is. Keynesian theory remains the most easily understood fallacy in economics, retaining its savour across the world in spite of its never having had a single success. Although the application of Keynesian economic theory has never worked in practice, it continues to be the basis for macroeconomic policy with its conclusion universally applied by governments at the first sign of recession.

I cannot emphasise enough how unique this book is. The following was written in 1959 and is as unfortunately true today as it was then. It is from Henry Hazlitt’s The Failure of the “New Economics”: An Analysis of the Keynesian Fallacies. It is a book in which Hazlitt attempted to explain what is wrong with Keynesian economic theory. There he wrote:

‘There must be hundreds of economic books that may be variously described as Keynesian, pro-Keynesian, semi-Keynesian, or “post-Keynesian,” and there must be thousands of such pamphlets and articles; but there is a great dearth when we come to any literature since 1936 that may be described as definitely anti-Keynesian – in the sense that it is explicitly and consistently critical of the major Keynesian doctrines. In the works of such writers as Ludwig von Mises, F.A. Hayek, Wilhelm Röpke, Frank H. Knight, Jacques Rueff, and others, we do indeed have an impressive non-Keynesian literature, based on “neo-classical” premises, with occasional explicit criticism of Keynesian tenets. But full-length books exclusively devoted to a critical analysis of Keynesianism may be counted on the fingers of one hand.’ (Hazlitt 1959: 437)

Right up till the publication of The General Theory there had been an economic consensus across the economic mainstream going back into the nineteenth century that public spending might usefully be increased during recession but only by a bit and never as the solution to the problem. It was part of classical policy, at least in its later stages, for governments to employ the unemployment in temporary forms of work during recessions. What is different about Keynesian theory is that stimulating aggregate demand is now seen as the solution to unemployment rather than just being a palliative while the economy gets back on its feet. It is even worse. There is now a consensus that public spending in general, whether in recession or not, is necessary to maintain economic growth and low rates of unemployment. Nothing is further from the truth.

It would be one thing if such policies had had a string of successes rather than the trail of catastrophic failures that have inevitably followed every peace-time Keynesian stimulus in the past.

This book brings together in one volume a series of articles by economists who find Keynesian economic theory fundamentally wrong. Even with our economies continuing to falter, in none of which there has been a genuine recovery since the GFC in 2009 in spite of every effort to stimulate demand, the allegiance to Keynesian theory remains as strong as ever. Economists must at some stage recognise that modern macroeconomic theory, built on the supposition of aggregate demand, may be fundamentally wrong in every important respect. The aim of this book is to clarify these issues so that you can understand why our economies are not responding to these Keynesian policies and therefore begin to understand what should be done instead.

What’s Wrong with Keynesian Economic Theory? is out now.

Chapter One: The Keynesian liquidity trap: an Austrian critique is free to read on Elgaronline.