Keynes:The Return Of The Master (Skidelsky)

The introduction of this book discusses the explanation of the Great Recession of 2008 as a macro- level problem instead of a micro-level one.There are two main macro-economic theories of what went wrong,pointing to very different conclusions for policy and the book tries to help us decide between them.The first is derived from the quantity theory of money,the second from Keynesian theory of aggregate spending.

The first,or monetarist,theory attributes the collapse to instability in the supply of money.The central banks of the world,led by the Fed, made money and credit too easy in the years leading to the crash resulting in an asset-price inflation built on debt that also spilled over into a consumer boom (Maybe our jobs didn't pay us enough to support the American middle class lifestyle..as a teacher,I lost 15% of my purchasing income due to small raises and higher inflation in the previous ten years).A collapse was bound to happen when credit tightened.The collapse of the real estate boom(residential and commercial) hit the banks which over-lent to this market and spread to the banks via securitization(banks knew the government would come to the rescue for their gambling).The pile of bank losses led to a credit freeze(collapse in the money supply) which spread the recession to the whole economy.

The Keynesian theory attributes the crises to the instability of investment.The macroeconomy falters when saving runs ahead of investment(what the companies are doing now by hoarding cash and not investing).The crises can be traced to the fall in demand for new investment following the collapse of the dot.com bubble in 2001.(continues today and is the main reason unemployment is so high).Greenspan's cheap money policy and the Bush deficits(lower taxes,two wars,costly health bills for Medicare) were insufficient to revive private sector investment demand.What they did is create a highly-leveraged asset(banks had very high asset to debt ratios and the lower/middle class used credit cards,money from home refinancing to keep their heads above water due to low pay and increased inflation)) and consumption boom.Too few new assets were being created(was it all in high paying securities?) and the private sector became progressively over-indebted.The collapse of the real estate boom disclosed the extent of the over-indebtedness(so goes the unemployed who had no decision making in the process).The de-leveraging of household,banks,and companies brought about the collapse in aggregate demand which caused the great recession(see my post on Robert Reich's proposals to create,stimulate aggregate demand).

These two theories have different causes that brought the great recession to our doors.According to the first,the crises was caused in a mistake in policy(Fed's inability to cut off asset inflation).The second can be attributed to the failure of the Treasury to offset the failure of private investment by sufficiently expanding public investment(That's an irrational thought with Republicans in power 2000-2008)The monetarists(Classical theory) believe recovery will come when the central bank expands the money supply(doing that now).The Keynesian's believe government action is needed to increase aggregate demand and that the increase in the quantity of money is a consequence,not a cause, of the recovery of business activity(companies are still sitting on their money(savings) and delaying investment because they understand the demand isn't strong enough to expand supply..thus high unemployment).

The two theories imply different approaches to the problem of global imbalances(China and East Asia(surpluses) and the USA and much of the developed world(deficits)).The global imbalances,according to the monetarists,play no part in the genesis of the crises.The Fed had complete control over its own monetary policy.The monetarists sees the US deficit as a consequence of US overspending.Keynesian's believe Chinese over-saving had a deflationary impact on the US and developed world.One key difference dominates the gulf between the two theories.The monetarists view the market economy as relatively stable(all the math formulas didn't save the securitization of debt collapse) in the absence of monetary shocks while the Keynesian's view it as unstable in the absence of government policies to steady aggregate spending.This is because one key component of aggregate spending-investment-is governed by uncertain expectations(as we have today).The monetarist view is in the ascendant today but the recent crises confirms the validity of Keynesian spending thesis according to Skidelsky.

More to come from this book soon.