We Forgot Everything Keynes Taught UsBy Robert Skidelsky
Sunday, October 19, 2008; B03
No one can complain of a shortage of information about the Great Financial Meltdown. The biggest growth industry today is words: A whole new vocabulary has spread from board tables to kitchen tables. Superannuated whiz kids planting cabbages to offset their newly straitened means can blame their troubles on collateralized debt obligations, special investment vehicles, credit default swaps. Subprime mortgage holders find themselves censured for a new and virulent disease called toxic debt.
But what is in even shorter supply than credit is an economic theory to explain why this financial tsunami occurred, and what its consequences might be. Over the past 30 years, economists have devoted great intellectual energy to proving that such disasters cannot happen. The market system accurately prices all trades at each moment in time. Greed, ignorance, euphoria, panic, herd behavior, predation, financial skulduggery and politics -- the forces that drive boom-bust cycles -- only exist offstage in their models.
The Great Financial Meltdown would not have surprised the British economist John Maynard Keynes, who died in 1946, for he thought that this was exactly how unregulated markets would behave. The New Economics, as Keynesian economics was known in the United States until it became the Obsolete Economics, was designed to prevent such turbulence. It held that governments should vary taxes and spending to offset any tendency for inflation to rise or output to fall.
The New Economics generated its own problems, causing it to collapse into stagflation in the 1970s. But for most Americans and Europeans, the years from 1950 to 1975 were a golden age. The developed world grew at an average annual rate of 3.2 percent with very moderate inflation, and without the benefit of the huge rewards now deemed necessary to keep executives properly incentivized. Above all, growth was stable. The business cycle was severely dampened.
Keynes first became convinced of the instability of unregulated economies in the boom years of the "Roaring '20s." In many ways, the 1920s were like the last 15 years in their technological dynamism, the extravagant lifestyles of the very rich and in their "irrational exuberance." But they were especially like the recent past in their belief that prosperity would continue without interruption. .......(more)
The complete piece is at:
http://www.washingtonpost.com/wp-dyn/content/article/2008/10/13/AR2008101302090_pf.html