Hubris by Meghnad Desai

Author:Meghnad Desai
Language: eng
Format: epub
ISBN: 9780300213546
Publisher: Yale University Press

Keynesian Economics in Action

Keynes’s theory lent itself easily to a mathematical formulation. During World War II, scientific research had been harnessed to the war effort. The idea that government policy could be improved by using modern tools of mathematics and statistics was central to both the war effort and postwar policy-making. If so, the parameters of the relationships derived in Keynes’s theory, such as the marginal propensity to consume or the accelerator, could be estimated from historical data and used to guide future policy. Econometrics itself was a developing subject in those days and computing power was slowly increasing. Keynesian economists could promise statistical sophistication to policy-makers. (Keynes himself was skeptical about the use of these statistical tools, but his objections were ignored.)

The American Keynesians faced an immediate setback. As World War II drew to a close, they made dire predictions on the state of the economy. Based on the intuitive assumptions that government spending would be drastically reduced and that swathes of soldiers returning from the war would face unemployment, they forecast that a negative multiplier would come into play, which would result in a sizable reduction in output. But, as it turned out, there was a boom. People had been exhorted to save during the war, and indeed there had been very little to spend money on. Once the war ended, men and women got married and formed households. They had money to buy houses and refrigerators and radios and cars. The money balances available to spend lifted the economy and this continued until 1949. In a sense, this vindicated Pigou’s insight about money balances playing a crucial role in moving the economy up. Keynesians had to do better in predicting the workings of the economy.

But the econometricians were not dejected by this initial setback. The Cowles Foundation was the incubator for new developments in econometrics and there the first models of the US economy were estimated by Lawrence Klein (who won the Nobel Prize in 1980). They were based on annual data for income, consumption, investment, and employment. From small beginnings – the first model had only six equations – econometric models grew in size. By 1955, Klein, along with his associate Arthur Goldberger, had built a 20-equation model. These models were dominated by quantitative relationships among income and expenditure. Prices and interest rates played a minor part or no part at all in explaining the workings of the economy. The Keynesian orthodoxy about the irrelevance of money was maintained by these models. Their use for informing policy debates continued and by the early 1960s the American Social Science Research Council had invested financial and personnel resources to enable a larger model to be devised in which many US universities cooperated. The Brookings-SSRC Econometric Model of the US Economy had scores of equations.

One issue was to ask whether Keynesian models could mimic the cyclical behavior of the US economy. The data underlying the models spanned much of the early twentieth century and so it was reasonable to ask whether the models could reproduce the cycles.

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