Tuesday, October 25, 2011

A Remark On Keynesian Models

After the recent financial crisis and recession there has been a renewed interest in Keynesian models of the macroeconomy (e.g., see the many posts by Don Boudreaux at the excellent blog Cafe Hayek). Many of these are criticisms, pointing to the seemingly queer assumptions which must be made for a fiscal stimulus to be effective.  Keynesian models, it seems, does not make sense.  They certainly don't to me.

However, that criticism has a weakness.  Keynes developed his theory during a prolonged worldwide recession—a recession that also did not make sense. There is no good reason for why the depression was so deep and so long. The Great Depression does not make sense. It certainly doesn't to me.

Keynesian models don't make sense, but neither did the economy during the Great Depression. Yet, we know the Great Depression actually happened, so perhaps Keynesian models adequately described the economy at the time?

Note: I used to subscribe to Robert Higg's view of the Great Depression, which stipulated that the depression was so severe because many businessmen lacked the confidence to invest. Higgs described a survey in 1941 showing 37% of businessmen believed America would become a "semi-socialized society with little room for private economy." It is a fact worth pondering, but I'm wondering if causality couldn't run the other way? Perhaps businessmen saw so little room for capitalism because the Great Depression proved that capitalism failed? They lacked the confidence to invest, because they lacked confidence in capitalism.

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