Text I. Keynesian Principles of Macroeconomic Policy

The theory of macroeconomic policy, the subject of bitter controversy today, really developed after World War II and after Keynes’s death. The principles of what came to be known as keynesian policies were expounded in the postwar "neoclassical synthesis" by Paul Samuelson and others. They occupied the mainstream of economics until the powerful monetarist and new classical counterrevolutions of the last fifteen years. They were the intellectual foundations of official U.S. policies in the Kennedy-Johnson years, when the media discovered them and somewhat misleadingly called them the "New Economics". They are expounded in the 1962 Economic Report of the Kennedy Council of Economic Advisers.

Let’s review those principles, with particular reference to the items that are now particularly controversial, some of which are explicitly rejected by U.S. policymakers, as well as by those of other countries, notably the Thatcher government.

The first principle, obviously and unambiguously Keynesian, is the explicit dedication of macroeconomic policy instruments to real economic goals, in particular full employment and real growth of national output. This has never meant, in theory or in practice, that nominal outcomes, especially price inflation, were to be ignored. In the early 1960s, for example, the targets for unemployment and real GNP were chosen with cautious respect for the inflation risks. Today, however, a popular anti-Keynesian view is that macroeconomic policies can and should be aimed solely at nominal targets, for prices and/or nominal GNP, letting private "markets" determine the consequences for real economic variables.

Second, Keynesian demand management is activist, responsive to the actually observed state of the economy and to projections of its paths under various policy alternatives. The anti-Keynesian counterrevolutionaries scorn activist macroeconomic management as "fine-tuning" and "stop-go" and allege that it is destabilizing. The disagreement refers partly to the sources of destabilizing snocks. Keynesians believe, as did Keynes himself, that such snocks are endemic and epidemic in market Capitalism; that government policymakers, observing the snocks and their effects, can partially but significantly offset them; and that the expectations induced by successful demand management will themselves be stabilizing. (Of course, Keynesians have by no means relied entirely on discretionary responsive policies; they have also tried to design and build automatic stabilizers into the fiscal and financial systems.) The opponents believe that government itself is the chief source of destabilizing snocks to an otherwise stable system; that neither the wisdom nor the intentions of policymakers can be trusted; and the stability of policies mandated by nondiscretionary rules, blind to actual events and forecasts, are the best we can do. When this stance is combined with concentration on nominal outcomes, the results of recent experience in Thatcher’s Britain and Volcker’s America are not hard to understand.

Third, Keynesians have wished to put both fiscal and monetary policies in consistent and coordinated harness in the pursuit of macroeconomic objectives. Any residual skepticism about the relevance and effectiveness of monetary policy vanished early in the postwar era, certainly in the United States though less so in Britain. Keynesians have, of course, opposed the use of macroeconomically irrelevant norms like budget balance as guides to policy. They have, however, pointed out that monetary and fiscal instruments in combination provide sufficient degrees of freedom to pursue demand-management objectives in combination with whatever priorities a democratic society chooses for other objectives. For example, Keynesian stabilization policies can be carried out with large or small government sectors, progressive or regressive tax and transfer structures, and high or low investment and saving as fractions of full-employment GNP. In these respects, latter-day Keynesians have been more optimistic than the author of The General Theory: they believe that measures to create jobs do not have to be wasteful and need not focus exclusively on bolstering the national propensity to consume. The idea that the fiscal-monetary mix can be chosen to accelerate national capital formation, if that is a national priority, is a contribution of the so-called neoclassical synthesis. Disregard of the idea since 1980 is the source of many of the current problems of U.S. macroeconomic policy, which may not only be inadequate to promote recovery but also perversely designed to inhibit national investment at a time when greater provision for the future is a widely shared social priority.

Fourth, as was observed earlier, Keynesians have not been optimistic that fiscal and monetary policies of demand management are sufficient to achieve both real and nominal goals, to obtain simultaneously both full employment and stability of prices of inflation rates. Neither are Keynesians prepared, as monetarist and new classical economists and policymakers often appear to be, to resolve the dilemma tautologically by calling "full employment" whatever unemployment rate results from policies that stabilize prices.

Every American administration from Kennedy to Carter, possibly excepting Ford, has felt the need to have some kind of wage-price policy. This old dilemma remains the greatest challenge; Keynesian economists differ among themselves, as well as with those of different macroeconomic persuasions, on how to resolve it. It may be ironically true that, thanks to good luck and to the severity of the depression – the two Eisenhower-Martin recessions of the late 1950s helped pave the way for an inflation-free Keynesian recovery in the early 1960s, and the Volcker depression may do the same – revival of inflation is unlikely during recovery in the 1980s, just when policymakers are acutely afraid of it. But it would be foolish to count on that, even more to assume the problem has permanently disappeared.