August 19, 2003

Lord Keynes's Vision is Dead

Milton Friedman has a guest Ed in the WSJ today: The Fed's Thermostat paid site only, sorry kids!

Yet it does, I believe, suggest the answer. Central banks the world over performed badly prior to the '80s not because they lacked the capacity to do better, but because they pursued the wrong goals according to a wrong theory. Keynes had taught them that the quantity of money did not matter, that what mattered was autonomous spending and the multiplier, that the role of monetary policy was to keep interest rates low to promote investment and thereby full employment. Inflation, according to this vision, was produced primarily by pressures on cost that could best be restrained by direct controls on prices and wages.
That Keynesian vision was thoroughly discredited by experience in the '70s and '80s. It has since been replaced by what has become known as New Keynesian Economics, which incorporates some key quantity theory (monetarist) propositions: that inflation is always and everywhere a monetary phenomenon; that monetary policy has important effects on real magnitudes in the short run but no important effects in the long run (the long run Phillips curve is vertical), the crucial function of a central bank is to produce price stability, interpreted as a low and relatively steady recorded rate of inflation. Once the banks adopted price stability as their primary goal, they were able to improve their performance drastically.

The article is a little technical but it's a compelling look at the gains made since Keynesianism stopped being the law of the world. Nixon said "We're all Keynesians now." It was true then and we have the '70s to prove it. Someday, a president will say "We're all Friedmanites, now." Get ready for good times when you hear that!

Posted by jk at August 19, 2003 06:04 PM
Comments
| What do you think? [0]