We have learned since September that the present generation of economists has not figured out how the economy works. The vast majority of them were blindsided by the housing bubble and the ensuing banking crisis; and misjudged the gravity of the economic downturn that resulted; and were perplexed by the inability of orthodox monetary policy administered by the Federal Reserve to prevent such a steep downturn; and could not agree on what, if anything, the government should do to halt it and put the economy on the road to recovery.Central to Keynes' theory--the reason behind the now-apparent recovery, as the Judge writes--is that consumption is, after all, "the sole and end object of all economic activity." Sparing complicated mathematic explanations, this is partly because passive investments (i.e., income not necessarily infused into productive activity, but derived from savings) theoretically take some time to stimulate economic growth. Alternatively, active investments create income and essentially form what Keynes calls a "multiplier effect," further increasing the "incomes of people . . . on the receiving end [of any initial income spent on a given product]." Judge Posner uses this example:
When I buy a bottle of wine, the cost to me is income to the seller, and what he spends out of that income will be income to someone else, and so on. So the active investment that produced the income with which I bought the wine will have had a chain-reaction--what Keynes calls a "multiplier"--effect.Consumption, in Keynes' theory, is the driving force of economic growth. And, as the Judge explains in this article, the government must effectively counterbalance times when consumption is lacking and hoarding is rampant. From this vantage point, Judge Posner notes that "[b]y now a majority of economists are in general agreement with the Obama administration's exceedingly Keynesian strategy for digging the economy out of its deep hole."
Keynes' theory, of course, presupposes business cycles. However, I have rarely seen consideration given to the structural imbalances in the capital structure of our economy. Many economists, in fact, quite convincingly show that reckless monetary policy obfuscates real interest rates, creating distortions in long-term demand for capital. In addition, persistent bailout guarantees and a hyper-expanding credit market have created perverse incentives for private market actors. Put another way, these instances may in some respect be attributed to bad government policy. So a question I must ask is that, even if Keynes' theory solves the structural distortions of the business cycle--a point which I am admittedly not equipped to debate--are there other policy measures directed at resolving potential core causes of the financial crisis that should be taken into account before we grant the government a medal of honor?
Check out Judge Posner's article.