Luke’s reign failed to dethrone Keynesian economics
John Maynard Keynes (1883-1946) is undoubtedly the most influential and eminent economist of the past century. His ideas have had a lasting influence on policymakers around the world, who to this day swear by his concepts of fiscal stimulus and monetary policy as measures to revive the economy. This seems intuitive and logical. Most of the ideas were developed during the Great Depression of the 1930s. His magnum opus The General Theory of Employment, Interest and Money was published in 1936, in the midst of two world wars and at the bottom of a deep global recession. His approach was abstract, yet his precepts seemed practical. He introduced many new concepts to macroeconomics, one of which was the prevalence of widespread involuntary unemployment to explain chronic unemployment. The word ‘involuntary’ may seem superfluous, because no one chooses to remain unemployed in a recession, right? He also posited the concept of downward sticky wages that do not fall despite high unemployment. Keynes’s advice was followed by governments, but the flaws in his model caused some unease among economists, especially those with laissez-faire tendencies. They were accustomed to the idea of supremacy of supply and demand and could not easily accept ad hoc deviations from free market principles. But if the market functioned, why didn’t wages fall to zero to accommodate the hordes of the unemployed during a recession? Keynes was right about the facts, but his theory lacked a sufficiently rigorous mathematical model to explain sticky wages. And how can macroeconomic outcomes be explained by optimizing and maximizing behaviour? A policy implication of Keynesian theory was that there was a trade-off between unemployment and inflation, and that it was possible to reduce unemployment by tolerating higher inflation. This was the famous Phillips curve.