Why Do Bad Ideas Spread? Luzzetti and Ohanian on the Rise and Fall of Keynesianism

3 January 2011 at 11:21 am 2 comments

| Peter Klein |

O&M generally takes a dim view of Keynesian economics. And yet Keynesianism triumphed after WWII and, while mostly dormant among academics from the 1970s to the 2000s, made a sweeping comeback over the last 2-3 years. If we anti-Keynesians are so smart, why is Keynesianism so popular?

This is an important question for the history, philosophy, and sociology of science, and we’ve addressed it before. Keynesianism appeals to fine-tuners, is easily formalized, appeared to “work” during and after WWII, has a “progressive” and “scientific” veneer, and justifies policies that governments have long championed (but all serious economists opposed).

Matthew Luzzetti and Lee Ohanian propose a similar narrative in their new NBER paper, “The General Theory of Employment, Interest, and Money After 75 Years: The Importance of Being in the Right Place at the Right Time.” In a nutshell, Keynesianism told people what they wanted to hear, gave them hope that the “new” economics could cure the Depression and bring long-term prosperity, worked well with the new empirical methods appearing in the 1940s and 1950s, and seemed consistent with observation. By the 1970s, however, the situation became almost reversed, and Keynesianism was dumped by the research community. Here’s an excerpt from the introduction:

The GT was published during the Great Depression, one of the most devastating international economic crises, and one in which the GT off ered hope for understanding what otherwise seemed inexplicable, and that also o ffered a promise for economic policies that could restore prosperity. Our view is that the GT had such signi cant and long-lasting impact because Keynes was in the right place at the right time, involving two key elements. For at least some time, the evolution of macroeconomic variables seemed to conform to the predictions of the theory, as wartime spending, at least in the United States, coincided with a wartime economic boom, lending credence to the view that increasing government spending fosters higher employment and output. And the relative economic stability of the 1950s and 1960s convinced many economists that the tenets of the GT were responsible for curing depression and providing an economic management blueprint for governments. The second element is that fundamental econometric breakthroughs occurred just after publication of the GT, and these econometric developments provided a methodological basis to advance the ideas in the GT and provide a quantitative framework for analyzing macroeconomic problems.

But the same broad features that gave the GT such prominence in theory and policymaking for so many years — methodological developments that made it feasible to build and quantify economic models and the empirical features of the macroeconomies — were ultimately the reasons why the GT was replaced as the dominant macroeconomic paradigm. In particular, the evolution of Muth’s approach of rational expectations [Muth, 1961], combined with the integration of dynamic general equilibrium theory with recursive methods, made it feasible to develop formally specifi ed dynamic macroeconomies with deeper theoretical foundations than was present in the GT. And the recognition that supply-side factors were important for fluctuations, together with the breakdown of the Phillips curve, also contributed to the end of the Keynesian Revolution, at least among research economists.

Luzzetti and Ohanian describe their account as “neoclassical,” so it is somewhat narrower than the versions told by Austrian and other heterodox economists, but the broad outlines are consistent with these other accounts.

Ideas have consequences, in Richard Weaver’s famous phrase. But the development and persistence of ideas depends on circumstances. What does that imply for academic research and education?

Entry filed under: - Klein -, Bailout / Financial Crisis, History of Economic and Management Thought, Methods/Methodology/Theory of Science, Myths and Realities.

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2 Comments Add your own

  • 1. Rafe  |  4 January 2011 at 5:52 am

    It may help to use an epidemiological approach, so you have an outbreak of the infection during the 1930s (an epidemic if you like), then it is systematically spread by teaching it to several cohorts of students, so it becomes endemic in the profession, and beyond the profession to the extent that it is taught to school students and to uni students who enter other professions. Once the disease is endemic in the community it will take the best part of a century to “wash out” even when you start teaching something different! Good luck!

    Keynes dominated the high shool economics texts of Australia in 1990 (according to a survey) and casual obervation suggests that little has changed since then. It is surprising that there is not more agitation about school texts and school courses generally.

  • 2. David Hoopes  |  9 January 2011 at 4:23 pm

    Perhaps the lack of comments here means that O&M readers agree that Keynes and especially those who use his name are quite wrong regarding macroeconomics and public policy.

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