Was Keynes Correct?

My answer is going to be much more nuanced than the title might imply, but I think it is something that a discussion of this type requires. For example, it would be quite natural to answer the question in the title with another question (“Was he correct about what?”). The impetus behind this post was inspired by two unrelated, but thought-provoking blog posts by Casey Mulligan and Roger Farmer, each of whom answer the question in the affirmative for entirely different reasons. As someone who both appreciates Keynes and is skeptical of the effects of fiscal policy I thought that I might weigh in to provide my unique perspective.

Casey Mulligan asserts that Keynes was correct when he wrote, The Economic Consequences of the Peace regarding government spending and inflation. Indeed, I think that many would agree that this might have been Keynes’s greatest text. However, Mulligan notes on his own blog that the General Theory is “incorrect or at best unintelligible.” I have always had trouble with this type of statement as it begs the question “incorrect about what?” while simultaneously giving the impression that the GT is somehow impossible to understand — a point which I do not believe to be true. If Mulligan is referring to fiscal policy, which is somewhat indirectly implied by the context of his statement, then I think that he is correct. However, fiscal policy is not a primary theme in the GT. I would similarly argue that Keynes’s consumption function is incorrect in that consumption is not given by a stable relationship with current income, but rather permanent income as Friedman’s 1957 text demonstrated.

Ultimately, however, I think that the most important theme throughout the GT is the role of expectations and uncertainty. This is the topic of Roger Farmer’s post:

In the FT’s Economists’ Forum, Benn Steil wrote a stimulating piece in which he argued that Keynes was wrong. His argument is that interpretations of Keynesian economics are all based on the assumption that wages and prices are sticky. But wages and prices are not sticky. Ergo – Keynes was wrong. Mr. Steil and I are in complete agreement that the Keynesians, interpreted in this way are, to use a technical term, out to lunch. But that does not imply that Keynes was wrong. At least not entirely wrong. Far from it.


Keynes said three things in the General Theory. First: the labour market is not cleared by demand and supply and, as a consequence, very high unemployment can persist forever. Second: the beliefs of market participants independently influence the unemployment rate. Third: It is the responsibility of government to maintain full employment.

I have already stated my skepticism about the third point, but I think that Farmer is correct that these are the important themes of the GT.

Much of Farmer’s work has been dedicated to these ideas. He has demonstrated using reasonable models that a continuum of equilibria can exist. In such a case, the realized equilibrium can be a function of “sunspots”, or beliefs that are uncorrelated with fundamentals. Thus, changes in beliefs can have an impact on business cycle dynamics.

Whether or not you agree with Farmer’s research agenda or his particular methodology, I think that he is the closest of nearly anyone in modern macro to understanding the truly important themes of Keynes’s GT. The idea that beliefs about things that are uncorrelated with market fundamentals might have an impact on the business cycle was certainly a theme drive home by Keynes in the GT.

In short, I think that whether Keynes was correct requires a much more nuanced perspective than is generally presented. As I have expressed, I think that Keynes was incorrect about the consumption function and overly optimistic about the role of fiscal policy. However, I think that he was correct in asserting that expectations and confidence, which need not always be consistent with fundamentals in a world of uncertainty, can have a significant impact on economic fluctuations.

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