As we lurch through successive credit crises, central bankers and economists believe they learn valuable lessons every time, and that the ultimate prize, the suppression of business cycles through monetary policy, will be achieved.
We saw, over Brexit, how wrong the Bank of England’s and the UK Treasury’s models were, and these errors were also evident in the OECD’s model. Brexiteers smelled conspiracy, but in the absence of evidence, perhaps we should give them the benefit of the doubt and assume the errors were genuine. If so, all computer economic modelling has been a waste of time.
Then there’s the old mantra of garbage in, garbage out, which is certainly true. However, the problem goes deeper than the models, and is rooted in the rejection of classical economic theory. This rejection dates from Keynes’s General Theory, published in 1936, which forms the basis of today’s macroeconomics. Even though macroeconomics began to evolve during the depression years, Keynes’s book really marked the birth of it becoming mainstream.
The failures are manifest and multiple. And while we have no knowledge of the counterfactual, there is a good reason to believe the errors made by following macroeconomic theory are far greater than if we were still basing government policy on classical economics. Admittedly, this is a broad statement that does not allow for differences of opinion between the classical economists of yesteryear, and differences of opinion between economists post-war. But there are some fundamental distinctions between the two disciplines that can be agreed.
The most fundamental is of approach. Classical economists agreed that demand is subordinate to supply. In other words, the time-line of goods and services acquired by the individual is that his demand for them must be successfully anticipated before being produced and supplied. The reasoning is unarguable. It, therefore, must follow that a recession cannot be the result of a lack of demand. It is the result of goods being produced in error, either unwanted or too expensive for the market, and that error not being corrected by the efficient reallocation of capital. This is just one of the important conclusions of what came to be called Say’s law, and it is not revealed by Keynes’s incorrect definition of it, that supply creates its own demand.i[i]
This five word phrase, accepted by the mainstream, has perhaps done more economic damage than any other definition. Keynes compounded his error two pages further on, by stating that,
Say’s law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output is equivalent to the proposition that there is no obstacle to full employment.ii
The obfuscation is deliberate, dressing up a statement to make it both innocuous and indeterminate. Note how Keynes tries to turn his earlier inaccurate statement into an equation, and then connect it to his assumption. As we all know, equations must balance, and this equation’s balance has an obvious element of doubt. The seeds of doubt can then be made to grow in the reader’s mind. It is no more than simple prestidigitation.
