Keynes and Friedman on the employment policy

4 Introduction

great compromise between freedom and efficiency rather than on the relevant compromise to be made (and in particular on the proper way to stabilise the economy) that they are poles apart.

Likewise, the specific logics that underlie their respective pleas can also provide the fundamental rationales of their advocacies regarding the way fiscal and monetary policies should be conducted. We will see that the contemporary perspective, which formulates the debate in terms of rules versus discretion, appears much too narrow to encompass the whole of the stakes of the debate between our two authors. On the one hand, what one now calls rules is much too discretionary to fit into a Friedmanian policy advice setting. On the other, what we now call discretion is merely alien to Keynes’ overall policy principles. Keynes too advocates ‘policy guidelines’ although he parts company with Friedman about the ultimate goal of the rules and differs in the dose of leeway to be given to the authorities. Yet, we hasten to add that discretion is highly needed for Keynes when the system endures unforeseeable shocks despite the stabilising effect of the rules implemented. However, the fact remains that Keynes is quite alien to fine-tuning and to deficit spending.

Ultimately, with the help of Keynes and Friedman we should be able to rethink the critical issue of crises, which is at the centre of the debates today. Indeed, for both of them the basic tenets of the economic policy they call for are strongly embedded in their interpretation of the 1929 crisis and the way the latter turned into the Great Depression. Keynes and Friedman were both struck by the Great Depression. It is usually considered that the 1929 crisis and the way it turned into the most severe recession of the twentieth century fixed the whole of their respective intellectual background – as a contemporary for Keynes and much more as a historian for Friedman. As during the time of the Great Depression, one can now find again at the core of debates issues such as the selfregulating forces that a decentralised market system might possess (or not), the ability of financial markets to coordinate the inter-temporal plans of investors and savers, but also and strikingly the role played by public authorities in the sudden occurrence of economic crises.

First, what are the critical elements at the origin of the crisis? In particular, is it possible for State authorities and in particular for monetary authorities, to have created the crisis through misguided policies, as Friedman claims regarding the 1929 episode and as Taylor argues today in his Getting off Track: How Government Actions and Interventions Caused, Prolonged and Worsened the Financial Crisis (2009)? Or are the very causes of the current recession to be found in the financial side as well as in the real side of the economy, through financial markets’ malfunctions and global imbalances, as Keynesians would argue?

On this basis, coming back to the policy devices Keynes and Friedman originally advocate should help us to reframe the terms of the debate surrounding the economic policy to be followed to escape the recession. What should be State priorities: the then-and-now diseases of a severely out of equilibrium economy? Or in a more long-run perspective the restoration of the self-stabilising forces that the system inherently possesses, having as its corollary a close attention paid

Introduction 5

to the growth-path tendency of the economy? Bearing in mind the overall advocacies of our two authors, no doubt policy-makers would argue that something has to be done, and that it does not make sense to simply and purely let the purge go on. As a reminder of Keynes’ most important lesson, one should keep in mind that the State is the central player in the economy able precisely to influence the course of things. To this extent, the State authorities’ duty is first and foremost to formulate a way ahead, to help private agents chart a course regarding the future ‘states of the world’. In this perspective, one might seriously wonder whether a great recession is the right time for austerity in public finances. If the very duty of the State is to drive the investors’ and the entrepreneurs’ long-term real expectations, no doubt pessimistic expectations on behalf of centralised authorities can only be harmful for the already depressed private agents’ expectations. By contrast, it might be the perfect time to design and to implement new institutional settings with the view to launch public-private partnerships, with the double goal of ‘pump priming’ in a short-term and demand-side perspective and the combined aim to make the economy more competitive in a long-term and supply-side perspective. And as a reminder of Friedman’s deepest matter of concern, one should consider seriously the stickiness of private agents’ nominal expectations. That is, people do take time to revise their inflationary expectations, and uncertainty regarding the discretionary policies carried out in the future is very likely to destabilise the real side of the economy. Consequently, confidence both in the economic climate and in the ongoing policy regime is critical to stabilise the economy around full employment. Erratic policies are very likely to make matters worse. Friedman’s claim appears to be a deep warning directed towards those who concentrate on the short-run diseases and urge for devices which are immediately visible at the expense of long-term stabilisation concerns, especially when this sort of short-termism means a significant reversal of priorities in a very short space of time.

Keynes published his first academic paper in 1909 in the Economic Journal (Keynes 1909, “Recent Economic Events in India”, CW 11, pp. 1–22). And he had always been committed to public life: he began as a civil servant for the Indian Office, then worked for the Treasury during World War I and ended his career as a political adviser – Keynes’ last plea dates from 1945. As for Friedman, he started what would become his ‘counter-revolution’ precisely at that time, until the last edition of Capitalism and Freedom (1962a) in 2002 as well as in his posthumous “Tradeoffs in Monetary Policy” (2010). Friedman, too, was fully engaged in the political and intellectual debate until his death in 2006. In between there was a lot of water under the bridge. One saw the rise of the ‘Keynesian revolution’, progressively superseded by the monetarist ‘counter-revolution’. The worlds respectively faced by our two authors were in many extents radically different. Regarding the way Keynes and Friedman respectively deal with the ‘real’ world, suffice it to mention the place allowed to the State in the economy or the role played by the ‘big company’. As far as theory is concerned we have learnt a lot: new tools are at our disposal, such as econometrics; new disciplines emerged,