Conclusion: where to draw the line between laissez-faire

6 Introduction

such as public economics. Undoubtedly, such a long time span might render any inquiry such as ours quite perilous. Accordingly, the first stumbling block to be avoided all along this study is anachronism. Moreover, Friedman did not battle with Keynes himself, but with his heirs. Here, our investigation runs the risk of being distorted by the presence of the Keynesians, or at least by the proponents of the income-expenditure Keynesian sub-current. Accordingly, the second rock on which an undertaking such as ours might come to grief is ventriloquism.

As for the first reef, as time obviously elapsed between Keynes’ first advocacy to Friedman’s last plea, we need to be particularly cautious in taking into account the specific historical circumstances of such or such a plea. As far as Keynes is concerned, we will concentrate our investigation each time it will be possible to the time of and after the General Theory. As for Friedman, our way to solve this difficulty will be to put as far as possible his critique of Keynesianism aside, and to concentrate on his own original analyses. Finally, we will adopt for both authors consistency as a working hypothesis. Indeed, as for all great authors we will consider that Keynes and Friedman meant exactly what they wrote when scrutinising their texts and that, despite local amendments, their thoughts should be considered as consistent bulks.

1.2 Synopsis

If one plans to compare Keynes and Friedman on the issue of the proper way to enforce stability of macroeconomic systems, there is a prerequisite to be fulfilled, that is to put the Keynesians of the neo-classical synthesis off-stage. Chapter 2 deals with these preliminaries. Indeed, Friedman was definitely not a contemporary of Keynes. He did not battle with Keynes himself, but with his heirs, especially with those of the (Walrasian) neo-classical synthesis. The scope, scale and intensity of the quarrel varied as time elapsed. He is even said to have shown more flexibility towards Keynes in comparison to the Keynesians. This chapter aims to clarify the issues of the debate at stake, on both the theoretical and the methodological level, by specifying the context and especially by attempting to disentangle Friedman’s critique towards the Keynesians from his own original arguments. We will see that Friedman’s critiques of functional finance, of inflationary gap analysis as well as the Keynesian consumption function hardly apply to Keynes. Besides, since our main concern refers to political economy, the so-called ‘Keynesian’ Phillips curve will be at the core of our investigation in this chapter. The main issue of this chapter is to assess the relevance of Friedman’s assault on the Phillips curve for the economics of Keynes himself. Again, we will see that Keynes’ construct stands quite immune to Friedman’s critique, whether in respect to the call for short-term devices, inflationary remedies to unemployment or the employment-wages dynamics underlying the ‘Phillips curve exercises’.

Chapter 3 probes into Keynes and Friedman’s respective views on institutions, either private, ‘semi-public’ or public. We know well that neither Keynes nor Friedman were directly and explicitly interested in institutions as such. Yet,

Introduction 7

both of them developed original thinking regarding the individualistic competitive body, the ‘big company’ or the ‘State’ understood as centralised authorities. Through this particular lens, we aim to bring to light some of the rationales behind their respective views on the self-adjusting capacity of a laissez-faire economy – which are hardly reconcilable. Here, we focus on the salient features of a modern economy with regard to the old type of laissez-faire: Keynes’ ambitions to take advantage of the natural tendency of the system towards concentration while Friedman calls for the return to a purely competitive system. We also show that Keynes’ and Friedman’s appraisal of the ‘State’ as an institution ensues from their respective confidence towards the ‘collective’, a deep confidence in collective bodies regarding Keynes and a basic distrust towards anything which is not individualistic regarding Friedman. Finally, these findings are applied to their respective interpretation of the 1929 financial collapse. Their analyses of the main features of the US economy during the 1920s as well as their severe assessment of the Fed’s inept monetary policy at the end of the period are not so distant. But a careful reading of their positions regarding the way the 1929 crash turned into the Great Depression brings to light the type of mechanisms at work in a monetary economy on which they respectively insist to sustain their opposite appraisals of the ability of collective institutions to behave efficiently: Keynes insists on the second-round real effects of a financial collapse while Friedman focuses solely on monetary disturbances. This comparison allows us to learn lessons regarding Keynes’ and Friedman’s policy philosophies: Keynes’ new liberalism basically consists in the set-up of new institutions to cope with the inability of a laissez-faire regime to absorb by itself large and protracted shocks while Friedman calls for the return to the principles of the ‘old liberalism’, which means power as dispersed as possible in both the political and the economic markets.

Our concern in Chapter 4 is for the practical policy devices they call for to enforce stability in decentralised market economies. Here, we will focus on the employment policy along its two main fronts, the fiscal and the monetary policies. First, how to define and how to measure full employment? And what are the proper policy guidelines to ensure full employment? Keynes’ and Friedman’s respective pleas are mixes of true points of agreement, not so distant positions and hardly irreconcilable advocacies. Basically, what they share is a long-run concern – for both monetary and fiscal policy – the distrust of short-run devices to ‘fine-tune’ the economy as well as the rejection of inflationary remedies for unemployment. In particular, both of them take structural unemployment into account and are concerned about supply-side policies. Now, this is not to say that they are in perfect agreement on the efficiency of fiscal policy or on the proper target of monetary policy; far from it. On the side of budgetary policy, Keynes reminds us that the true purpose of a budgetary weapon is to drive private long-term real expectations in a world of uncertainty. Regarding Friedman, the analysis is complicated by the fact that Friedman moved from the acceptance of an ‘automatic stabiliser’ argument toward a crude acceptance of the crowding-effect. On the side of monetary policy, both Keynes and Friedman

8 Introduction

remind us that monetary policy implies much more complex issues than the management of overnight interest rates. All in all, Keynes and Friedman cannot be basically opposed, as is too often argued in a simplistic manner.

Do their shared visions that come out in our inquiry regarding the proper stabilising devices to be implemented in our modern economies correspond to fundamental points of agreement, or are they merely outward similarities? Chapter 5 aims to find the answer to this riddle. We divide this issue into two main parts. In the first step, we investigate their respective understanding of the functioning of a monetary economy, through especially the analysis of their respective demand function for money. We show that Friedman sticks to a ‘real’ determination of the interest rate whereas Keynes’ monetary theory gives rise to a monetary determination of the interest rate. What is at stake here is Friedman’s appraisal of Keynes’ liquidity-preference concept. Even if for both Keynes and Friedman ‘money matters’ they hold contrasted views on the dynamics at work in a monetary economy, and from that contrasted understandings of coordination and stabilisation. It is not surprising that their views on uncertainty and their ensuing treatment of expectations are at the core of this ultimate explanation. In comparison with our contemporary rational expectations approach, Keynes’ and Friedman’s respective treatment of uncertainty is worth telling. While Keynes’ concern for ‘true’ uncertainty (i.e. when the entire set of the ‘states of the world’ is not fully known) requires a genuine treatment of the liquidity issue, Friedman insists that private agents do take time to revise their nominal forecasts so that inflationary expectations should be considered adaptive rather than rational. Coordination failures appear as the rationale behind Keynes’ overall economic guidelines. For him, it is a key role for the State to drive the long-term real expectations, which means to provide the indispensable stable policy regime without which individuals would not coordinate themselves towards full employment. In sharp contrast, the way Friedman grasps the issue of the ‘transmission mechanism’ leads him to argue that State stimulus is fatally flawed since a decentralised market economy possesses, at least in the long run, the endogenous mechanisms essential for its stability. For him, the State should content itself with providing a stable competitive framework, which means to provide a stable monetary background that anchors nominal expectations.

Finally, what kind of lessons should we learn from Keynes and Friedman for today? First and foremost, it seems to us that our two authors should help us to reframe the terms of the debate at stake regarding policy devices. The very lesson is that some policy devices have to be implemented, that some State intervention is needed. Beyond that, both Keynes and Friedman compel us to bypass and to move beyond the terms of the debate as it is framed today in terms of rules versus discretion. Viewed this way, Keynes’ and Friedman’s respective lessons are far-reaching but yet for completely opposed reasons. To say it quite plainly, on the one hand one might need to resort to certain institutional settings and policy devices that Keynes outlined at his time. This is true regarding the true purpose of monetary and fiscal policies in the long run. This is also true regarding almost forgotten devices such as the private-public partnerships that

Introduction 9

‘pump-prime’ in the short run but have also the great advantage of improving the economy competitiveness in the long run. On the other hand, we should take seriously Friedman’s warning against optimal control devices that lead to erratic reversals of priorities in our policy guidelines in a very short space of time. Yet, there is another way to shape the debate, almost forgotten today, which is our ultimate questioning. As Hayek would ask in the Road to Serfdom (1944): how and where should the line be drawn between laissez-faire and planning? On the one hand, Keynes’ ‘Middle Way’ doctrine, his ‘new liberalism’, relies on pragmatism – despite his elitism. Keynes freely concedes that the world has changed and that State duties ought to change accordingly: some planning is to be conceded if we want ultimately to preserve our basic freedom. Yet, regarding the practical issue of where to draw the line, Keynes leaves us almost down-and-out. On the other hand, Friedman’s plea for a return to the ‘old liberalism’, his libertarian posture can be qualified as more ‘normative’ – not to say dogmatic. As is the case for Hayek, Friedman’s ‘radical liberalism’ concedes here and there that the logical extreme is not possible and that some compromise has to be recognised. It is ‘as if’ Friedman refused to draw the slightest line. But Friedman is not so much concerned with the practicality issue but rather with the evolutionary tendency, the long-term dynamics at work in our modern market societies: ultimately, are we following the right track?