Robert Skidelsky writes a very interesting article about the cycle of ideological debates and what Keynes actually meant (I wonder why people are still not (
trying) understanding the simple, common sense concept put forth by Keynes in the 1930s). The beauty of classical economics and its different variations is that their models can be proved mathematically in a very slick and convincing fashion (ceteris paribus). This does not mean that they represent reality cent percent. Economics is a social science and not all things can be simplified without missing some stuff. What matters is good judgment arising from some sort of economic model (may or may not be comprehensive). This is what Keynesians do!
And remember, when resources are idle, economy is not in full employment, and market forces hesitate to function as they should (due to, say, crisis of confidence arising from self-fulfilling and reinforcing prophesy of some speculators/investors), government can turn the tide around by managing demand/using fiscal policies to put idle resources to work. Things could go awfully wrong even in a stable market economy, when then needs an escort to safety. Isn’t this a common sense?
For 30 years or so Keynesianism ruled the roost of economics – and economic policy. Harvard was queen, Chicago was nowhere. But Chicago was merely licking its wounds. In the 1960s it counter-attacked. The new assault was led by Milton Friedman and followed up by a galaxy of clever young disciples. What they did was to reinstate classical theory. Their “proofs” that markets are instantaneously, or nearly instantaneously, self-adjusting to full employment were all the more impressive because now expressed in mathematics. Adaptive Expectations, Rational Expectations, Real Business Cycle Theory, Efficient Financial Market Theory – they all poured off the Chicago assembly line, their inventors awarded Nobel Prizes.
No policymaker understood the maths, but they got the message: markets were good, governments bad. The Keynesians were in retreat. Following Ronald Reagan and Margaret Thatcher, Keynesian full employment policies were abandoned and markets deregulated. Then along came the almost Great Depression of today and the battle is once more joined.
Keynes had proved that such crowding-out could occur only at full employment: if there were unemployed resources, fiscal deficits would not drive up interest rates without also expanding the economy. Prof Ferguson’s ignorant remarks only confirmed that “we’re living in a Dark Age of macroeconomics, in which hard-won know-ledge has simply been forgotten”.
This is to take economics to be like a natural science, which Keynes never believed it was, because he thought its subject matter was much too variable over time.
Markets could behave in ways described by the classical and New Classical theories, but they need not. So it was important to take precautions against bad behaviour. Ultimately, the Keynesian revolution was a triumph not of good science over bad science, but of good judgment over bad judgment.