Arrowsmith was an economics professor at the City College of New York.  After he left that position, he worked for many years as a business economist for a multinational oil company, where, like most corporate economists, he used a macroeconomic framework essentially based on Keynes. -Jeff

Whatever can explain the rise of mass hysteria over the U.S. national debt and federal deficits? To be sure, debt/deficit issues give the Administration’s political opponents a grand weapon in the gladiatorial contest that constitutes the nation’s public politics, but the issue only works because of a virulent public antipathy to serious macroeconomic analysis that has developed over the past four decades. In 1971, President Nixon announced “now I am a Keynesian,” but by 2011, President Obama (in his State of the Union address) said “Every day, families have to live within their means. They deserve a government that will do the same.”

In this environment, as the U.S. continues to suffer from massive unemployment of labor and underutilization of physical and intellectual capital, political survival  almost  requires economic policy-makers  to pay obeisance to the most primitive anti-Keynesian economic theology.

The proverbial Martian certainly would not anticipate such widespread disdain for serious macroeconomics from the overall educational endowment of the American population. By historical standards, the U.S. population is highly educated, with over 40 percent of the labor force having completed tertiary education as of the end of the last decade and annual four-year college graduations reaching 1.6 million. While only about 3-5 percent of U.S. undergraduates major in economics, a far larger proportion experience some exposure to economics. Although data are far from perfect, the best estimates suggest that half undergo a one-semester introductory course and as many as one third of the total cohort take a two-semester sequence. At first blush, even with the most cynical view of the seriousness of students or their instructors, this suggests that a substantial part of the electorate might be expected to have assimilated central theoretical concepts such as the intrinsic difference between the national economy and the individual household and the potential use of federal budgets to stabilize the economy.

Apparently, this has not happened in the U.S. Why? One possible explanation, of course, is a change in the content of the college curriculum. Has mainstream macroeconomics gradually been displaced from introductory textbooks? Are innocent —or, at least, young—minds being subjected to systematic anti-Keynesian theories? Has such a Creationist-type economics become the pedagogic norm across an ever-growing swath of the nation’s colleges?

If anti-macroeconomics were becoming the norm in college teaching, new textbooks would surely have been required. However dedicated they might be intellectually, even the most sadistic instructors would balk at requiring their students to plod through actual texts by von Mises or Hayek. Moreover, producing such textbooks would surely provide an attractive market opportunity both for professors and publishers. The lack of anything like an English-language Hayekian equivalent to Samuelson’s Economics is powerful evidence that there is no substantial volume of Hayekian teaching in the basic economics courses.

Explanations for the declining role of serious rational macroeconomic analysis in America’s marketplace of ideas suggest themselves. Among the more tempting are the rise of cable television and, especially, the rise of the internet. While both developments yield substantial benefits, there are also negative externalities. Cable television under its current regulatory regime is largely a slogan bazaar, dominated by loud, frenetic voices,which overwhelm measured discourse on complex issues.

The internet, meanwhile, despite its huge promise for the expansion of serious knowledge and analysis in all areas, has become a highly effective mechanism for the propagation of all the silly ideas known to mankind. In our culture of credulity, many believe that anything posted online must be true even if it has never been subject to fact-checking or editing. Ill-informed rhetoric on the inevitable, horrifying impact of federal deficits and debt carries as much weight as the most careful analysis. Anecdotal evidence supports the hypothesis that the internet has been providing a major channel for spreading the current American panic over debt and deficit.

And all this takes place in the context of the national propensity to allow religious/moralistic perspectives to overwhelm pragmatism in discussing economic and social issues. Such moralism, of course, is compounded by anti-intellectualism, since as elsewhere strong beliefs are far more common than powerful intellects.

The failure of economics in the runup to and aftermath of the Great Recession has generated a lively debate about how to reform economics and more specifically about the renewed relevance of Keynesian economics, which had fallen out of favor since the 1970s. The Keynesian message, so important in this latest round of political wrangling over the increase in the US debt ceiling, is that cutting government spending in a slump will only worsen the unemployment problem. The role of expansionary fiscal policy, according to Keynesianism 101, is to provide demand for goods (and thus for employees to produce those goods) when the main sources of demand in a capitalist economy — households and businesses – are not providing a level of demand necessary to generate a socially acceptable level of unemployment.

Keynesianism 102 is about the multiplier effect of changes in spending. This is the notion that an increase in demand (from any source, not just government but certainly including government) will impact employment and incomes with a ripple effect. This includes a direct impact and then a secondary impact when the direct incomes are then spent (in some fraction) and an additional fraction of that is spent, etc.

There are two corollaries to the lesson of Keynesianism 102 that are worth mentioning because they have been raised in the current policy debate. The first is about the differential multiplier effect of a spending increase compared to a tax cut. Empirical studies show that the multiplier effect of the former is greater than the multiplier effect of the latter. The second is about the differential multiplier effect depending on the income of the recipients. Since the poor are more likely to spend a higher percentage of additional disposable income than the rich, a tax cut that benefits low-income people will have a bigger multiplier effect than a tax cut that benefits the rich.

These lessons have not been integrated into current economic policy in the US, where deficit spending and progressive tax reform and expanded benefits for the poor and unemployed have been successfully resisted by the Republican congress. Nonetheless, they are well-established lessons of Keynesianism that most professional economists would accept.

The argument against Keynesianism 101 revolves around the psychology of investor confidence in the face of a rising fiscal deficit. The argument is that business people will reduce their investment spending when they see the government deficit becoming very large because it signals the likelihood of some detrimental future adjustment – either in interest rates, tax rates or government outlays – that will be detrimental for future profits. There is simply no empirical evidence to support this theory compared to Keynesianism 101.

But all this is sideshow in comparison to the lesson of Keynesianism 103.  The fundamental economic point of Keynes’s 1936 General Theory of Employment, Interest and Money was not about fiscal policy or the multiplier or income distribution.  It was about the fact that economic equilibrium (a stable condition from which no economic change would occur without external impetus of some sort) will not necessarily be characterized by full employment. Economists prior to (and some subsequent to) Keynes thought that free market economies would naturally adjust to full employment, as an excess supply of labor would lead to a lowering of wages and a corresponding increase in the amount of employment. Keynes explained that the natural state of a capitalist economy is “unemployment equilibrium,” and without a shock to aggregate demand conditions, there was no reason why the economy would not stay at this unemployment equilibrium. Keynes’s insight implied that the wage reduction strategy was not just theoretically wrong but, if implemented, would likely make the situation worse, since it involved a reduction in household buying power and thus would reduce business confidence.

A prospect as disastrous as the second “dip” that the American economy is about to experience is that of a long period of high unemployment that has no natural tendency to reverse itself. We should not stop our analysis at Keynesianism 101 and 102, since the great social problems facing America are understood best by Keynesianism 103.

So what is to be done? Paul Krugman has been a superb critic of the politicians’ focus on the deficit and the debt rather than on job creation. But he has been relatively quiet about what could be done if in fact the political winds were to shift. Robert Reich has been more explicit. His proposals for job creation include:

1. An additional cut in the payroll tax on employees and employers
2. An increase in infrastructure investment

My guess is that President Obama’s speech this evening will address these issues. If it does, it should be understood as not just a political maneuver, but as a serious attempt to tackle our economic problems.

The current economic slowdown constitutes a breakdown for advanced capitalism.  Its means of allocating capital – financial markets – froze up and would have collapsed completely if governments had not intervened on a massive scale.  The rates of growth of output and employment in most industrialized countries are anemic and persistent.  Does not the breakdown of capitalism require some fundamental rethinking of its explanation system, aka economic theory? Today’s troubles and the failure of most economists to predict them have given rise to a lively debate within the discipline about the sources of failure of economic theory and the ways in which it should be reformed. This is a good sign. But the current debate among economists is shallow and confined to a tweaking of its existing toolkit.  There is no indication that this debate will produce the intellectual revolution needed to respond to the theoretical and policy challenges facing industrialized countries.

The discipline of economics has been no stranger to methodological controversy. The Methodenstreit (debate over method) among German social scientists in the 1880s, the Keynesian revolution in the 1930s, the ‘F-twist’ debate in the 1960s over the importance of realism of assumptions, and the ‘Cambridge controversy’ over the meaning of capital in the 1970s are some of the most notable debates. But not all methodological discussions are created equal. Some are profound—questioning the very structure of the reigning methodology—while others are more superficial, aiming at incremental reform or merely cosmetic change. We find that the current discussion is for the most part quite shallow, and will remain so unless certain voices in the debate are given more emphasis.

The central problem is that almost nobody dares to rethink the nature of economic life and the proper scope of economic thinking. This deeper approach is precisely what we find in the Methodenstreit and in Keynes’ innovations. On its surface the Methodenstreit was a debate over whether concrete historical analysis or mathematical modeling was better suited to explain economics. But this question ultimately rested on the question of what the realm of political economy was actually like—i.e. whether it was comprehensible as a complex of generic building blocks at the level of individuals, or whether it was a network of irreducibly social institutions that individuals created and lived within. The debate led to revolutionary change —namely, a bifurcation of the discipline.  The Historical School’s philosophy of science—updated and improved by Max Weber—ultimately found a home in sociology.  The Austrian School, meanwhile, populated the burgeoning discipline of neo-classical economics, with its focus on the properties of a fully-decentralized competitive market system composed of rational and self-interested individuals functioning in a world of scarce resources.

John Maynard Keynes © IMF | imf.org

Keynes’s innovations were pitched at a similarly sweeping level, with the same revolutionary effect. Keynes introduced a new understanding of the concepts of time, uncertainty, and expectations. He argued that aggregate phenomena determine individual outcomes, a reversal of the direction of causality presumed in the dominant theory of his day. He established a new way of thinking about markets by showing how aggregate demand rather than wage flexibility created employment growth.  When wages fall, incomes and consumption drop, which can lead business to reduce rather than increase its ranks of employees.  Keynes showed how raising demand through real wage increases could thus increase employment.

The economic malaise since 2008 has generated a massive volume of criticism and self-questioning by economists in academic journals, newspapers and blogs.  But the discussion has been floating on a shallow level. Roughly, we can separate the positions in the debate into three categories.

A first group proposes that we ‘Do Nothing’ to change economic theory. This group, which includes such prominent macro economists as Thomas Sargent and Eugene Fama, claims that the theory of efficient markets has not been falsified by recent events. Either because the theory is about normal times rather than crisis, or because events don’t show any individual irrational behavior but rather a pattern of damaging economic policies, such as excessively high wages and money growth, leading up to the crisis.

The second group we refer to as ‘Add Finance and Stir.’ This eclectic group, which includes Robert Schiller, Paul Krugman, David Colander and Lance Taylor, sees the main limitation as the failure to link finance to macroeconomic theory. For this group, economics can be fixed by introducing a model of the financial sector that directly influences the ‘real’ sector of the economy.

A third group wants economics to be infused with more complexity and a richer understanding of institutions. This group ranges between those who propose more refined mathematical modeling to those who want to eliminate the use of mathematical formalization in economic theory entirely. We call it the ‘Add Institutions/Complexity’ group.

Unfortunately, these responses are shallow compared to the thorough debates of the past. They offer little hope that economics’ recent failures will be met with substantial reforms. True, some in the third group, for example Geoffrey Hodgson and Tony Lawson, are calling for a re-examination of the purpose of economics and its a priori commitment to the exclusive use of mathematical modeling to analyze economic life. But this view is not taken seriously within the profession.

It is certainly possible that the proper response to economics’ latest malfunction does not require a complete rethinking of the conceptual foundations. But we cannot simply presume that our current toolkit is entirely adequate. We need someone with Keynes’s radical spirit, including a willingness to look beyond the reigning way of doing economics. Refusing to do so is a recipe for superficial debate and cosmetic changes that simply kick the real problems down the road.