Why the Keynesians lost

24 Sep

Cornel Ban and Daniela Gabor “The Politics of Collateral Damage: Finance and Varieties of Capitalism in the Eurozone Crisis” forthcoming)

“Constructivist political economists argue that the analysis of policy shifts should focus on the political battles that define the origins of crises and the solutions that are institutionally available (Widmaier, Blyth and Seabrooke 2007: 748; Blyth 2002; 2012; Lindwall 2009; 2011; Mandelkern and Shalev 2012; Biswas 2011; Vali 2011; Hay 2011; Schmidt 2011; Carstensen 2011; Radula and Kattel 2011; Ban 2011; Bell 2012; Matthijs 2012; Yee 2012; Widmeier and Park 2012; Baker 2012; Finlayson 2012). When applied to the fiscal outcomes studied in this paper, the constructivist approach yields the hypothesis that the adoption of austerity measures throughout the Eurozone has been the result of the victory of anti-Keynesian ideas in pivotal nodes of the European policy field. Specifically, they seek for evidence of the intellectual skepticism of New Consensus macroeconomists about the long-run effectiveness of fiscal policy during a recession marked by financial market volatility and a strong sovereign risk channel effect (for an overview and critique see Arestis 2009).

While few doubt the fiscal policy skepticism of European central bankers (Gabor 2011; Cecchetti 2011), the situation is less clear at the level of national policy elites and the economics profession where no research has been carried out so far. Constructivists also have to explain the shift for “Keynesianism for about ten months” (Blyth 2012) to the neoclassical (New Consensus) retrenchment of 2010. Thus, concerns with the contractionary effects of fiscal austerity in Europe were voiced inside the IMF, an erstwhile proponent of fiscal adjustments to address competitiveness issues (Blanchard 2010; Pescatori et al 2011). Most importantly, outside of the world of European central banks, in late 2008 and early 2009 the kind of activist fiscal policy associated with the Keynesian tradition seemed to dominate the approach to the crisis of national policy elites. If this was so, what explains the abandonment of Keyensian ideas on fiscal policy and the return to New Consensus macroeconomics by the same elites towards the end of 2009?

Two constructivist studies delved into the puzzle of austerity empirically and in a way that showcases the centrality of the interaction of power and ideas (Farrell and Quiggin 2012; Blyth 2012). Their findings can be summarized as follows: in 2008-2009 leading American Keynesian economists and a coterie of prominent defectors from New Consensus macroeconomics managed to provide usable policy theories to policy elites confronted with an unprecedented crisis that appeared to be better explained by Keynesians than by their foes. As Mark Blyth’s history of austerity avers, 2008 and 2009 were the years of an intellectual tailspin in orthodox economics:

A large part of the reason that Keynesianism became the policy du jour was that governing neoliberal ideas pretty much denied such a crisis could ever happen. So when it happened it was bound to open up some room for ideas that said such events were bound to happen if you left markets alone to regulate themselves, which is exactly the Keynesian point. Given this, it was hard to defend publicly the logic of self-correcting markets at a time when they were so obviously not self-correcting […] Furthermore, as well as denying it could happen, neoclassical policy was entirely focused upon avoiding one problem, inflation, and providing one outcome, stable prices. As a result it seemed to have very little to say about a world where deflation was now the worry and price stabilization meant raising, not lowering, inflation expectations.

By 2010, however, the newfound Keynesian equilibrium of a seemingly disrupted macroeconomics field was ruptured by the fading effects of the post-Lehman financial crisis and the emergence of a new crisis in parallel with a strategic regrouping of New Consensus economists. The new crisis was the deterioration of deficit and debt levels following the extensive bank bailouts from 2008 and 2009 and the effects that the financial crisis had on automatic stabilizers. To boot, the Greek fiscal scandal of early 2010 sent the cost of borrowing in the euro “periphery” soaring. The confluence of these events provided opportunities for skeptics to widen the debate and call for fiscal consolidation now that the worst of the crisis was over. But what shifted the ground decisively against Keynesians was the pro-austerity mobilization of the hitherto silent European Central Bank and of the once pro-stimulus European Commission and OECD (Lutz and Kranke 2011). This offered Germany an opportunity to argue for rapid consolidation despite American pressures to do the opposite. Germany’s ideational entrepreneurship was hardly surprising for this a policy leader in the Eurozone given thet its bipartisan Ordoliberal policy establishment had been highly biased against Keynesianism’s inflationary risks throughout since the end of WW2. As Blyth puts it

Germany gave austerity a new lease of life via the social market economy and its postwar economic miracle. ‘Erst sparen, dann kaufen’ leaves no room for the profligate except austerity, and it allows no room for compensation apart from that which speeds the adjustment of the market. The imprint of these ideas on the institutions of the EU is not in doubt. There is no place for Keynes and compensation in an economic union where competition produces income and growth through the production of competitive products and the running of surpluses – not the shallow demand of the money press. In such a world, the slump, not the boom, is the right time for austerity (Blyth 2012).

The constructivist account is powerful but it needs further specification of the reason why coordination was ultimately achieved even in countries like Spain, where the policy elite in charge did not easily buy the credibility thesis (Ban 2012). One way to address this gap is to explore the explanatory potential of the hierarchical relations characteristic of European governance. One hypothesis that could be derived from this approach is that the pro-austerity E.U. coalition (Germany and its allies, the ECB, the Commission) had the power and used it against dissenting policy elites (and publics). Another avenue is to turn to an analysis of the constraints put on the fiscal policy space of all European sovereigns by the long-run effects of financialization and the sudden stop in transnational financial flows from export (coordinated) economies to liberal and mixed varieties of capitalism.”

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One Response to “Why the Keynesians lost”

  1. Development Studies at Brown November 26, 2012 at 17:38 #

    Reblogged this on Development Studies at Brown University.

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