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«In theory there is no difference between theory and practice. In practice there is. attributed to L.P. (‘Yogi’) Berra 1. Introduction The ...»

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Keynes, Lerner and the Question of Public Debt

Tony Aspromourgos*

In theory there is no difference between

theory and practice. In practice there is.

attributed to L.P. (‘Yogi’) Berra

1. Introduction

The question of sustainable or desirable public debt trajectories has long been a motif of debate and

controversy around Keynes’s economics; and the financial crises of 2007 forward have naturally

revived Interest in the issue – partly due to a consequent revival of interest in Keynes’s thought in general, partly due to deterioration in public sector balance sheets in the course of those financial and wider economic crises.

The purpose of what follows to explore Keynes’s views on public debt, in relation to the novel and unorthodox theory of aggregate economic activity levels that he embraced from about 1932. Keynes of course was very considerably engaged in policy debates prior to the 1930s, including public debt issues. Indeed, The Economic Consequences of the Peace (1919) – the book that first made Keynes a major public figure in policy debates – was about sustainability of public or national debt, albeit of a very special kind. But the public debt views of the pre-1930s Keynes might be misleading to the extent that they are conditioned by his then orthodox theoretical views. It is public debt in relation to the theory of 1936 that is of interest here. Therefore consideration of Keynes’s views is limited to the later period, though even this material will not be exhaustively examined. Indeed, the focus will be particularly upon one strand of his deliberations on public debt in the 1940s: his responses to Abba Lerner’s Keynesian-inspired views on the issue. The reason for that focus is that this strand seems to offer particular insight into Keynes’s conception of how recourse to public debt should be understood in relation to his new theory.

As to how Keynes’s novel theory properly is to be understood, we assert without argument here that, at core, it is the principle that planned saving and investment are equilibrated by the level of aggregate economic activity (the principle of effective demand); or equivalently, investment determines saving via the multiplier, with demand-side determination of activity levels, as against the supply-side doctrine of marginalist orthodoxy. Following from this, the general level of interest rates is no longer understood to be determined by underlying ‘real’ forces, in the orthodox manner, but rather, as a creature of the interaction between money market sentiment and monetary policy (Aspromourgos 2007). The key negative theoretical implications that Keynes draws are that a competitive economy has no automatic tendency towards zero involuntary unemployment, and further, that mature capitalism exhibits a general, persistent tendency to insufficiency of effective demand. This is the ‘worst-case’ point of theoretical departure from which to consider deficits and debt. For the purpose of aggregate demand management aimed at full employment, if the efficacy of monetary policy, or of monetary policy alone, is rejected, as it is by Keynes, then the pursuit of full employment must be by fiscal means (Aspromourgos 2012). And if further, these fiscal means require deficit spending, then a chronic underemployment problem might require permanent deficits and indefinitely growing public debt.

Lerner’s (1943) radical or at least very relaxed position on public debt is a useful point of reference for exploring Keynes’s position on the issue because he explicitly addressed Lerner’s views, endorsing them in some instances but also elsewhere repudiating them – particularly in a somewhat notorious public confrontation with Lerner at a 1943 meeting in Washington. Section 2 examines the latter incident, with the following section assessing the wider intellectual relations and exchanges between the two men. Section 4 then provides a resolution of Keynes’s position on public debt trajectories vis-à-vis Lerner’s ‘functional finance’ doctrine. Keynes’s rather nuanced view of the relation between theory and practice, more subtle than Lerner’s approach to policy, is the key to explaining their differences on debt.

2. A Confrontation in Washington In the set of interviews with some founding figures of American Keynesianism that makes up the contents of CL, there are five distinct accounts of this incident – by Evsey Domar, Alvin Hansen, Lerner himself, Richard Musgrave and Paul Samuelson (though Samuelson was not present). None of them gives the precise date and they conflict considerably in their detail. But they agree as to the spirit of the encounter: Keynes behaved badly in repudiating Lerner in a gratuitous and rather savage manner. There is even some dispute as to where the meeting took place. Hansen, sitting in on the Lerner interview, claims to have organized the meeting as ‘a dinner at one of the [Washington] hotels’, with about forty economists in attendance; Lerner says it was ‘a seminar at the Federal Reserve’. Hansen says there was a subsequent seminar at the Fed at which Keynes spoke; and while there is also no date provided for this meeting, it must have been no earlier than 1944, since Hansen has Keynes very warmly commending Lerner and his 1944 Economics of Control (CL: 106–08).

Keynes’s response to that book is considered in sections 3 and 4. The Fritz Machlup letter discussed below confirms Hansen’s recollection of two seminars, as do the accounts by Domar and Samuelson.

That there were two Washington meetings at which Keynes spoke might explain some of the discrepancies of detail between the five retrospective accounts of the confrontation with Lerner, those details being recalled decades after the event.

Notwithstanding Hansen’s recollection, in his own account Lerner persists in insisting that the 1943 meeting was at the Fed; he was standing ‘in the middle of the back of the hall’ with Domar beside him; and Keynes’s subject was the danger of a post-war slump. Lerner recalls his exchange with

Keynes as follows:

I asked why we should have to worry about that: if you give people enough money they will spend more and then there will be enough spending; there’s no need for any depression if you’re prepared to give them more money. So he asked where would you get the extra money and I didn’t say, ‘the printing press’. I said you could borrow it. He said, you mean the national debt will keep on growing, and I said yes. ‘What would happen?’ I said – nothing. So we talked for a moment and he said: ‘No,

that’s humbug … the national debt can’t keep on growing’.... [T]hat was the end of his discussion. (CL:

108–09)1 Lerner’s denial that he referred to printing money is a response to Hansen’s recollection of the

exchange, in the same interview:

In the discussion you [Lerner] raised the question... ‘Mr. Keynes, why don’t we forget about all this business of fiscal policy, public debt and all those kinds, and have some printing presses?’ To which Keynes made this reply: ‘It’s the art of statesmanship to tell lies, but they must be plausible lies.’ This was supposed to squelch you for the evening and, as a matter of fact, you said nothing more.

Hansen also says that Lerner was ‘sitting in the corner of the room’ and the meeting involved ‘a small group of about twelve’.2 Lerner says there were ‘about a hundred people’ present and ‘no sitting at a table’; that is to say, reiterating his denial that it was a dinner meeting (CL: 107–08).

Domar had moved to Washington in February 1943 to work as Hansen’s assistant, Hansen being then ‘Special Adviser’ to the Federal Reserve Board. Domar claims that it was he who suggested to Hansen to organize a seminar series at the Fed. Because Keynes happened to be in Washington at the time, he became the series’ first speaker. Domar does not say where the meeting was held or how many were in attendance; but he speaks of limiting it to ‘some thirty persons’, and that in the 2 end, ‘only Federal Reserve economists, plus a few outsiders’ were invited, though ‘several others

crashed the gate’:

I don’t recall what Keynes talked about. It was not a formal presentation. But I do remember... his nasty comments on functional finance. Someone asked Keynes about it. In response he said that you could fool all of the people some of the time, etc., but you could not fool all of the people all of the time. He probably used the word ‘humbug’ or something equally strong. I sat next to Lerner at the end of the table (with Keynes and Hansen at the head) and recall very vividly how red was his face. No one defended him. (CL: 184–5) Note that Domar does not have Keynes’s repudiation of functional finance as a direct response to Lerner himself (but nor does Domar contradict that recollection by others), while his account supports Hansen’s claim of a relatively small attendance (‘the’ table), whether or not it was a dinner.

Samuelson’s account conforms with Hansen’s, which fits with Samuelson’s recollection that he heard about it ‘at the time – probably from Hansen’. Keynes, Samuelson recalls, gave ‘two famous Federal Reserve seminars’; at the first he was ‘kind of reactionary’ and ‘jumped on’ Lerner in relation

to functional finance:

One of the things he said... was, ‘Plato said, “The art of politics is the art of telling plausible lies.” But you know, Abba, those lies have got to be plausible’, implying that Lerner’s weren’t. He must have felt... that Lerner had overdone it.... But anyway, in the meantime, Lerner’s The Economics of Control

came out... and in the second seminar he made redress and went out of his way to say nice things. (CL:

177) Musgrave worked at the Fed in Washington during the 1940s. According to his recollection, Keynes’s topic was ‘problems of war finance and international financial arrangements in the postwar world’, and it was Lerner who proposed that the post-war problem would be ‘over-saving and

unemployment’ (as against Hansen’s recollection):

... Keynes harshly rejected the risk of post-war stagnation, holding that because of Social Security there would be a large reduction in private saving and so that would be no problem. And then he practically said no sensible person would still be a Keynesian in such a period. I remember feeling sorry for Abba’s being left in the cold.

[Interviewer:] It’s interesting. Alvin Hansen has a totally different memory of an encounter of Keynes and Lerner; Hansen remembers Abba saying at one point, ‘Why don’t you forget all this stuff like deficit finance and everything, and just print money?’ After he looked around and saw that no reporters were there, Keynes said, ‘It’s the art of statesmanship to tell lies, but they must be plausible lies.’ (CL: 202) One further voice may be added to the testimony of these five. In a 24 October 1944 letter to Keynes, Machlup notes Keynes’s comments on Lerner’s ‘idea of “functional finance”... last year, at the Seminar in the Statler Hotel’, involving ‘pretty strong words’, and that ‘we all interpreted as being rather disparaging’, adding: ‘Lerner and his friends were disappointed and Lerner’s opponents rather elated’ (emphasis added). Machlup contrasts this with Keynes’s ‘complimentary remarks’ on the same subject ‘at the Seminar meeting in the Federal Reserve Board the other day’. Machlup also makes the point that ‘[y]our [1943] comments have received wide circulation; whenever functional finance is now brought up for discussion everyone hastens to add that Lord Keynes has disapproved of it’ (JMK/CO/4/274; Colander 1984: 1574, incidentally, incorrectly places the 1944 Keynes Washington seminar in 1945). The motive for Machlup’s letter was to invite Keynes to contribute to a symposium on functional finance, to include Lerner, for publication in the American Economic Review, Machlup being then the Acting Managing Editor of the journal. Keynes declined, blaming his overwhelming war-related obligations.


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