According to Keynes, the root cause of economic downturns is insufficient aggregate demand. During World War II and it's immediate aftermath, Keynes was immensely influential. By the 1970's when the great inflation was unfolding,even Keynes' chief critics such as Milton Friedman or Robert Mundell still retained many Keynesian assumptions. With the crisis of 2008, Keynesian policies came back with a bang and reoccupied center stage.
Following the Crash of 2008, these policies are no longer satisfactory. If the entire global economy is to follow Keynesian medicine, which requires more money printing, spending, borrowing and bailing out - on top of all the money printing, spending and borrowing that preceded the crisis, then we need to look at them with fresh and critical eyes.
The place to begin is with what Keynes actually said.
First of all, Keynes did not believe that fiscal stimulus alone could ‘kick’ the economy into full employment equilibrium as many of his modern day proponents, such as Paul Krugman, claim. Keynes viewed fiscal stimulus as a short-term stop-gap more than anything; viable to get the economy going and keep people in employment, but not sustainable in the long run.
Keynes himself in his writings is often obscure, even at first glance self-contradictory. In some cases, very close examination reveals that Keynes was not actually contradicting himself. Often he was simply being sloppy, although sometimes he seems to be intentionally opaque, rather like former US Federal Reserve Chairman Alan Greenspan used to be when testifying to Congress. Opacity has its uses in politics, especially when there is a logical difficulty to obscure or evade.
Keynes stated that Interest rates are too high.
"The rate of interest is not self-adjusting at a level best suited to the social advantage but constantly tends to rise too high. . "
This is a frontal assault on the entire price system.
Keynes does not define any of his terms. He does not say what the "social advantage" is. He does not tell us how we will know when interest rates have fallen far enough. Nevertheless, he has told us something important—that the price system cannot be trusted.
It is important to keep in mind that interest rates are a price, the price of borrowed money. They are not only a price; they are one of the most important prices in an economy. All prices are interconnected, but this price in particular affects all other prices.
Keynes stated that by continually lowering interest rates, we can abolish slumps and enjoy a state of perpetual quasi-boom. It may appear extraordinary that a school of thought should exist which finds the solution for the trade cycle in checking the boom in its early stages by a higher rate of interest. The remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.
This, of course, is precisely the formula for creating inflations, bubbles, and crashes. If printing "a bit more money", as economist Paul Krugman often maintains, will "cure" a "massive economic slump," then only the tiniest amount of newly printed money should be needed to keep a boom going. But this has not proved to be the case. In fact, larger and larger amounts of new money are needed to keep a bubble from popping. Eventually all the debt associated with the new money becomes too great a burden for the economy and everything collapses.
But the central paradox of Keynesianism is that it attempts to “fix” the price and profit system — by subverting it. No free price or profit relationship is left untouched. Keynes wanted interest rate controls,subsidies, direct or indirect currency controls, asset price floors, wage floors, executive compensation controls, direct price controls, trade barriers, and interference with the profit system.
President Obama says "I strongly believe in a free market system". Unfortunately he doesn't understand, in his Keynesian righteousness, that he has been jamming big sticks into the spokes of the market wheel, then loudly exclaiming that the wheel is not moving and is in urgent need of government repair.