Keynesian economics is primarily a theory designed to explain how market economies can remain persistently depressed.
I agree with Krugman as to what it is that Keynesian economics concerns. I totally dispute the allegation that market economies remain persistently depressed absent government interference and I dispute the allegation that Keynesian policies cure depressions.
Economic panics and recessions are caused by artificial credit expansion caused either by fractional reserve banking and/or central banking.
Pre Fed panics were caused because the banks combined the money warehousing function with the loan function. The institution of fractional reserves mixes these two functions, such that warehousing becomes a source for lending. The bank loans out money that has been warehoused and stands ready to use in checking accounts or other forms of checkable deposits, and that newly loaned money is deposited yet again in checkable deposits. It is loaned out again and deposited, with each depositor treating the loan money as an asset on the books. In this way, fractional reserves create new money, pyramiding it on top of a fraction of old deposits. Depending on reserve ratios and banking practices, an initial deposit of $1,000, thanks to this "money multiplier," turns into deposits of $10,000. From the depositor point of view, this system has created certain illusions. As customers of the bank, we tend to believe that we can have both perfect security for our money, drawing on it whenever we want and never expecting it not to be there, while still earning a regular rate of return on that same money. In a true free market, however, there tends to be a tradeoff: you can enjoy the service of a money warehouse or you can loan your money to the bank and hope for a return on your investment. You can't usually have both. The Fed was created by the banking cartel as a back-up to this fractional-reserve system with a promise of endless bailouts and money creation, attempts to keep the illusion going.
Even with a government-guaranteed system of fractional reserves, the system is always vulnerable to collapse at the right moments, namely, when all depositors come asking for their money in the course of a run (think of the scene in It's a Wonderful Life). The whole history of modern banking legislation and reform can be seen as an elaborate attempt to patch the holes in this leaking boat.
See Chapter 2, “End the Fed” for an outline of this topic.
See chapters 1, 2 and 3 of “Money, Bank Credit and Economic Cycles” by Jesus Huerta de Soto for the full account.
Thus, the banking cartel created the Fed so that it could create legal counterfeit money to bail out its inherently risky fractional reserve banking. It was also handy to have the Fed around to help fund the unnecessary entrance of the U.S. in WWI.
The inflationary dislocations caused by the Fed and the War resulted in the depression of 1920, the one you never hear about (because it totally disproves the Keynesians). No Keynesian type solutions were tried and the crisis was over quickly.
Between the second quarter of 1920 to the third quarter of 1921, wholesale prices fell 44%. Factory employment and industrial production fell 30%. The Fed raised the discount rate from 4% to 7% and then back to 4%. The Harding government did basically nothing in the way of so called Keynesian stimulus. Harding specifically and intentionally did nothing to interfere with falling wages and prices. Further, Federal spending declined from $6.3 billion in 1920 to $5 billion in 1921 and $3.3 billion in 1922. Tax rates, meanwhile, were slashed—for every income group. And over the course of the 1920s, the national debt was reduced by one third. The crisis was over quickly. Thomas Woods has an interesting article and excellent video on this topic.
The 1920 depression demonstrates that even after a horrible inflationary dislocation caused by the Fed, prices and wages can and do readjust fairly quickly without the need of government interference.
The Fed then increased the money supply by 2/3, causing the 1929 crash.
Hoover wasn’t a Hooverite. Hoover behaved as a textbook Keynesian after the stock-market crash. He immediately cut income tax rates by one percentage point (applicable to the 1929 tax year) and began ratcheting up federal spending, increasing it 42 percent from fiscal year (FY) 1930 to FY 1932. In 1931, the New York fed had lowered interest rates to 1.5 %.
Look at his last two budgets. In 1932, receipts were $1.9 billion and expenditures were $4.7 billion. In 1933, receipts were $2 billion and expenditures were $2.6 billion. He urged business to keep wages high which helped cause the unprecedented unemployment.
Hoover then decided to raise tax rates. Check the historical tax rates here. Note how the rates rise to ridiculous levels starting in 1932 under Hoover and keep going up. No wonder the depression lasted until FDR died and Congress slashed spending by 2/3 after WW II.
So along comes Keynes in 1936. The 1920 depression showed that the market can and will readjust all by itself to rid itself of malinvestment and dislocations caused by Fed monetary dilution. The 1929 depression showed that intervention prolongs depressions. Keynes writes in his "General Theory" (without any historical reference or proof whatsoever) that the market cannot self adjust from a depressions (Keynes ignores the fact that it was the central bank's monetary diliution that caused the problem in the first place). He then states that it would be better if the central bank would simply just dilute the money supply so that there might be UNIFORM wage reductions to cure unemployment:
(i) Except in a socialised community where wage-policy is settled by decree, there is no means of securing uniform wage reductions for every class of labour. The result can only be brought about by a series of gradual, irregular changes, justifiable on no criterion of social justice or economic expedience, and probably completed only after wasteful and disastrous struggles, [when did this happen????] where those in the weakest bargaining position will suffer relatively to the rest. A change in the quantity of money, on the other hand, is already within the power of most governments by open-market policy or analogous measures. Having regard to human nature and our institutions, it can only be a foolish person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter. Moreover, other things being equal, a method which it is comparatively easy to apply should be deemed preferable to a method which is probably so difficult as to be impracticable…….
(ii)…..If important classes are to have their remuneration fixed in terms of money in any case, social justice and social expediency are best served if the remunerations of all factors are somewhat inflexible in terms of money. Having regard to the large groups of incomes which are comparatively inflexible in terms of money, it can only be an unjust person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter.
(iii) The method of increasing the quantity of money in terms of wage-units by decreasing the wage-unit increases proportionately the burden of debt; whereas the method of producing the same result by increasing the quantity of money whilst leaving the wage-unit unchanged has the opposite effect. Having regard to the excessive burden of many types of debt, it can only be an inexperienced person who would prefer the former. Pages 268-269
Keynes himself sounds exactly like Prof. Hayek describing Keynesianism.
