Wednesday, July 22, 2020

In “Hydraulic Keynesianism,” the Models Resembled the Mathematical Description of a Plumbing System

The difficulty in understanding the General Theory may have contributed to its success as the founding text of macroeconomics. The book is open to alternative interpretations. In the post-war years, if you wanted to propose interventionist policies to ‘stabilise the economy’ or otherwise improve economic performance, you might well cite the General Theory as the source or context for your proposed policies. Thus, a variety of interventionist systems of thought were labelled ‘Keynesian’.

After the war, one version of economics, described as Keynesian, came to dominate macroeconomics. This breed of Keynesianism would estimate a consumption function, an investment function and other functions intended to represent stable relationships determining the overall levels of output, employment and prices. Changing policy variables such as the government deficit could, it was thought, shift these functions about and give us a better combination of output, employment and prices. Increasing money growth, for example, would inevitably cause some price inflation, but it would also reduce unemployment. This supposed inverse relationship between inflation and unemployment (Samuelson and Solow 1960) is known as the ‘Phillips curve’. Assuming a stable Phillips curve, any event that might increase unemployment could be met with a bit of inflation as a reliable offset.

This sort of macroeconomics is sometimes called ‘hydraulic Keynesianism’. Keynes was claimed as an important source and it was ‘hydraulic’ because the models resembled the mathematical description of a plumbing system. The flow of spending in an economy looked like the flow of water in a system of pipes. And just as we can regulate the flow of water with a few valves, we can regulate the economy with a few relatively simple policy instruments – or so it was thought.

—Roger Koppl, From Crisis to Confidence: Macroeconomics after the Crash, Hobart Paper 175 (London: Institute of Economic Affairs, 2014), 41-43.