"The Great Policy Debate"


Keynesianism: What is and why it still matters"

Back to Basics: Progressive Economics for the 21st Century

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THE ECONOMY AS A "CORRIDOR":

POLICY EFFECTIVENESS & ECONOMIC STRUCTURE


The use of monetary and fiscal policy to achieve full employment are the hallmarks of Keynesian economics. However, it is vital to recognize that these instruments of policy are only effective in an appropriate economic environment. This is the lesson of structural Keynesianism outlined in chapter 1. In the period 1945-1973, the structure of the economy was such that this was the case. The success of the Keynesian economic policy revolution therefore rested on a new understanding of the significance of monetary and fiscal policy, combined with a favorable economic structure,
The importance of structure was not well understood, and, as the economic structure deteriorated in the period after 1973, so too did the feasibility and efficacy of Keynesian demand -management policies. Therefore, restoring the viability of demand- management policies requires the restoration of an appropriate economic structure. In the absence of this, Keynesian policies are unlikely to be able to permanently restore aggregate demand. Instead, their sustained application is likely to produce rising government deficits and debt, persistent trade deficits, and financial turmoil resulting from capital flight. These arc the hallmarks of the last twenty years, and they have prompted a retreat from the policies of demand management. Rather than retreat, the appropriate response should have been to refashion the system so as to restore the feasibility and effectiveness of demand management.
Such considerations link with the observation in chapter 1 that capitalist economics come in a range of forms, and the real problem lies in fashioning the form that works best for the average person. The metaphor of a corridor can be used to describe the economic system.

The walls of the corridor are analogous to the institutions, laws, and regulations that constrain economic activity, and economic activity takes place within the corridor. The goal of policy should be twofold. Structural policy should see to it that the corridor is designed such that it is wide enough and pointed in the right direction: demand-management policy should ensure an appropriate level of economic activity within the corridor.
Further reflection reveals that the situation is even more complicated. The walls of the corridor constrain the activities and choices of business. Because these constraints are binding, business has an incentive to try and get around them. This is where the process of creative destruction enters, because business will seek to introduce innovations that mitigate the constraints of the corridor. Thus, if unchanged, over time the corridor is likely to become increasingly ineffective at guiding economic activity. The increase in capital mobility, the decline in transactions costs, and the increase in the power of business relative to government and labor correspond to a gradual erosion of the corridor. This reveals that policy design must be an ongoing process that responds to developments brought about by the process of creative destruction.
Restoring prosperity requires rebuilding the corridors governing economic activity and seeing that they are again pointed in a direction that promotes social well-being. This is what is meant by restoring structural conditions favorable to Keynesian demand-management policies. Unfortunately, conventional economics, which dominates the Counsels of economic policy making, has actively sought to demolish the existing corridors. The policies of orthodoxy have therefore exacerbated an already difficult situation, and these policies threaten to entrench deep structural changes in the domestic and international economy that will be difficult and perhaps impossible to reverse.


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Source: Thomas Palley, "Plenty of Nothing....", p. 102-103,1998.