Richard Posner: "How I Became a Keynesian"

Second Thoughts in the Middle of a Crisis
Richard A. Posner
The New Republic
September 23, 2009

Until last September, when the banking industry came crashing down and depression loomed for the first time in my lifetime, I had never thought to read The General Theory of Employment, Interest, and Money, despite my interest in economics. I knew that John Maynard Keynes was widely considered the greatest economist of the twentieth century, and I knew of his book's extraordinary reputation. But it was a work of macroeconomics--the study of economy-wide phenomena such as inflation, the business cycle, and economic growth. Law, and hence the economics of law--my academic field--did not figure largely in the regulation of those phenomena. And I had heard that it was a very difficult book, which I assumed meant it was heavily mathematical; and that Keynes was an old-fashioned liberal, who believed in controlling business ups and downs through heavy-handed fiscal policy (taxing, borrowing, spending); and that the book had been refuted by Milton Friedman, though he admired Keynes's earlier work on monetarism. I would not have been surprised by, or inclined to challenge, the claim made in 1992 by Gregory Mankiw, a prominent macroeconomist at Harvard, that "after fifty years of additional progress in economic science, The General Theory is an outdated book.โ€….โ€….โ€…. We are in a much better position than Keynes was to figure out how the economy works."

We have learned since September that the present generation of economists has not figured out how the economy works. The vast majority of them were blindsided by the housing bubble and the ensuing banking crisis; and misjudged the gravity of the economic downturn that resulted; and were perplexed by the inability of orthodox monetary policy administered by the Federal Reserve to prevent such a steep downturn; and could not agree on what, if anything, the government should do to halt it and put the economy on the road to recovery. By now a majority of economists are in general agreement with the Obama administration's exceedingly Keynesian strategy for digging the economy out of its deep hole. Some say the government is not doing enough and is too cozy with the bankers, and others say that it is doing too much, heedless of long-term consequences. There is no professional consensus on the details of what should be done to arrest the downturn, speed recovery, and prevent (so far as possible) a recurrence. Not having believed that what has happened could happen, the profession had not thought carefully about what should be done if it did happen.

Baffled by the profession's disarray, I decided I had better read The General Theory. Having done so, I have concluded that, despite its antiquity, it is the best guide we have to the crisis. And I am not alone in this judgment. Robert Skidelsky, the author of a superb three-volume biography of Keynes, is coming out with a book titled Keynes: The Return of the Master, in which he explains how Keynes differed from his predecessors, the "classical economists," and his successors, the "new classical economists" and the "new Keynesians"--and points out that the new Keynesians jettisoned the most important parts of Keynes's theory because they do not lend themselves to the mathematization beloved of modern economists. Skidelsky's summary of what is distinctive in Keynes's theory is excellent.

Richard A. Posner


Given your day job jaw literally dropped when, in your New Republic Keynesian piece, you said "The dominant conception of economics today, and one that has guided my own academic work in the economics of law, is that economics is the study of rational choice.  People are assumed to make rational decisions across the entire range of human choice, including but not limited to market transactions, by employing a form (usually truncated and informal) of cost-benefit analysis."

How many times--each and every day--are you, in your capacity as a Seventh Circuit Judge, confronted with situations involving people who have made anything but rational decisions, and you are left to clean up the resulting wreckage?  And I'm not just talking about the criminal docket either.

Don't compounded non-rational decisions, on a group- or mass-scale, lead to everything from frat parties that get totally out of hand to market bubbles?  How many people apply cost/benefit analysis (however informal), let alone rational choice, to their choice of a spouse, of friends, of associates?  And, if so, how can a whole theoretical system be based on an assumption that assumes away all of that, all that you see before you each day?

This is, in truth, the most astonishing thing I have read since Brooksley Born was quoted in the ABA Journal, saying that Alan Greenspan told her that "I don't think there is any need for a law against fraud".  From so much that you have written and that I have, despite coming from a very different perspective, admired, I expected better.