I am on the hop from event to event right now, so I do not have time to give the keen-witted Greg a full and comprehensive answer to his question–nevertheless, the question does deserve a full, comprehensive, yet short answer. So may we crowdsource this?

On Wed, Jun 25, 2014 at 8:58 AM, Greg Ip wrote:

… 2)Separate but related, I am trying to describe the origins of stabilization policy. Keynes created a world in which such policy was needed; I assume it displaced a classical view of the business cycle which contained no role for government intervention. Can you point me to an article, by you or anyone else, that describes the classical view of the business cycle – and how Keynes displaced it?


2) You know, that is a remarkably hard question. There are really, three different ‘classical’ theories of the business cycle:

2.a) There was Joseph Schumpeter-Friedrich von Hayek view, as set forth in Schumpeter’s 1933 “Depressions” article for the “Economics of the Recovery Program” volume:

[There is a] presumption against remedial measures which work through money and credit. Policies of this class are particularly apt to produce additional trouble for the future…. [D]epressions are not simply evils, which we might attempt to suppress, but forms of something which has to be done, namely, adjustment to change…. [This creates] the chief difficulty… most of what would be effective in remedying a depression would be equally effective in preventing this adjustment…

2.b) There was Walter Bagehot’s “Lombard Street” http://www.gutenberg.org/cache/epub/4359/pg4359.txt view: have a central bank that stabilizes the money market, leans against the wind in managing interest rates, and deals with financial crises by lending freely but at a penalty rate as long as it can lend to illiquid but solvent institutions on collateral that would be good in normal times–what you should do with insolvent institutions that are TBtF Bagehot does not say, but it is consistent with the spirit of “Lombard Street” that you take their equity and all upside possibilities and resolve them as quickly as possible in a way that does the least damage…

2.c) And then there was the third view, which focused on how both inflation and deflation were evils that needed to be avoided, a Marshall-Wickell-Fisher view. For this last, let me recommend three things:

2.c.i) Alfred Marshall and Mary Paley Marshall (1881), “The Economics of Industry” 2nd ed. , Book III, chapter I (Note that page 155 contains the first mention of the “confidence fairy”):

After every crisis, in every period of commercial depression, it is said that supply is in excess of demand… a state of commercial disorganization; and that the remedy for it is a revival of confidence…. Though men have the power to purchase they may not choose to use it…. The greater part of it could be removed in an instant if confidence would return, touch all industries with her magic wand, and make them continue their production and their demand for the wares of others…. Confidence by growing would cause itself to grow…

2.c.ii) John Maynard Keynes (1923), “A Tract on Monetary Reform” http://delong.typepad.com/keynes-1923-a-tract-on-monetary-reform.pdf:

We see, therefore, that rising prices [inflation] and falling prices [deflation] each have their characteristic disadvantage. The Inflation which causes the former means Injustice to individuals and to classes–particularly to investors; and is therefore unfavorable to saving. The Deflation which causes falling prices means Impoverishment to labor and to enterprise by leading entrepreneurs to restrict production, in their endeavor to avoid loss to themselves; and is therefore disastrous to employment…. Thus Inflation is unjust and Deflation is inexpedient. Of the two, perhaps Deflation is, if we rule out exaggerated inflations such as that of Germany [in 1923-1924], the worse; because it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier. But it is not necessary that we should weight one evil against the other. It is easier to agree that both are evils to be shunned…

2.c.iii) John Hicks (1937), “Mr. Keynes and the ‘Classics’: A Suggested Interpretation” http://web.econ.unito.it/bagliano/macro3/hicks_econ37.pdf:

Mr. Keynes will reply that there is no classical theory of money wages and employment. It is quite true that such a theory cannot easily be found in the textbooks, but that is only because most textbooks were written at a time when general changes in money wages in a closed system did not present an important problem. There can be little doubt that most economists have thought they had a pretty fair idea of what the relationship between money wages and employment actually was. In these circumstances, it seems worthwhile to try to construct a typical ‘classical’ theory…

At least, that is how I see it…