A conversation with the author of “Keynes: The Return of the Master”

Question: What were the factors in his life that contributed to Keynes’ philosophy?

Robert Skidelsky:  Well, that's a big, tall order.  I think first name to mention is Cambridge, that is Cambridge, England.  He was born there, his parents were Dons, his father taught at Cambridge University, he then started teaching at Cambridge University at King's College.  So Cambridge was the intellectual center of his life.

The next big center was treasury, British government.  He worked at the treasury during the first World War, worked at the treasury during the second World War.  So British government was his third, sort of third center.

And then the Bloomsbury Group, which was the group of his friends, he met them at Cambridge, they were artists, writers, and famous names that everyone's heard of, like Virginia Wolfe.  And this was his group of personal friends and of course when he married the ballerina, Lydia Lopokova, then ballet entered into his life.  So there was economics, there was government service, and there were the arts.  I think those three things contributed to his formation as an economist and as a thinker.

Question: What are the key tenets of Keynesian economics?

Robert Skidelsky:  Well, I would single out two.  First of all, markets are not very stable, they're liable to crash, especially that's true of investment markets.  And secondly, when they do, and as a result of their crashing, economies run down, governments have a duty to provide a stimulus in order to break the fall and promote recovery because the markets won't do that themselves.  So I think those are two basic features of Keynesian economics.

Question: In what ways did the neglect of these principles contribute to the economic crises of 2008?

Robert Skidelsky:  Well, I think that the regulators and governments thought the financial markets were much stabler than they turned out to be, and therefore, they could be allowed to regulate themselves.  So I think monetary policy, or macro policy was not attempted to the possibility of these big bubbles building up and then crashing.  But on the second part, I think the fact that governments came in with a stimulus, once the economy had started to run down, was attribute to Keynes.  I think the difference is with the Great Depression itself of the early '30's, when governments did the exact opposite, they tightened their budget, they cut their spending, they raised taxes, and as a result, made things worse.  This time I think they did the opposite and the reason they did the opposite was Keynes had already written his theories, his great book and governments instinctively did what he had advised them to.

Question: Does the Keynesian understanding of consumer choice illuminate the dramatic downfall in the stock market?

Robert Skidelsky:  Well, I don't know that it was consumer choice that is the illuminating thing.  What I think his theory does enable us to understand is that investment is quite uncertain because people don't know what the future is going to bring, they bet, they bet on the future.  And a lot of those bets can go wrong.  I think it was also due to the fact that the banking system, or a lot of it, had been deregulated and therefore, there was very little control over financial innovation.  And financial innovation, a lot of it was very, very destructive.  So I think that Keynes' economics illuminates how that sort of thing can happen.

And also on the other side, I think he did insist that when there was a big disturbance like in the investment markets, so it could be in any sort of market, economies don't bounce back quickly on their own.  They do aggregate demand, as he called it, or aggregate spending, does start falling.  And when it falls, unemployment starts rising.  So I think that's where his, that's where his economics is particularly illuminating, in those two areas.

Question: What role did morality play in his economic philosophy?

Robert Skidelsky: I think he always asked the question, what is wealth for?  What is money for?  It's not something that economists ask on the whole, they assume that people have come to market with wants of their own and that the sole occupation of economics is to show how those wants are most sufficiently satisfied and they will thought they were doing a good thing if they set up systems which allowed one's satisfaction its fullest play.  Keynes always said, "No, let's look at the nature of these wants and we need to always have a moral critique of wants.  Economic progress is to enable people to lead a good life."  And he didn't think that that was what every, you know, that that was just an individual choice, what a good life is, he was based on certain traditions and moral philosophy, which said a good life consists of these things.

Now, you can say, of course, well, that didn't enter into his economics and many other economists also might have an idea of a good life, which is detached from what, their technical economic work, but I think he tried to keep them connected in his own mind and I think very few economists followed him in that direction.

Question: What facts have changed in the recent economy that might cause Keynes to change his mind?

Robert Skidelsky: Of course you can't have the same, you can't have exactly the same remedies for a completely different kind of economy and things have changed since his day.  And therefore, it's always a slightly artificial discussion to say, "Well, what would Keynes have done under the present circumstances?"

Still, to try and carry the point a bit further, I don't think there's been as much change in the financial system as one might think.  Sure enough, Keynes' focus was on the stock market rather than on the banking system because at that time, firms, you know, raise money on the whole, they raise capital through the stock market and the role of bonds and bank borrowing in the financing of business was less than it is now.  But, if you read chapter 12 of the General Theory, you get an analysis of herd behavior and the volatility of psychology of financial markets, which I think can be applied without very much amendment to what happened in 2007 and 2008.  I think he's got the psychology of these markets right.

There's much less manufacturing done than there was on his day and that may mean that when an economy starts running down, there are different factors involved.  It may be that, in fact wages are more flexible now because when you have very heavy manufacturer, this was also the scene of very powerful unions.  But on the other hand, you have a larger public sector than you did in Keynes' day so I'm not sure that wages would be any less sticky today than they were in his day.

Question: What has distinguished the psychology of the hoarding saver from that of the rabid investor in the last few years?

Robert Skidelsky: That distinction between the psychology of the saver and the psychology of the investor is very closely connected with Keynes' distinction between risk and uncertainty.  He did not think that the future was always merely risky in the sense that you, it was like betting on things happening and giving, being able to put numbers.  In other words, having a set of probabilities about what would happen.  He thought that a lot of it, and particularly when you were doing long-term investment, was unknown.  You just didn't know what was going to happen.  Of course, you invented various ways of dealing with that, but you didn't know and therefore, he thought of uncertainty as being a very, very dominant impulse in human behavior, dominant motive for human behavior.  And when the future is uncertain, in that sense, he thought that a lot of saving would be directed towards securing, securing more, getting more security in the present, rather than building wealth in the future, which was the classical view, you save in order to invest, in order to consume more later on.  Keynes thought of saving much more as a kind of hoarding, or rather, what he had called the propensity to hoard or liquidity preference, would normally be stronger than the inducement to invest.

And so that's the way he separated them out via this crucial category of uncertainty.  If you have no uncertainty, then of course the classical economics is true, and also a lot of modern financial economics.  You have no uncertainty, you don't need, you have no problem of liquidity, you don't need to keep cash, there's, money has no utility in a certain world, whereas an uncertain world it has a great deal of utility.

As we, you know, we have to act, we have to take views and to say I don't know isn't really the basis for a decision unless we just act on caprice, you know?  But, I mean, investors expect more than that.  And so what were people selling, selling securities and anything else, is they do insurance policies, whatever, they invent numbers.  Now, they're not inventing them in some sense of trying to cheat, but they are saying, "Well, let's start with some estimates," in other words, through something like using Bayes Theorem, we'll bet that it'll be like this.  And then we look for evidence that confirms that.  And so in a way, they're trying to work out some risk premiere that have some correspondence with actual risks.  But they don't, they're not, they can't go very far that way, along those lines, because the actual correspondence isn't really there in a lot of cases.  So once people stop believing in these stories, and then the crash can come very, very quickly.  They believe that house prices are correctly priced for some time and then suddenly they realized there's no real basis for that.  But what is the correct price?  We don't know that either.  It's just that everything swings.  People suddenly cancel their existing bets and want to get out.

Now, none of that behavior seems to me to be explicable unless you have uncertainty there.  And economics should start, I think, with the assumption that a lot of economic life is going to be uncertain.  Now, what kind of economics and economic modeling and economic theory follows from that?

Question: Can there be an imbalance between saving and investment?

Robert Skidelsky: Well, I think we can certainly have an imbalance X and T before the event, because in his equilibrium model, saving and investment are always equal, by definition.  But that's realized saving and investment.  But before, as you're coming into your crises, then there is an imbalance.  People want to save more than others want to invest.  And unless, and then he says, well, look, in classical theory, the theory he was combating, the theory of his day, what happens in that situation is the rate of interest moves immediately to adjust these two, this discrepancy, this X and T discrepancy, so that in fact, everything proceeds smoothly and savings flow into investments smoothly.  Whereas Keynes says, "No, the rate of interest doesn't do this because the rate of interest, what it equalizes is the desire to hoard money with the supply of money so that it can remain above what's necessary.  It doesn't fall by as much as is necessary to equalize saving and investment."  And so in a way, that self-adjusting mechanism, which classical economics assumed to exist, wasn't there.  I know that's a bit technical, but all it means is that you, the government has to intervene at that point.  That there's no automatic mechanism in a market system that reconciles the desire to save and the desire to invest.  And therefore, the government has to sort of do something or the Federal Reserve, the Fed, or the Central Bank, or whatever, it has to intervene.

It has to create enough investment, I would put it this way, for the economy not to suffer from a fall in aggregate demand because if you have a fall in the savings function relative to what people want to say, you then start having spending falling off because that sort of portion of spending, that is going to investment, has decreased and all that's happened is that the extra saving, if you like, saving relative to investment is just left to fall in aggregate spending, that leads to a fall in output, and that leads to a rise in unemployment.

So, if you don't have a balance within the market system itself, then you need an external balance and that's what I think Keynes believed and I think that's what happened last time.  What would've happened, do you think, had the government not intervened in October 2008?  Suppose it had let the whole of, a lot of the banking system collapse?  And what would've happened, do you think, to the economy?  I mean, people would have then lost a lot of their money, or some of it might have been secured because there was deposit insurance up to a certain point, but a lot of people would have just lost their money.  That means that they wouldn't have had any spending power left.  How could they have bought anything without any money if it had all disappeared?  The catastrophe to the economy would've been absolutely unbelievable.  And yet classical economists say, "Oh, well, no, it would've adjusted perfectly happily, a few weeks of pain and then everything would've gone on as before, without a banking system left."  I think you only have to sort of think about that and realize that the government had to intervene to save the economy.  And that's what makes it so maddening, that these bankers are back saying it was all the government's fault.  I mean, the government saved their skins.  It didn't want to, but it needed to save their skins in order to save the rest of us.  And now they say--I mean, it makes me very annoyed actually.

Question: Is there anything the government can do to speed up the adjustment process in the financial sector?

Robert Skidelsky: Well, there's a lot to unpick in that.  I don't, first of all, I don't know what building too many houses and that really means.  I mean, one of the, what I do know is that the housing bubble was not based largely on house building.  It was actually based on swapping titles to houses because new starts as a proportion of house sales had plummeted.  And so in a way it was a speculative bubble.

Now, I think, and that had to be, that had to collapse.  And so I agree with you, prices got out of line and the crises was in a way a return to something that was more sustainable.  But the deeper question is how had this got to happen?  Was it really because monetary policy had been kept too loose for too long as was later alleged.  Because if it's true that as financial economics claims, that securities are always correctly priced and the risks are correctly priced, how did this huge under-pricing of risk actually happen?  And I don't think the classical people have a good answer to that.  I think Keynes has an answer because he says that such mis-pricing of risks is inevitable because we don't actually know what the risks are.  And therefore, they may be correctly priced by accident and also if they, and there may be a lot of conventional belief that they are correctly priced, but the chances are very, very high that they won't be and therefore, they'll come crashing down.  So I'd like to know what the classical story is about this under pricing of risk worldwide.  How was it possible for this systemic mis-pricing of risk, which was later acknowledged to be at the root of the banking crises to develop?  I don't know the answer to that.

Question: Keynes foresaw the possibilities of economic problems becoming less important. Are we on schedule for that?

Robert Skidelsky: That's a great question, I've been thinking a lot about it.  In one way, we're on schedule for it because we are getting wealthier at roughly the rate Keynes predicted, we haven't quite got there yet.  I think he thought that within the next 20 years we'd have, on the whole, each person in the west, west and developed countries, would have about $60,000, as sort of household income, not average, but that's a lot of people would have more.  But that's what people would have got to, be able to get to, and that would be enough, they'd sort of ease off work.

Now, I think we are, I mean, we have been getting rich at roughly the rate Keynes suggested we would.  But our hours of work haven't been falling by nearly as much as he thought they would and so the question is, why not?  Why haven't we started, why haven't we traded more consumption for leisure, why do we still seem to want more consumption and more consumption?  And I don't know the answer, did Keynes underestimate greed?  Did he think that wants were satiable, that is that there was some limit beyond which your wants would sort of tail off?  And it was very easy to think of that, especially in the old days, when wants consisted much more of demands for physical things.  I mean, food and clothing and you know, you could almost add up and say, "Well, look, how much is enough?"  And then you could sort of, you could carry it a bit further and say, "Well, look, you don't really want 50 motor cars, do you?  I mean, 2 would be enough, or maybe 3."

But when you then think of everything in terms of just money, then almost nothing is enough.  I mean, how much money is enough?  Because it's hard to translate money into goods.  And I think people, once, I think there's a lot things can believe, and once they start thinking about wealth in terms of money, they lose the idea of enough-ness.

I think the other thing he underestimated was keeping up with the Jones, you know, just envy.  Not ordinary straightforward greed, but just envy, the fact that some other family has a bit more than you do, makes you envious and you want to get it, and then they get envious about someone else.  So that somehow you never got this escalator of mounting wants.  And he didn't really give a good answer to that, Keynes.  But I think the answer is you do just have to go back to moral philosophy and you've got to say, okay, there is greed, people do want more and more, but then what restrains them and what restrained them in the past was a view of life in which one's satisfaction wasn't the most important thing, that you just, you needed enough and you could say, "Enough is enough."  Maybe religion will get you there, maybe just classic moral philosophy, but you have to have some of that, or else you're always on the gravy train.

Question: Where does the bulk of the blame lie in this financial crisis?

Robert Skidelsky: I committed myself in my book, Keynes:  Return Of The Master, to the view that the blame lies chiefly with the economists, because of my conviction that ideas matter and that other people, they're not just puppets of ideas, but what goes on in their heads, what they think about the world, is really provided by the thinkers and in this case, the economists.  And that shapes their actions to an extraordinary degree.  It's not enough say, "Look, bankers were immensely greedy and that they committed lots of frauds."  I mean, that's not, they were set free, that sort of particular proclivity in human nature was set free to do its best and its worst.  Well, who set it free?  Well, obviously regulators and governments.  But politicians and regulators are consumers of ideas.  They never have any ideas of their own, it would take too much like hard work to develop ideas, you get them off menus and you pick the ones that suit you.

And so they were they, so there was this chain, and I think that was the important thing, and if you like, financial intermediation, financial services were set free to go beyond their rightful place, a place by which they have been restrained in the past.  And I think in the periods when they were restrained, economies were much more stable than they became later on.  So that's my basic answer, it's the ideas that are important.

Question: If Keynes were still alive, would he have prescribed a different approach in the early stages of the crisis?

Robert Skidelsky: I think by the time you're in a hole, I mean, the crises, remember, came on very, very suddenly.  You could say it had been germinating for the previous year, of course, people were alert to things even in 2007, but, you know, it then hit with a thunderclap and within a month it was as the whole of the western banking system was about to be wiped out.  And that's when they came in very, very fast, governments, and central banks.  And then after that, they had to say, "Okay, now we're in this whole, how do we sort of nudge economies out of it?"  Because economies were, by this time, on a life support system, the banks were on a life support system and the real economy was starting to be on a life support system.  So Keynes, I think, would've actually approved of, I think some things he would've done in a different way.  But, you know, go back to the old, old question, it's almost no use asking what would he have done in detail, because things have changed.  But it's the spirit, his analysis, and the spirit in which he would've tackled these problems that are important and I think he would've been on the side of expanding always when you're sliding down, rather than buttoning up your coats and saying we must tighten our belts, because I think he would've that would bring us even lower than we've gone.

Question: What is the process for becoming a Lord?

Robert Skidelsky: Well, appointed as a Lord, you're right to say that all members of the House of Lords are appointed and they're not elected.  Some have been, some are still hereditary, they sit there by virtue of the fact that their families have sat there in the past.  At one time, they were all appointed.  Well, ideally for outstanding public service and ability to contribute advice to the Queen as required.  It's all done in the name of the Queen.  This is the wonderful, fictional character of the British constitution.  I mean, when I was made a peer, I was made so by the Queen and the Queen, in a way, summoned me to advise her on matters of high policy.  And that is the standard formula that is used and one got a sort of, a wonderful bit of parchment or handwritten, "I, Queen," whatever, and so on.  But she doesn't actually have anything to do with it at all.  I think if she disapproved enormously of someone who it was proposed to make a peer, she could probably stop it.  But I think this would be a very unusual intervention.

Question: What power does the Queen exercise in British politics today?

Robert Skidelsky: No overt power.  But the power of being there and having been there for a long time now, her right to be consulted and to advise, because she has a weekly, usually a weekly meeting with the Prime Minister.  And at that point, she can say, "I'm worried about this or I don't like the way this is going."  The Prime Minister doesn't have to take any notice of that at all, but it's just the authority of being there and being in that position.  She has a few formal powers left, which, some powers of appointment.  But broadly speaking, she's a symbol.  If things, all her powers, in other words, are outsourced.  But if things go very, very badly wrong at any point, the theoretic possibility is they could be in-sourced again.  Now, in Britain, of course, that's almost inconceivable, it hasn't happened for, you know, a couple of hundred years, virtually.  But it's possible that they could be in-sourced again and the Queen's prerogative could be invoked by the Monarch personally if some terrible calamity occurred to the political system.  I think that's as accurately as I can describe it.

Question: What lessons can the history of Britain teach America, if China supersedes us?

Robert Skidelsky: Well, it's going to be a different story because Britain's world power was really based on a territorial empire and it lost that through de-colonization.  America's isn't, really, America's power in the world is based on its economic supremacy and also, I think the attraction of the American way of life and it's economic supremacy allows it to maintain very, very large military forces all around the world.  I mean, as America's economic power shrinks in the world relative to others, as it's bound to, doesn't mean it has to decline absolutely, but relatively speaking, America's role in the world will diminish.  So it's military power relative to others will diminish and so its attractiveness will diminish.

It's a question of how, it's a psychological adjustment, isn't it?  I mean, I feel sometimes Americans feel as though the only position they can possibly occupy is number one and if they're not number one, well, the end of the world has come.  But for many, many centuries, America wasn't number one and it's been number one, you know, relatively, for relatively few years really, since the Second World War.  Less than 100 years.  That's a short time.  I don't think America is doomed to decline quickly.  America is still way ahead of most every other country, really.  And so I think it's premature to talk about the end of the American empire.

But I think America has to be careful now.  It has to try and do more things in partnership with other countries and get other countries to sort of go along with it, more than was usual under the last president.  I think President Obama understands that, he's rhetoric is much better suited, I think, to this phase of American world leadership than was President Bush's rhetoric. 

Recorded on December 16, 2009