Robert Skidelsky in Project Syndicate:
At issue here is the oldest unresolved dilemma in economics: are market economies “naturally” stable or do they need to be stabilized by policy? Keynes emphasized the flimsiness of the expectations on which economic activity in decentralized markets is based. The future is inherently uncertain, and therefore investor psychology is fickle.
“The practice of calmness, of immobility, of certainty and security, suddenly breaks down,” Keynes wrote. “New fears and hopes will, without warning, take charge of human conduct.” This is a classic description of the “herd behavior” that George Soros has identified as financial markets’ dominant feature. It is the government’s job to stabilize expectations.
The neo-classical revolution believed that markets were much more cyclically stable than Keynes believed, that the risks in all market transactions can be known in advance, and that prices will therefore always reflect objective probabilities.
Such market optimism led to de-regulation of financial markets in the 1980’s and 1990’s, and the subsequent explosion of financial innovation which made it “safe” to borrow larger and larger sums of money on the back of predictably rising assets. The just-collapsed credit bubble, fueled by so-called special investment vehicles, derivatives, collateralized debt obligations, and phony triple-A ratings, was built on the illusions of mathematical modeling.
Liberal cycles, the historian Arthur Schlesinger thought, succumb to the corruption of power, conservative cycles to the corruption of money. Both have their characteristic benefits and costs.
But if we look at the historical record, the liberal regime of the 1950’s and 1960’s was more successful than the conservative regime that followed. Outside China and India, whose economic potential was unleashed by market economics, economic growth was faster and much more stable in the Keynesian golden age than in the age of Friedman; its fruits were more equitably distributed; social cohesion and moral habits better maintained. These are serious benefits to weigh against some business sluggishness.