Economists need to restore key aspects of Keynes's theory that were left out of Mainstream Keynesian theory

Mainstream Keynesian theory does incorporate some of Keynes's most important contributions to macro theory. In particular, it demonstrates that a capitalist economy has many possible states of short-run equilibrium other than full-employment equilibrium, that underemployment equilib­riums can be stable or persistent, that the AD (or total spending) function is a crucial determinant of the equilibrium levels of income and employ­ment, that changes in investment spending affect equilibrium income via a "multiplier" that depends on the mpc (and therefore on the distribution of income and wealth), and that the government can influence the equilib­rium levels of income and employment in the short run through monetary and fiscal policy.

Unfortunately, as we have seen, many of the most important innovations in Keynes's theory emphasized in this book were never incorporated into Mainstream Keynesian theory. One can only speculate on the reasons why they were not, but certainly that the Golden Age was a period of widely shared prosperity in many countries was one factor, and the fact that Keynes's radical theory and policy threatened the economic and pol­itical dominance of capitalism may have been another. The early postwar period of Trumanism and McCarthyism in the USA was one of extreme hostility to all socialist ideas, labeling them "un-American." I will briefly review some of Keynes's most important contributions to economic theory that were lost in the Modern Keynesian translation of Keynes and should be resurrected.

First, contrary to conventional wisdom, neither The General Theory nor, for that matter, the bulk of Keynes's work in the interwar period is devoted exclusively to the theory of the short run. I have argued that Keynes believed that modern capitalism was an economic system that tended toward long-term stagnation in the absence of historically contin­gent factors such as high population growth, war, or system-transforming technical change. He became convinced early in this era that the model of global capitalism that dominated in the "glorious" nineteenth century was permanently broken and could not be restored after WWI. This is the main theme of The Economic Consequences of the Peace, which is discussed in Chapter 2. Chapters 13 and 14 of this book document his emphasis on the theoretical possibility of secular stagnation and explain why he believed that Britain and much of the world would remain stagnant unless cur­rently unforeseeable new sources of long-term growth emerged. WWII and its aftermath led to the end of that particular episode of stagnation.

Keynes's focus on the possibility of long eras of stagnation disappeared from economists' understanding of Keynesian economics after the war. His theory was replaced by Mainstream Keynesian theory, a theory focused on the short and intermediate runs. It promised a perpetual Golden Age under appropriate macro policy and seemed to deliver on that promise for a generation or so. The disastrous economic and political aftereffects of the recent global financial and economic crisis, a crisis that was neither predicted nor explained by Mainstream Keynesian theorists, showed this theory to be fundamentally flawed and led to a renewed interest in the possibility of secular stagnation in modern capitalism by some respected Mainstream Keynesian economists. Long-term stagnation remains an important area of study and neither Keynes nor those Modern Keynesians interested in stagnation theory have had the last word on the subject.

Second, there are two major system-changing innovations in Keynes's macro theory. The first is the model of high unemployment equilibrium caused by inadequate AD - the model taught in university courses on Keynesian economics. The second is Keynes's assumption of fundamental or radical uncertainty, which, as we have seen, transformed not only the theory of agent choice, but also the theory of the ontology and epistem­ology of the agent.

Keynes had the courage to accept an obvious and important "fact" that almost all other economists reject - that the probability distributions that describe future states of the economy are unknowable in the present and are affected by the choices agents make in the present in ignorance of the future. Radical uncertainty changed the behavioral equations inserted into Keynes's AD-driven macroeconomic model and therefore changed the basic characteristics of the model, a model derisively labeled "chapter 12 Keynesianism" by many mainstream economists. Keynes's agents do not have the complete and correct information about future economic states needed to make assuredly optimal decisions. They therefore have to con­jure up expectations through behavioral and conventional heuristics, then decide how much "confidence" to place in the truth content of these expectations before they can determine the choices they should make in the marketplace. Keynes was thus one of the earliest creators of behavioral theory in economics. He used his more radical form of behavioral theory to overthrow received theory rather than make moderate adjustments to it as today's behavioral theorists claim to do.

Keynes argued that expectations are typically formed through extrapo­lation from past trends, that confidence in expectations reflects the accuracy

Relevance of Keynes's work today 373 of expectations in the recent past, and that when expectations thus formed suddenly become substantially inaccurate, confidence in the truth content of expectations evaporates and agents can suddenly become extremely risk averse.

Keynes's macro theory, which combines his theory of agent choice based on radical uncertainty with his theory of the semiautonomous behavior of AD, has a number of major implications for improving the current state of macro theory.

First, it generates a theory of an economic system that is incessantly changing and evolving due to endogenous processes. It does not have to be exogenously "shocked" to move.

Second, unlike neoclassical theories of general equilibrium, Keynes's capitalism has no demonstrably optimality properties; sometimes it works well (see again the "glorious" nineteenth century, which worked very well for Britain's ruling elites) and sometimes it creates depression and mass unemployment. It all depends on the institutional and behavioral "facts" specific to time and place.

Third, Keynes's theory can explain why capitalist economies experience bouts of extreme instability such as the boom-crash experience in the USA in the late 1920s and early 1930s or the global economic and financial crisis that began in 2008. This can be seen most clearly in chapters 11-15 and 22 of The General Theory, which deal with financial markets, capital invest­ment, and business cycles. Keynes's theory of endogenously generated instability, which has a key role in financial markets, was popularized by Hyman Minsky. Any economic theory that claims to explain the long-term behavior of capitalist economies must be able to explain not just ordinary business cycles, but also why such economies experience both vigorous expansions and severe economic downturns and depressions from time to time. Mainstream Keynesian theory cannot do this.

Fourth, Keynes insisted that, in order to have useful economic theories of actually existing capitalist economies, we must study the "facts" about how disequilibrium dynamics function under various institutional and historical conditions.

major contribution to macro theory by Keynes that is not reflected in Modern Keynesian theory.