Modern Prophets: Schumpeter or Keynes? - Page 4

When the Keynesian prescriptions were initially tried - in the United States in the early New Deal days - they seemed at first to work. But then, around 1935 or so, consumers and businesses suddenly sharply reduced the turnover velocity of money within a few short months, which aborted a recovery based on government deficit spending and brought about a second collapse of the stock market in 1937. The best example, however, is what happened in this country in 1981 and 1982. The Federal Reserve's purposeful attempt to control the economy by controlling the money supply was largely defeated by consumers and businesses who suddenly and most violently shifted deposits from thrifts into money-market funds and from long-term investments into liquid assets - that is, from low-velocity into high-velocity money - to the point where no one could really tell anymore what the money supply is or even what the term means. Individuals and businesses seeking to optimise their self-interest and guided by their perception of economic reality will always find a way to beat the "system" - whether, as in the Soviet bloc, through converting the entire economy into one gigantic black market or, as in the United States in 1981 and 1982, through transforming the financial system overnight despite laws, regulations, or economists.

This does not mean that economics is likely to return to pre-Keynesian neoclassicism. Keynes's critique of the neoclassic answers is as definitive as Schumpeter's critique of Keynes. But because we now know that individuals can and will defeat the system, we have lost the certainty which Keynes imposed on economics and which has made the Keynesian system the lodestar of economic theory and economic policy for fifty years. Both Friedman's monetarism and supply-side economics are desperate attempts to patch up the Keynesian system of equilibrium economics. But it is unlikely that either can restore the self-contained, self-confident equilibrium economics, let alone an economic theory or an economic policy in which one factor, whether government spending, interest rates, money supply, or tax cuts, controls the economy predictably and with near-certainty.
That the Keynesian answer were not going to prove any more valid than the pre-Keynesian ones that they replaced was clear to Schumpeter from the beginning. But to him this was much less important than that the Keynesian questions - the questions of Keynes's predecessors as well - were not, Schumpeter thought, the important questions at all. To him the basic fallacy was the very assumption that the healthy, the "normal," economy is an economy in static equilibria. Schumpeter, from his student days on, held that a modern economy is always in dynamic disequilibrium. Schumpeter's economy is not a closed system like Newton's universe - or Keynes's macro economy. It is forever growing and changing and is biological rather than mechanistic in nature. If Keynes was a "heretic," Schumpeter was an "infidel."