From Mankiw's WSJ review of Skidelsky's recent book, Keynes: The Return of the Master:
> To admirers, Keynes was nothing short of the savior of the
> capitalist system. His "General Theory of Employment, Interest and
> Money" (1936) proposed a diagnosis and remedy for the calamity known
> as the Great Depression. According to Keynes, economic downturns are
> not a fundamental indictment of the market economy. Rather,
> recessions and depressions arise from insufficient aggregate demand.
> A smart government can remedy the problem with its monetary and
> fiscal policy—say, by printing up some money and spending it. Once
> the right policies are put in place, the thinking goes, the world is
> safe again for free markets.
http://online.wsj.com/article/SB10001424052970204518504574417810281734756.html
As I recently tried to show, this misinterprets Keynes's evaluation of capitalism, an evaluation which, like Marx's, treats it as primarily justifiable as a means for solving "the economic problem", for creating the material pre-requisites (highly developed "forces of production") of the "ideal commonwealth". This ideal would not be "capitalist", i.e it would not be a society characterized by "dependence upon an intense appeal to the money-making and money- loving motives of individuals as the main motive force of the economic machine."
Instead, when capitalism had worked to remove the material obstacles in the way of its realization and when, in addition, the "spiritual" obstacles had been removed, we would be "free":
"to return to some of the most sure and certain principles of religion and traditional virtue‑that avarice is a vice, that the exaction of usury is a misdemeanour, and the love of money is detestable, that those walk most truly in the paths of virtue and sane wisdom who take least thought for the morrow. We shall once more value ends above means and prefer the good to the useful. We shall honour those who can teach us how to pluck the hour and the day virtuously and well, the delightful people who are capable of taking direct enjoyment in things, the lilies of the field who toil not, neither do they spin." http://www.eco.utexas.edu/facstaff/Cleaver/368keynesgrandchildren.html
Implicit in this treatment of capitalism, however, is the source of another of Mankiw's interpretive mistakes, one shared by almost all interpreters of Keynes. Mankiw doesn't notice that Keynes's analysis of capitalism, including his analysis of financial crises, is based on ontological, anthropological (in the philosophic sense) and psychological assumptions radically different from his own. In particular, it's based on the above psychological assumption that "the essential characteristic of capitalism" is "the dependence upon an intense appeal to the money-making instincts of individuals as the main motive force of the economic machine", a motive force Keynes treats as "irrational" in the psychoanalytic sense of "psychopathological".
It's this that explains the difficulty Mankiw has trying to make
Keynes's argument "logically cohere", a task he mistakes with trying
to make it consistent with assumptions radically different from
Keynes's own. His obliviousness to Keynes's actual assumptions, in
this case his ontological and anthropological assumptions, also
explains the mistaken role he assigns to "mathematics" both in the
project of trying to make sense of Keynes and in economics generally.
> Mr. Skidelsky fails to give Keynes's intellectual opponents their
> due. In academic circles, the most influential macroeconomist of the
> last quarter of the 20th century was Robert Lucas, of the University
> of Chicago, who won the Nobel Prize in 1995. His great contribution
> to the discipline was to analyze how government policies influence
> the economy in part through their effect on people's expectationsâ
> €”a lesson that Keynes would likely have appreciated but that early
> followers of Keynes often ignored.
>
> Yet Mr. Skidelsky chooses to make Mr. Lucas sound like some kind of
> idiot savant, more interested in playing with mathematical models
> than in trying to understand how the world actually works. Mr.
> Lucas, we are told, is following in the tradition of the "French
> mathematician Leon Walras [who] pictured the economy as a system of
> simultaneous equations." The very idea is made to sound slightly
> crazed.
>
> This brings us to the biggest problem with "Keynes." Mr. Skidelsky
> admits to being poorly trained in the tools that economists use: "I
> find mathematics and statistics 'challenging,' as they say, and it
> is too late to improve. This has, I believe, saved me from important
> errors of thinking."
>
> Has it, really? Mr. Skidelsky would like to think that his math-
> aversion allows him to focus on the big ideas rather than being
> distracted by mere analytic details. But mathematics is,
> fundamentally, the language of logic. Modern research into Keynes's
> theories—I have conducted such research myself—tries to put his
> ideas into mathematical form precisely to figure out whether they
> logically cohere. It turns out that the task is not easy.
>
> Keynesian theory is based in part on the premise that wages and
> prices do not adjust to levels that ensure full employment. But if
> recessions and depressions are as costly as they seem to be, why
> don't firms have sufficient incentive to adjust wages and prices
> quickly, to restore equilibrium? This is a classic question of
> macroeconomics that, despite much hard work, is yet to be fully
> resolved.
>
Keynes's ontological and anthropological assumptions, in particular his assumption that social relations are "internal relations", limit the applicability of axiomatic deductive, including "mathematical", reasoning. This is because the assumption means, as A.N. Whitehead (one of Keynes's Cambridge teachers) puts it, that: "Complete self- identity can never be preserved in any advance to novelty." The argument explaining why this limits the applicability of axiomatic deductive reasoning can be found at the beginning of this chapter from Whitehead's Modes of Thought: http://www.brocku.ca/MeadProject/Whitehead/Whitehead_1938/1938_06.html
Keynes also claimed that this mistake was psychologically motivated. Lucas illustrates this. He is, on this understanding of the psychological basis of the misidentification of "rationality" with "logic", another example of "how, starting from a mistake, a remorse logician can end up in Bedlam."
It was for this reason Keynes claimed the mentality dominant in "physics" lacked the capabilities required for insight into social, including economic, phenomena. As Keynes attempted to show in his psychobiographical essay on Newton, the mentality was "obsessional" (in Newton's case, to the extreme degree compatible with psychotic breakdown).
It's this mentality, however, that, since Keynes, has come pretty much to dominate both economics and Wall Street. This explains the migration of the "idols" of the "Bedlamite economists", e.g. the "efficient market hypothesis" as embodied in the Black Scholes Merton formula for pricing options and in David Li's "gaussian copula function" for measuring correlation default risk, to Wall Street, a Wall Street dominated by "quants". In his 1937 summary of the General Theory, Keynes had associated the "rational expectations" theory of "classical economic theory" with the same psychopathology he claimed underpinned "conventional" forecasting practices, including conventional financial market practices.
“Though this ["conventional" forecasting] is how we behave in the market place, the theory we devise in the study of how we behave in the market place should not itself submit to market-place idols. I accuse the classical economic theory of being itself one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future.” (vol. XIV, p. 115)
The psychopathology also makes the mentality immune to rational critique (e.g. immune, as are adherents of the "efficient market hypothesis", to a reductio ad absurdum argument). In particular, it makes much misinterpretation of Keynes immune to such critique.
Ted