1. History of Modern Macroeconomics Lecture 4, Fall 2017
History of Modern Macroeconomics Lecture 4. World War II and the New Economics ( ) Kevin D. Hoover Department of Economics Department of Philosophy Center for the History of Political Economy Duke University
History of Modern Macroeconomics Lecture 4, Fall 2017

2. How the Depression Ended
History of Modern Macroeconomics Lecture 4, Fall 2017

3. History of Modern Macroeconomics Lecture 4, Fall 2017

4. Where did the unemployment go?
History of Modern Macroeconomics Lecture 4, Fall 2017

5. History of Modern Macroeconomics Lecture 4, Fall 2017

6. History of Modern Macroeconomics Lecture 4, Fall 2017
War and the Economy
Between 1937 and 1944: GDP rose 108%
11% per year
15% per year between
At the peak, the military absorbed 20% of the prewar civilian workforce
Civilian employment was lower in 1944 than in 1940
History of Modern Macroeconomics Lecture 4, Fall 2017

7. History of Modern Macroeconomics Lecture 4, Fall 2017
Lend-Lease
History of Modern Macroeconomics Lecture 4, Fall 2017

8. History of Modern Macroeconomics Lecture 4, Fall 2017
Economists and the War
“The other thing that was so important in the ’fifties and ’sixties was operations research. The World War II generation brought a whole bunch of smart guys, like Abraham Wald and Friedman,. . . I mean everybody into Washington to work on the war effort, and economists thought of all kinds of great stuff I guess that’s what we always claim. We invented the convoy system we basically won the war singlehandedly. “
Robert E. Lucas, Jr.
History of Modern Macroeconomics Lecture 4, Fall 2017

9. Wartime Planning and Controls
History of Modern Macroeconomics Lecture 4, Fall 2017

10. Wartime Planners John Kenneth Galbraith (1908-2006)
Milton Friedman ( )
History of Modern Macroeconomics Lecture 4, Fall 2017

11. Macroeconomic Planning
Keynes’s “How to Pay for the War” (1940)
Opposed price controls
Favored macroeconomic intervention:
profits tax
compulsory saving
investment management
First treatment of inflation since before the General Theory
History of Modern Macroeconomics Lecture 4, Fall 2017

12. The National Accounts: Early Development
Early estimates of national income in 17th century
Systemization promoted by the Depression
Boosted by consilience with Keynes’ General Theory
3-way application of double-entry bookkeeping
Y = value of all production
Y = all expenditure
Y = all income
Key identities
S = I
Y = C + I
Modern versions
[G – (T – TR) ] + [S – I] + [M – X] = 0
Y = C + I + G + (X – M)
Colin Clark ( )
Simon Kuznets ( ; Nobel Prize 1971)
History of Modern Macroeconomics Lecture 4, Fall 2017

13. The National Accounts: World War II
United Kingdom
promoted by Keynes
elaborated and used in UK budget planning
United States follows UK
Richard Stone ( ; Nobel Prize 1984)
James Meade ( ; Nobel Prize 1977)
History of Modern Macroeconomics Lecture 4, Fall 2017

14. History of Modern Macroeconomics Lecture 4, Fall 2017
Postwar Fears – 1
History of Modern Macroeconomics Lecture 4, Fall 2017

15. History of Modern Macroeconomics Lecture 4, Fall 2017
Postwar Fears – 2
History of Modern Macroeconomics Lecture 4, Fall 2017

16. The “New Economics” Ambivalent attitude to Keynes Samuelson
American Institutionalist roots
Hansen’s two reviews
IS-LM as the essence of the General Theory
Samuelson
Student and collaborator of Hansen
Promoter of formal/mathematical economics
Supervisor of Lawrence Klein; Ph.D thesis (1944) The Keynesian Revolution
Alvin Hansen ( )
Paul Samuelson ( ; Nobel Prize 1970)
History of Modern Macroeconomics Lecture 4, Fall 2017

17. History of Modern Macroeconomics Lecture 4, Fall 2017
The Basic IS-LM Model
History of Modern Macroeconomics Lecture 4, Fall 2017

18. Basis for Curve Shapes – 1
IS Curve
Some prewar studies (surveys and econometric) showed very low elasticity of investment to interest rates
History of Modern Macroeconomics Lecture 4, Fall 2017

19. Zero Interest-rate Elasticity of InvestmentIS LM
History of Modern Macroeconomics Lecture 4, Fall 2017

20. Basis for Curve Shapes – 2
LM curve
Hicks’s interpretation of Keynes suggested that the LM curve could be interest elastic
War finance: U.S. controlled interest rates during the war; essentially enforcing the equivalent of infinite elasticity at a fixed rate of interest.
History of Modern Macroeconomics Lecture 4, Fall 2017

21. Zero Interest-rate Elasticity of Money DemandIS LM
History of Modern Macroeconomics Lecture 4, Fall 2017

22. History of Modern Macroeconomics Lecture 4, Fall 2017

23. History of Modern Macroeconomics Lecture 4, Fall 2017
Fiscal Policy When the IS curve is perfectly interest-inelastic and the LM curve is perfectly interest-elastic Y r IS LM
History of Modern Macroeconomics Lecture 4, Fall 2017

24. The “Keynesian Cross” – 1
Income (Y)
Consumption Function
C + I + G
Expenditure
(Y)
45º-degree line
History of Modern Macroeconomics Lecture 4, Fall 2017

25. The “Keynesian Cross” – 2$
I + G
S + (T – TR)
History of Modern Macroeconomics Lecture 4, Fall 2017

26. The War through the Eyes of the “Keynesian Cross”
History of Modern Macroeconomics Lecture 4, Fall 2017

27. A Failure of Macroeconomic Analysis – 1
History of Modern Macroeconomics Lecture 4, Fall 2017

28. A Failure of Macroeconomic Analysis – 2
History of Modern Macroeconomics Lecture 4, Fall 2017

29. The Postwar Recession that Wasn’t
A brief mild recession in 1945 ended just after the surrender of Japan
Unemployment rates rose in the immediate postwar period, but stayed very low relative to prewar levels
GDP and GDP per capita fell slightly
But consumption rose even during the recessions of 1945
In short, fears were not realized.
History of Modern Macroeconomics Lecture 4, Fall 2017

30. History of Modern Macroeconomics Lecture 4, Fall 2017
Why?
Pent up demand for consumer durables (houses, cars, washing machines) boosted expenditure
Women left the workforce
GI Bill moved many ex-servicemen and women into higher education
The rise of the Iron Curtain and the onset of the Cold War
History of Modern Macroeconomics Lecture 4, Fall 2017

31. The New Economics and the New Orthodoxy – 1
The “Age of Samuelson
Economics: “Keynesianism” without Keynes
Foundations: dominance of formal/mathematical economics
History of Modern Macroeconomics Lecture 4, Fall 2017

32. The New Economics and the New Orthodoxy -- 2
Biography
Russian, Jewish émigré to Britain
educated LSE
emigrated to U.S.
wrote Economics of Control
Functional finance
accounting balance on government budgets irrelevant
budgets to be judged by effects on economy
laid groundwork for fiscalist “Keynesianism”
Keynes himself opposed
Abba Lerner ( )
History of Modern Macroeconomics Lecture 4, Fall 2017

33. The Rise of the Welfare State: U.K.
Lord Beveridge ( )
History of Modern Macroeconomics Lecture 4, Fall 2017

34. The Rise of the Welfare State: U.S.
Harry S. Truman ( , President )
Alvin Hansen ( ), American popularizer of Keynes
History of Modern Macroeconomics Lecture 4, Fall 2017

35. The Wages of Intervention – 1
History of Modern Macroeconomics Lecture 4, Fall 2017

36. Wages of Intervention – 2
History of Modern Macroeconomics Lecture 4, Fall 2017

37. Internationalization of Institutions – 1
Keynes and Harry Dexter White (U.S. Delegate)
Bretton Woods (NH) Resort
Keynes and the Soviet Delegate
History of Modern Macroeconomics Lecture 4, Fall 2017

38. Internationalization of Institutions – 2
Bretton Woods Conference 1944
History of Modern Macroeconomics Lecture 4, Fall 2017

39. What was “Keynesian” about the New Economics?
Consilience of Keynes’s ontology with the national income and product accounts
Interventionist attitude
The Neoclassical Synthesis:
Already in Keynes: classical is special case of the general theory
Picked up by Klein (The Keynesian Revolution)
Samuelson: implicit in 1st edition of Economics (1948); term coined in 3rd edition (1955)
History of Modern Macroeconomics Lecture 4, Fall 2017

40. History of Modern Macroeconomics Lecture 4, Fall 2017
Thanks 
The End
History of Modern Macroeconomics Lecture 4, Fall 2017