‘Until Keynes, Say’s Law had ruled in economics for more than a century. And the rule was no casual thing; to a remarkable degree acceptance of Say’s Law was the test by which reputable economists were distinguished from the crackpots. Until late in the ’30s no candidate for a Ph.D. at a major American university who spoke seriously about a shortage of purchasing power as a cause of recession could be passed. He saw only the surface of things, was unworthy of the company of scholars. Say’s Law stands as the most distinguished example of the stability of economic ideas, including when they are wrong.’
Well let me say three things about this. The first is that the initial statement is absolutely right. Before the Keynesian Revolution, denial of the validity of Say’s Law placed an economist amongst the crackpots, people with no idea whatsoever about how an economy works. That the vast majority of the economics profession today would have been classified as crackpots in the 1930s and before is just how it is.
And what did it mean to believe in Say’s Law? It meant that since we live in an exchange economy, although the existence of money tends to obscure the process by which demand is created by supply, the only way money can actually contain purchasing power is if the money one holds had been received in exchange for having sold something to others. I produce and receive money by selling what I have, which includes my labour time. Others receive their money for doing exactly the same. Therefore when each of us buys, we are actually exchanging the value of what we had each produced.
Deficit financing, on the other hand, creates money to spend without first bothering to produce the goods and services the money is supposed to represent. Since this fake money is identical to the real thing, its existence first dilutes the value of money. And then, secondly, because this money is always spent by governments in the first instance, the pattern of production is changed from what the market prefers to what the government prefers, which inevitably lowers the productivity of the economy. Debt, deficits and slow growth are therefore inevitable.
Secondly, Galbraith not only doesn’t understand the meaning of Say’s Law, he doesn’t even understand Keynes. The one thing that both the classical side and Keynes agreed on was that a shortage of purchasing power is never the cause of recession. It is not whether people have the purchasing power that is at issue, but whether they spend it. That is why saving is such a major issue in the Keynesian model. People could spend their money but choose not to. It is never argued that they never had the money in the first place which was not the issue of Say’s Law either. How incredible it is, not to mention disgraceful, that one of the leading Keynesians of his time had no idea of one of the fundamental ideas behind The General Theory.
Thirdly, if we are looking for some crackpot notion that stands as a truly distinguished example of the stability of economic ideas, including when they are wrong, there is virtually nothing in the history of ideas quite as incredible as Keynesian economics itself. Inane to the point of vacuity, destructive of prosperity on every occasion it has been applied, utterly useless as a guide to policy, Keynesian economics is the ultimate in crackpot ideas that stay long past their welcome in spite of every form of evidence that it is entirely mistaken about how an economy works and what needs to be done when recessions occur.