The post-war displacement of Keynesianism involved the replacement of Keynesian economics as the leading theoretical influence on economic life in the developed world. Similarly, the allied discipline known as development economics was largely displaced as the guiding influence on economic policies adopted by developing nations.
Significant departures of government policy from the previous Keynesian orthodoxy largely took place in the late 1970s and early 1980s. These shifts were preceded by efforts to discredit Keynes's economic ideas intellectually, which had taken place over several decades.
The displacement of Keynesian thinking was driven by those who leaned towards purer free market policies, rather than the mixed economy which require a significant role for government intervention. Their motivations included a dislike of large governments which they saw as prone to interfere excessively in the lives of their citizens; an intellectual preference for Classical or Neoclassical economics and related schools; or in some cases a belief that their individual interests were best served by promoting a limited role for government. Efforts against Keynesianism took place on three fronts – in the academic world, in politics, and in the wider world of business and public opinion.
Background Starting in 1936 with the publication of his General Theory, the Keynesian Revolution in economic thinking had by the end of the 1940s elevated John Maynard Keynes's ideas to an ascendant position in mainstream economics. The new post-WWII international monetary and trading system, reflected by embedded liberalism, was partly a creation of Keynes, and not just theoretically. Keynes had personally negotiated many of the practical details at the 1944 Bretton Woods Conference. During the Golden Age of Capitalism of the 1950s and 1960s, governments of the United States, United Kingdom and many other countries adopted Keynesian principles; moderate intervention by governments in their domestic economies was believed by Keynesians to deliver higher levels of employment and prosperity than would be possible from the unaided free market.
In the academic sphere, Keynes's position as the principal authority was largely confined to the Anglo-Saxon world; elsewhere Keynes was influential but not as central. This is partly because neoclassical economics,Keynes more commonly used the term 'classical economics' in his attacks, but it is widely accepted (e.g., Hayes, 2008, Edward Elgar publishing, The Economics of Keynes p 2) that he generally meant what we would now call neoclassical economics. the system of thought which Keynes launched his revolution against, had never been firmly established beyond the English-speaking nations in the first place, where instead there was often a tradition of using mixed-economy models such as the French dirigiste system. While a critic of Keynes, the economic journalist Henry Hazlitt was to write in 1959:
Similarly, the economic policies adopted in the developing world were largely based on Development economics – although that branch of economics is usually regarded as distinct from Keynesianism,For very undeveloped countries it has been argued (e.g., by Subrata Ghutah, 2003, Routledge Introduction to development economics p39 - 43) that the economy behaves closer to the classical model than to Keynes's - as output tends to be very inelastic there is no multiplier effect from stimulus, and due to said elasticity along with money dualism (many preferring land or commodities like gold to the legal tender, especially when they wish to save) increases in the money supply tend to translate to price rises in the classical fashion as predicted by the Quantity theory of money. it is also a mixed economy model with many of its principles based on Keynes's work. In the early years after WWII, the US was highly supportive of development economics as they believed it would help accelerate the rollback of imperialism, inhibit the spread of communism and swiftly help underdeveloped nations to become prosperous capitalist economies; so it heavily funded its promotion by United Nations programs. The only significant parts of the world that had rejected Keynesian principles were the communist nations which used the command economy model.
In the 1960s forces emerged that by the mid-80s would end the ascendency of Keynes's ideas. For Keynes's biographer Robert Skidelsky these can be divided into practical and intellectual dimensions; they are interrelated but in a complex and indirect way. The failure of what was at the time perceived to be Keynesian economics to halt the stagflation of the 1970s lent credibility both to academic and popular attacks on Keynes's ideas. Some even argued that the poor economic performance was due to Keynesian economics. The latter view has been roundly rejected by post keynesians, who suggest the inflation following the Vietnam war was due to the decision not to pay for the war with tax rises, against Keynesian advice.Though while war efforts were being escalated, the extent of war spending was hidden from President Johnson's Keynesian Economic Council, see The return to Keynes (2010), p29
Economic historians have labelled the period from about 1951–1973 as the Age of Keynes or more commonly the Golden Age of Capitalism due to its relatively high average global growth, low unemployment, reduction of inequality, lowering of public debt and very low incidence of financial crises - based on these criteria, Anatole Kaletsky judged the Keynesian age to be the most successful era of capitalism so far. After the transition period of the 1970s, the period that spanned from about 1980–2009 has been labelled the Washington consensus era.
The anti-Keynesian revolution
As early as 1947, Friedrich von Hayek had gathered together some 40 intellectuals with free market sympathies to form the Mont Pelerin Society.Hayek had previously been involved in international resistance to Keynesianism and other forms of collectivist economic arrangements throughout the 1930s, attending for example the Colloque Walter Lippmann, which can be viewed as a forerunner of the Mont Pelerin Society. (see Cockett 1995, chpt 1) They were mostly economists but also included journalists, historians and philosophers. Their explicit intention was to nurture intellectual currents that would one day displace Keynesianism and other collectivist influences. Prominent members included Karl Popper, Austrian School founder Ludwig von Mises along with the then young Milton Friedman. Initially the society had little impact on the wider world - Hayek was to say it was as if Keynes had been raised to sainthood after his death with economists refusing to allow his work to be questioned. Yet, in the decades following its establishment, the Mont Pelerin Society came to take a central role within a network of over 100 pro-free market think tanks located all over the world.A few of the free market think tanks pre-dated even the Mont Pelerin Society, most of them were founded in the 1970s or later. The think tanks typically enjoyed financial support from commercial interests. Collectively the think tanks won increased acceptance for free market thinking within academia, within public opinion and among governments. In the U.S., two of the most influential free market think tanks are the Foundation for Economic Education and The Heritage Foundation. In the UK, the two most influential are the Institute of Economic Affairs and the Adam Smith Institute.
Hayek himself dropped out of mainstream economics in 1950 to work chiefly in political philosophy. Friedman and other allies continued to work as economists, though initially they only had marginal influence on the discipline as a whole.
According to Professor Keith Shaw an important early milestone in Friedman's campaign against Keynesianism was the 1956 publication of Studies in the Quantity Theory of Money. In this work Friedman restated the quantity theory of money, and obtained the attention of several Keynesian economists partly because he admitted Keynes was right to state that the velocity of circulation of money in the equation of exchange can vary, rather than being a constant as assumed by classical economists. However, Friedman's restatement was otherwise closer to the classical view in reducing the scope for beneficial government intervention in the economy. An even more influential work was his 1963 publication of A Monetary History of the United States. Drawing on extensive empirical data, it further strengthened the case for his restated quantity theory of money, arguing that inflation was "always and everywhere a monetary phenomenon", while conceding that it could take one or two years for an increase in the money supply to lead to inflation. This ran counter to the then orthodox Keynesian interpretation that inflation was linked to employment, as modelled by the Phillips curve which predicted an inverse relationship between the two variables. Governments at the time would use the Phillips curve as part of their models to calculate the expected cost in terms of inflation for a stimulus designed to restore full employment. In 1968 Milton Friedman published a paper arguing that the fixed relationship implied by the Philips curve did not exist, and that it would be possible to have both inflation and unemployment rise at once.Friedman had earlier made similar arguments verbally in his 1967 speech to the American Economic Association, where he had also first proposed his theory of the Natural rate of unemployment Friedman had also argued that workers' expectations of future high inflation could lead to an inflationary spiral as they would push for increased wages in advance to try to compensate for expected future inflation.
Friedman's work began to gain increasing acceptance among academics after 1973, when stagflation - the simultaneous increase in both inflation and unemployment - became prominent, just as he had predicted. While the 1973 oil crisis was clearly an inflationary shock to the global economy, Friedman was able to argue persuasively that inflation was much higher than it would have been due to the rapid expansion of the money supply by governments in 1971. By the late 1970s, empirical data was also present to suggest that Friedman was right to emphasise the role of expectations on inflation, further increasing the acceptance of his ideas by mainstream economists. Post Keynesian economist Paul Davidson has argued that part of the reason for Friedman's intellectual victory was that Keynes' ideas were misunderstood by the mainstream academics of the time (the Neo-Keynesians) who therefore didn't have a consistent framework to rebut the attacks.
So prominent was Friedman in overturning the Keynesian consensus that the efforts to do so are sometimes referred to as "Milton Friedman's counter revolution." However, there were several other key influences. Professor Roger E Backhouse lists the Lucas critique which led to the increasing influence of Rational Expectations and Real Business Cycle Theory; Professor Gordon Fletcher identifies the same influences as Backhouse while also adding S H Frankel's attack which was based on the work of Georg Simmel along with the influence of the Austrian School and especially Hayek, who enjoyed a resurgence in the 1970s;
Anatole Kaletsky again gives the same influences as Backhouse, saying the Policy Ineffectiveness Proposition was an especially significant statement of anti-Keynesian thinking. Journalist Adam Curtis describes how game theory and other ideas arising from the Cold War provided additional support for the theories Hayek had articulated in the 1940s, and helped them gain wider acceptance.
These attacks were so successful that by 1980 Robert Lucas was saying economists would often take offence if described as Keynesians.
The ascendancy of financial-sector interests