When I first studied macroeconomics the Stagflation era of the 1970s and the death of Keynesianism were still being quite hotly debated. They were still contemporary events. Well, they were contemporary events in the way that the election of Tony Blair is a contemporary event for us today – it seems like just yesterday for the lecturers but has almost no significance for the students because they were far too young at the time.

At an empirical level the death of Keynesianism was intimately associated with the breakdown of the Phillips curve. The trade-off between inflation and unemployment had been at the heart of macroeconomic management. The death of Keynesianism was hastened at a theoretical level by the Lucas critique and the rise of rational expectations.

But the death of Keynesian was also tied up with the argument that the nature of the macroeconomy is such that government attempts to fine-tune demand were inevitably doomed. Active policy has its effects only with a significant lag – 12 or 18 months. Governments were succumbing to the temptation to ‘fine-tune’ before they’d let previous changes work their way through the system. As a consequence the economy was forever under- or overshooting. Volatility was greater than it would have been if governments had resisted fiddling around. This is a practical argument, but it is also an ontological argument. It is about the very nature of the economy.

This old argument came to mind when we saw yesterday that asking prices for housing in London had increased by 10% over the last month, according to Rightmove. That follows a sharp upturn in prices in the previous month. The London average now stands at a truly eye-watering £544,232. [Read more...]