I view the 1920s as a sort of golden age of macroeconomics, before Keynes ushered in the long dark night. The standard model was similar to the AS/AD model we teach in intro textbooks. Nominal shocks have real effects in the short run, but merely lead to higher prices in the long run. Irving Fisher argued the business cycle was “a dance of the dollar.” He discovered the Phillips curve. Most economists pointed to wage and price rigidity as the cause of short run non-neutrality, the same explanation that we see in modern textbooks. People like Fisher, Pigou, Wicksell, Cassel, Hawtrey, etc, did great work in the 1910s and 1920s. And last but not least, there was the Keynes of the Tract on Monetary Reform (1924) and the Treatise on Money (1930.)
Hicks (1937) argued that the only thing in the General Theory that was really new was the zero rate trap. Otherwise it was all known to the economists of the 1920s. But Keynes had a big ego, and wanted to claim he had revolutionized macroeconomics, rather than just dress up well known ideas in a different language. So he grossly distorted the actual macro of the 1920s, by creating a fictional “classical” economics where the economy is always at the long run run equilibrium. His contemporaries were outraged, but since Keynesian economics won out in the long run, modern textbook writers accepted his version of events. Now we teach all our students a bunch of falsehoods, such as the myth that the pre-Keynesian economists had no explanation for high unemployment. Or that MV=PY is the quantity theory of money.
Brad DeLong is quite knowledgeable about economic history, so I was surprised to see him buy into the myth of interwar “classical” economics. He quotes this passage from the GT with approval:
The General Theory of Employment, Interest and Money: The idea that we can safely neglect the aggregate demand function is fundamental to the Ricardian economics, which underlie what we have been taught for more than a century. Malthus, indeed, had vehemently opposed Ricardo’s doctrine that it was impossible for effective demand to be deficient; but vainly. For, since Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to furnish an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain. Not only was his theory accepted by the city, by statesmen and by the academic world. But controversy ceased; the other point of view completely disappeared; it ceased to be discussed. The great puzzle of Effective Demand with which Malthus had wrestled vanished from economic literature. You will not find it mentioned even once in the whole works of Marshall, Edgeworth and Professor Pigou, from whose hands the classical theory has received its most mature embodiment. It could only live on furtively, below the surface, in the underworlds of Karl Marx, Silvio Gesell or Major Douglas. . . .
The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. For there would obviously be a natural tendency towards the optimum employment of resources in a Society which was functioning after the manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away.
Ah, the old “let well enough alone” myth. A poll in the late 1920s of 282 economists showed that 251 favored a monetary policy aimed at price level stabilization. Isn’t that sort of like New Keynesian inflation targeting? And of course the University of Chicago economists of the 1930s favored a combination of fiscal and monetary stimulus.
What Keynes did was move the profession away from the idea of monetary cures for business cycles–which actually can be effective, toward the idea of fiscal cures, which (short of WWII) are almost never effective. It would take many decades for money to be rediscovered. Indeed the influence of Keynes was so powerful that even in 2009 there were many Keynesian economists who should have known better who suddenly announced that monetary policy couldn’t work at the zero bound, and that fiscal stimulus was needed. Fortunately those Keynesians rediscovered money much more quickly this time, indeed within 2 years.