Post-Keynesian Essays from Down Under Volume I: Essays on Keynes, Harrod and Kalecki

Theory and Policy in an Historical Context

G. Harcourt, Peter Kriesler, Joseph Halevi, John Nevile

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9781137475381
• Topic: Economia
• Subtopic: Storia economica

Joseph Halevi, Geoff Harcourt, Peter Kriesler and J. W. Nevile bring together a collection of their most influential papers on post-Keynesian thought. Their work stresses the importance of the underlying institutional framework, of the economy as a historical process and, therefore, of path determinacy. In addition, their essays suggest the ultimate goal of economics is as a tool to inform policy and make the world a better place, with better being defined by an overriding concern with social justice. Volume I analyses the contributions of Keynes, Harrod and Kalecki.

Part I

Keynes

1

The Enduring Importance of The General Theory

G. C. Harcourt and Peter Kriesler

This paper examines some features of The General Theory that remain relevant 75 years after its publication. Keynes showed that even in a competitive economy with perfectly flexible prices, wages and interest rates, market prices could not guarantee full employment and that the achievement of full employment would only be a fluke. In other words, he showed that there was no natural mechanism to drive the economy to full employment, and that the level of employment was determined by effective demand rather than by the wage rate. He demonstrated this by using a method that stressed the relationship between cause and effect in determining key variables and relations in the economy. Keynes demonstrated that monetary variables affected real variables, and real variables affected monetary ones, in both the short run and long run. This can be contrasted with mainstream theory, where the long-run neutrality of money remains a key result. The paper proposes a rehabilitation of Keynes’s analysis of the supply and demand for money—away from its original role in explaining domestic monetary influences and towards providing an analysis of supply and demand for international money.

1.1Introduction

The question of what Keynes’s General Theory has to offer us 75 years after it was first published is not easy to answer. In part this reflects the fact that the book changed the landscape of economic thought and left a profound legacy on that branch of economics that has become known as macroeconomics.¹ Nevertheless, fundamental aspects of The General Theory have been neglected by the mainstream and still have much to offer. In essence, what Joan Robinson (1964) dubbed ‘pre-Keynesian theory’ after Keynes, has dominated economics during the last 40 years, even though that theory is both wrong-headed and inapplicable. Much that has been labelled ‘Keynesian economics’ really represents attempts to derive Keynesian results within a neoclassical framework. However, this misses the essential message of Keynes.

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Revised from Review of Political Economy, 23(4): 503–519, 2011, ‘The Enduring Importance of The General Theory’, by Harcourt, G. C. and Kriesler, P. With kind permission from Taylor and Francis Online http://www.tandfonline.com/doi/full/10.1080/09538259.2011.611616. All rights reserved.

In particular, a number of Keynes’s major contributions in The General Theory remain of great importance and have been ignored by mainstream macroeconomics. Keynes showed that, even in a competitive economy with perfectly flexible prices, wages and interest rates, market prices not only could not guarantee full employment but also that the achievement of full employment would only be a fluke. In other words, he showed that there was no natural mechanism that would drive the economy to full employment. This is a proposition that, 75 years later, remains foreign to mainstream economic theory, which tells us that there is no involuntary unemployment or, if there is, it is the result of some market imperfection. In other words, we still have much to learn from Keynes about the nature of unemployment in capitalist economies.

In addition, and contrary to the conclusions of pre-Keynesian theory, Keynes demonstrated that monetary variables affected real variables, and real variables affected monetary ones, in both the short run and the long run. This can be contrasted with mainstream theory, where the long-run neutrality of money remains a key result.

This paper argues that both of these conclusions are as relevant today as they were when Keynes originally proposed them. However, owing to major changes in the economic environment and economic institutions, the way Keynes arrived at them needs to be modified to incorporate these transformations. In particular, the paper proposes a rehabilitation of Keynes’s analysis of money supply and demand, one that moves away from its original role of explaining domestic monetary influences and towards providing an analysis of supply and demand for international money.

While our emphasis in this paper is on Keynes’s contributions and approach, and on the most appropriate and promising ways forward, it is important to briefly review the pre-Keynesian orthodoxy to which Keynes was reacting.

1.2Pre-Keynesian Theory

Keynes was brought up on Marshallian economics. Although Marshall only produced one volume of the at least three volumes he thought should make up a comprehensive principles of economics, he did leave in various places his views on money, finance and related matters, international trade and capital flows, as well as his unsatisfactory Money, Credit and Commerce (Marshall, 1923). From these sources, Keynes assimilated what he was to call ‘the classical system’.

On this view, in a competitive environment there was a tendency for prices and quantities to adjust so that all markets cleared, including those for the services of all classes of labour and capital goods. This implied, at least in the long period, the existence of Say’s Law. General gluts were impossible, and so the theory of output and employment as a whole was no more than an adding-up exercise.

In the labour market, the wage rate was seen as the price equating the demand and supply for labour. As long as demand and supply schedules behaved in the conventional ways, a market-clearing wage would be established, so that there would be no involuntary unemployment at that wage. Unemployment could only be the result of an impediment to the market mechanism, which prevented the wage rate from adjusting to its equilibrium level.

As the labour market was seen as guaranteeing full employment, unless there were rigidities, only in the event of such rigidities was there a role for government. For most economists, the role of government was limited to trying to eliminate such imperfections.

Once the level of employment was determined in the labour market, this determined the level of output. The level of output was independent of saving and investment, which were determined in the market for loanable funds. In this market, saving represents the supply of loanable funds and investment its demand. The rate of interest is the price that equates saving and investment, exactly the same way any price equates supply and demand. Underlying this is the view that the rate of interest is the reward for postponing consumption.

As the economy is always at full employment, the market for loanable funds determines the division of output between consumption goods and investment goods. Causality runs from saving to investment, with changes in saving leading to changes in investment. Given savings, an attempt by the government to increase its expenditures will require that it borrow savings and thus crowds out private investment. The more the government takes, the less will be available for the private sector. It is for this reason that most neoclassical economists argue that governments have limited ability to influence the level of employment, output or investment. With full employment resulting from the workings of the labour market, and investment determined in the market for loanable funds, any attempt by the government to influence the course of economic activity must be at the expense of private investment.

Accumulation is seen as the transformation of delayed consumption today (i.e. saving) into more consumption tomorrow, a psychological choice at the margin by economic agents and by business people who transform consumption foregone today through investment in capital goods into greater consumption in the future. The flows of each are equalized when their respective rates of swapping at the margin (one subjective, the other technical) match each other and the nominal rate of interest. Irving Fisher became the principal expositor of this view, which is still the dominant account of the accumulation process by mainstream economics today. It lies behind the commonly held view that saving determines investment, especially at the level of the world economy; this is in sharp contrast to the Keynesian view that investment leads and saving follows.²

In terms of the role of money, there was a strict dichotomy between the real and the monetary sectors so that the formation of relative prices and quantities in firms, industries and the economy as a whole could be analysed without any analytical role for money (other than as a ticket) and finance. In mainstream theory, the long-run neutrality of money is a fundamental result. There are no long-run effects of monetary variables on real ones—although, in the short run, the veil of money may flutter and splutter. Employment, saving, investment, the rate of interest and relative prices were all determined within the real sector. The price level is seen as a monetary variable determined exclusively within the monetary sector by the quantity of money.

According to Pigou, money is a veil. It is a surface phenomenon, having no real influence except that it can hide the underlying real story. Economic agents see the economy through the veil of the monetary variables, which lie between the real variables and those agents. So the perception of the economy was as if there was a box in which real variables were determined (including the rate of interest). In another box the monetary variables determined the price level, with no connection between the boxes, at least in the long run (Kriesler, 1997). This was especially so for the analysis of long-period competitive prices and quantities, or what Richard Kahn ([1929] 1989, p. xxviii) called ‘the real business’ of Marshall’s Principles.

Short-term fluctuations around the full employment level were part of trade and credit cycle theory, with a key role played by monetary policy and the nominal rate of interest. Basically, the natural rate of interest ruled the roost and the nominal rate had to be consistent with it in order to avoid cumulative processes of inflation and deflation. (Wicksell was the pioneer here.)

Keynes’s early writings, A Tract on Monetary Reform (Keynes, 1923) and A Treatise on Money (Keynes, 1930), were within this tradition, although he made some modifications and extensions. The Tract emphasized the role of monetary policy in the short run to attack inflation and deflation, while leaving the long run to the dead; in the Treatise he developed, within a quantity theory framework, theories of sectoral as well as the overall price level. He also analysed the banana plantation parable, which cried out for the concept of the multiplier to rid the analysis of ad hockery and provide a reason why the cumulative downturns in prices, quantities and employment would end endogenously (Keynes, 1973, pp. 158–160). But Keynes was still betwixt and between, providing, as Joan Robinson (1933, p. 56) pointed out, ‘a new theory of the long-period analysis of output’ without realizing it.

1.3Keynes

Keynes came to economics with a background in mathematics and philosophy. He always regarded economics as a moral science. The development of his own philosophical ideas constituted an integral part of the way he thought economics should be done and of his own revolutionary contributions to economic theory. Three aspects to his approach stand out. First, he argued that for a subject like economics, a whole spectrum of languages applies, running all the way from intuition and poetry through lawyer-like arguments (weight) to formal logic and mathematics. All have roles to play, depending upon what issues, or what aspects of issues, are being analysed.

Secondly, he emphasized that the whole may be more than the sum of its parts, a vital ingredient of his leading insight in the analysis in The General Theory and some of his other writings on the processes at work in the economy as a whole. Much modern macroeconomics is done in terms of representative agent models, which by their nature preclude this insight and the implications of the fallacy of composition.

Thirdly, there is his stress, also to be found in Marshall, that sensible, and sometimes not so sensible, people have to make important decisions in environments of fundamental uncertainty and so must develop behaviour and act in ways not contained in the assumption of homo economicus. This implies that much economic theory, developed either by assuming away the presence of uncertainty or treating it as the equivalent of risk, is inapplicable or, if applied, seriously misleading.

1.4The General Theory

With publication of The General Theory in February 1936, Keynes’s major responses to his critics in 1937 (Keynes, 1973, pp. 109–123), and his addition of the finance motive to his new system (Keynes, 1973, pp. 215–223), the key components of his revolution were brought together.

As the title of his work suggests, Keynes rejected the dichotomy between the real and the monetary, insisting that monetary matters be integrated in a general analysis right from the start. There are essential causal links between monetary and real variables, and Keynes believed in the necessity of integrating monetary and real analysis. In particular, he argued that the nominal rate of interes...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of Figures and Tables
• Preface
• Acknowledgements
• About the Authors
• Introduction
• Part I Keynes
• Part II Kalecki
• Part III Harrod
• Index