Who Were the Sea Peoples?

A reader asked me for the above. I thought I'd drag this up from the comments and make it a top-level post, to prompt commentary. So, here goes: 1) Aggregate demand need not equal aggregate supply. (In an economy with temporally lengthy production process and plans made for the far future, Say's Law holds only under special conditions.) 2) The investment portion of aggregate demand is volatile, and depends upon investor's "animal spirits" more than on "fundamentals." 3) On the other hand, for the consumption portion of aggregate demand, the average, marginal propensity to consume out of income is fairly stable. 4) Thus, when investment plunges, aggregate demand is likely to fall far short of aggregate supply. 5) Producers are likely to adjust to this situation through cutting back on production rather than by making price adjustments, so that the economy spirals down into a recession. As I see it, for someone who wants to intelligently rejec...

Wicksell postulates a process of forced saving when the money rate of interest is held below the natural rate, a process that maintains the ex post equality of savings and investment. Keynes turns that situation around, and postulates a process of forced investment (the piling up of inventories) when the money rate is held above the natural rate, a process that again maintains the ex post equality of savings and investment.

The Keynesian cross model is, of course, a highly simplified abstraction of Keynes's work. Even so, it is not hard to add Hayek to the model, and thus to illustrate how their work is complementary, rather than contradictory. Although highly simplified, of course, we can instruct undergrads as follows: Keynes was theorizing about the portion of the cross below where the aggregate demand line crosses the income equals output line, i.e. where savings exceeds intended investment. Hayek was theorizing about the portion of the cross above that equilibrium point, where intended investment exceeds savings. This is exactly the point made in the Shackle quote offered a few weeks ago on this blog. And, of course, the first region is characterized by the money rate of interest being above the Wicksellian natural rate, while the second region is characterized by the money rate being below the natural rate. And note: Both the Keynesian story and the Hayekian story rely upon disequilibrium i...

It turns out it is the same way that Keynes solved it: But Hayek had indeed, like Keynes, absorbed the lessons of the Sraffa exchange, and accordingly acknowledges that whereas the rate of increase of the physical amount of anyone input invested at an earlier date and the physical amount of the same input obtained at a later date may, and indeed will, differ for any two commodities, "the value equivalence in terms of the 'numéraire' at the two dates must bear the same ratio to one another for all commodities... This elucidation, we should note, is precisely the same as Keynes's own-rate setup in chapter 17." -- Tyler Beck Goodspeed, Rethinking the Keynesian Revolution , p. 120-1 The fact that Keynes, Hayek and Lachmann all see Sraffa's own-rate challenge as having been answered, and by the same answer that I see as meeting that challenge, gives me a fair amount of confidence I am on sound footing here!

Today's neoclassical mainstream tends to look at the economy as a series of shifts from one equilibrium state to another. Of course, all of the best neoclassicals recognize this as an idealized abstraction, but they largely think of it as an abstraction that largely captures what really occurs in an economy. Keynes, in common with Austrian economists, saw that while the market process generates a tendency towards equilibrium, it is never, or almost never, in an actual equilibrium state. Market participants do not have before them a neat little supply-and-demand diagram telling them just what the new equilibrium price will be when supply or demand changes. Instead, they must engage in a discovery process searching for the new "correct" price. Keynes's "vision" was based upon his realization that, in such uncertain conditions, buyers and sellers would be likely to make quantity adjustments as well as price adjustments to the new situation. (In contrast to ...

(Part three of an examination of Garrison's business-cycle  theory as an over-investment theory: part two is here .) It is true that lowering of the interest rate will raise the net present value of a long-term investment by more than it will reduce the net present value of a short-term investment. However, this does not mean that a lowering of the interest-rate will make it more likely that I will undertake a new long-term investment the new short-term investment. The fact is, what I will look at is the yield on my Investment versus my cost of borrowing to finance the investment. If the investment returns 5%, the interest rate was 6%, and it is been lowered to 4%, the investment now looks profitable to me, whether the investment is a one-year investment or 30 year investment. Thus, what we will see is more investment projects being undertaken, whatever the length of the project. (And of course, less saving.) But doesn't the greater increase in the net present value of a l...

"The revolutionary impact of Keynesian Economics on contemporary thought stemmed in the main, we have argued, from Keynes' reversal of the conventional ranking of price and quantity velocities. In the Keynesian model price velocities are not infinite; it is sometimes said that the implications of the model result from the assumption that money wages are 'rigid.' This usage can be misleading. Income-constrained processes result not only when price-level velocity is zero, but whenever it is short of infinite." -- Axel Leijonhufvud, Keynesian Economics and the Economics of Keynes , p. 67 In other words, the classical theory of markets, as we still present it to students today, posits that when faced with a disequilibrium price, the market will make infinitely fast price adjustments, so that no quantity adjustments will ever occur. That, certainly, is a very special theory: in reality, price adjustments can never be infinitely rapid, so there will always be some ...

As did... "Keynes envisioned and grand synthesis of the theory of value and the theory of money, as we have seen" (Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes , p. 31).

His name started with "John Maynard," and ended with "Keynes": "The basic contention [in the Treatise ] is that a monetary injection (for example) will not impinge with the same force on all markets and all prices." -- Axel Leijonhuvud, On Keynesian Economics and the Economics of Keynes , p. 23

"Hayek and Keynes could be said to have merely been theorizing on opposite sides of the same Wicksellian coin." -- Goodspeed, Rethinking the Keynesian Revolution , p. 119 I had been groping towards this conclusion myself: Keynes is concerned with what happens when the money rate of interest is above the natural rate, and Hayek with what happens when it is below the natural rate.

"More precisely, I define the marginal efficiency of capital as being equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price.. "Now it is obvious that the actual rate of current investment will be pushed to the point where there is no longer any class of capital-asset of which the marginal efficiency exceeds the current rate of interest. In other words, the rate of investment will be pushed to the point on the investment demand-schedule where the marginal efficiency of capital in general is equal to the market rate of interest.. "There is, to begin with, the ambiguity whether we are concerned with the increment of physical product per unit of time due to the employment of one more physical unit of capital, or with the increment of value due to the employment of one more value unit of capital. The former involves difficulties as to...

I'm reviewing Tyler Beck Goodspeed's book for The Review of Political Econom y, and... boy, I think this is going to be fun! Some initial quotes: "since the merger of Irving Fisherwith Walrasian general equilibrium, by Robert Lucas and the 'New Classicals,' all mainstream schools of macroeconomic thought... have adhered to a Walrasian approach" (p. 2). "not only did Keynes and Hayek both adhere to the Wicksellian approach, but also... the Wicksell 'connection' was, as a result, responsible for a fundamental convergence of their respective theories of money, capital, and the business cycle during the course of the 1930s" (p. 3) "Money, therefore, is intimately related to the second element of the Wicksell connection, namely, the identification of intertemporal coordination as the central problem in macroeconomics" (p. 6). ( As I noted .) "Critical to the Wicksellian approach, therefore, is the notion that producers, c...

Jonathan Finegold Catalán notes that Mises seemed to dismiss Keynes without even really bothering to read him, and wonders why. I suspect the answer is that Mises was done learning new things by the time The General Theory appeared. We see a similar reaction to the emergence of game theory, where the only thing I am aware he ever said about it was the rather dismissive remark: "'Patience' or 'Solitaire' is not a one-person game, but a pastime, a means of escaping boredom. It certainly does not represent a pattern for what is going on in a communistic society, as John von Neumann and Oscar Morgenstern assert." (As if a pastime might not have a similar pattern in it as some serious activity! Solitaire would still have the exact same game pattern if it was played as part of a death match, but it would hardly still be a pastime!) I don't think there is really even anything wrong with the fact he was not interested in these new avenues of research, except...

One often sees people contending that "Keynes thinks that markets don't work." Reading Schelling has clarified something for me here. That "markets work" usually means "markets equilibrate." But Schelling notes that "equilibrium" is a state of affairs where things have settled down, and not a normative appraisal: I could bring you to a state of equilibrium real quick by shooting you, but most of us would not say this has positive welfare implications. Keynes clearly thinks that markets equilibrate investment and savings. But there are two ways markets can do this if savings goes up: intended investment can go up as well, or intended investment can remain where it was, and inventories can rise. The latter process shows markets working to produce an equilibrium. It's just that it is an unpleasant equilibrium.

We've all seen statements like this floating around: "Say's law did not posit that (as per the Keynesian formulation of Say's law) 'supply creates its own demand.'" -- Wikipedia Now consider this quote from Say: "It is worthwhile to remark that a product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus the mere circumstance of creation of one product immediately opens a vent for other products." -- J.B. Say, A treatise on political economy OK, break it down: "It is worthwhile to remark that a product is no sooner creat...

Brad DeLong highlights a paper that appears to do this. The conclusion? We had a Hayekian problem, but we've dispensed with that. Now we are having a Keynesian problem. Anyway, this makes the point I've been repeating: Hayek and Keynes both had sensible cycle theories, and their theories are not even contradictory. There is no reason we can't have structural maladjustments and aggregate demand shortfalls at the same time, or in succession.

OK, I'm going to say upfront: I'm am a neophyte in understanding Keynes. I only truly started trying to comprehend what he has to say when I had to teach the history of economic thought and macroeconomics a couple of years ago.* But I am going to offer my understanding of how Keynes has an equally plausible story of how an economy can be driven further and further from equilibrium as do Mises and Hayek. If my understanding of Keynes is primitive, please forgive me! If we assume, as Keynes does, that the interest rate is moved by liquidity preference, then in response to an increase in liquidity preference, and thus a drop in the price of capital goods, as Jonathan Catalan notes should occur, what will happen? Well, per Keynes, at least as I understand him, this drop in the price of capital goods will further spook the animal spirits of investors, and increase their demand for liquidity yet more. That increased demand for liquidity will drive the price of capital goods yet l...

Daniel Kuehn worries that I don't have a single empirical test in mind to see whether liquidity preference or the market for loanable funds is more important in determining the interest rate. Well, he is right to worry: I don't. But he was interpreting my call for "empirical" work more narrowly than I meant it. I consider this paper a "test" of Austrian Business Cycle Theory, in that it looks in fair depth at the facts about a particular boom-and-bust cycle, and asks if ABCT can help us understand it. (The answer was "yes," by the way.) The Keynesian cycle and the Hayekian cycle are ideal types. And having studied Keynes more the last few years, in order to teach him properly, I am convinced they both have explanatory adequacy.* The question then becomes, how much do they fit the facts on the ground, i.e., in Weber's terms, do they have empirical adequacy? Econometric tests are a way to examine the empirical adequacy of an ideal type, b...

You'd think he is a Hayekian, but then you read: "In other words, even if the rate of interest is higher than what it should be given society’s time preference, the prices of the factors of production will reflect total aggregate demand for them. That is, the prices of the means of production would be lower than they would be if the rate of interest were lower." And what about when the rate of interest is lower than it should be, say... due to central bank policy? Presumably, the prices of the factors of production will rise until they correctly reflect total aggregate demand for them. So the Mises-Hayek boom will never happen. In what is purportedly an effort to defease Keynes, Jonathan has just declared the Austrian theory of the business cycle out of bounds as a reasonable theory of the cycle. Sneaky! (Just winding you up a bit, Jonathan!)

And in the same post noted just below, Kuehn puts his finger right on the crucial difference between Hayek and Keynes: For Keynes but not for Hayek, "those expectations of future profits are compared to an interest rate that is determined by liquidity preference and not the supply and demand of loanable funds." Just so! And they were both partially correct: the interest rate is influenced by both of these factors. So here is where we must get empirical: To the extent that the interest rate is determined by liquidity preference, to that extent Keynes was correct. To the extent the interest rate is determined by the supply and demand for loanable funds, Hayek was correct. As Olivia Newton-John would have put it: I've been patient, I've been good Tried to keep my data off the table It's gettin' hard this holdin' back If you know what I mean I'm sure you'll understand my point of view We know the scene theoretically You gotta know t...