A brief sketch of the Keynesian "vision"

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 reject Keynesian economics, here are the possibilities vis-à-vis each point above:

1) Given that Say himself conceded this point to Malthus in the last edition of Traité d'économie politique, I would not fight this fight on this battlefield, anti-Keynesians, if I were you.

2) This is a place where one might empirically dispute Keynes's claim: perhaps investors are more rational that he gave them credit for.

3) Again, a point for empirical testing: perhaps consumers actually do some sort of consumption smoothing a la Milton Friedman, or adjust to downturns in some other way.

4) This, of course, links back to point one. The logical arguments put forward to show that this just can't happen in general simply define away the possibility of an aggregate demand shortfall. Defining away the problem your opponent is pointing to is a good way to become known as intellectually shifty, but not a good way to win honest observers of the dispute over to your side.

5) Here is the final spot for a genuine argument against Keynes, and once again it turns out to be an empirical matter: do price adjustments take place rapidly enough in a largely unfettered market that quantity adjustments will play a relatively minor role? If so, a recession will never really build any momentum.

NOTE: I have limited the above to the purely "positive" aspects of Keynesianism, leaving any policy recommendations to the side. It would be quite possible to accept all five of these Keynesian points above, while rejecting his policy recommendations, perhaps because one thinks that actual governments will royally screw up attempts at aggregate demand management.

Comments

  1. This is a very neat description of the main tenets of Keynesianism - thanks for posting.

    It is my perception that many Keynesians today don't emphasize the stable/unstable function part of theory very much. They treat AD (combined C and I) as a whole and see recessions as just as likely to be caused by depressed consumption spending as "low animal spirits" affecting investments.

    Would you agree ?

    I'm guessing that empirical evidence would probably support this change in emphasis.

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  2. Thanks for this.
    You're right about the criticisms we often, but shouldn't, see rather than substantive ones.

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  3. Which of these five points is contradicted by the standard Austrian story of the Fed distorting price signals by keeping interest rates below the rate it would be Ina free market? What other points would Austrians of the Moses/Rothbard school reject?

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    1. Moses? Is he the one who parted the "Fed" sea? :-)

      "Which of these five points is contradicted by the standard Austrian story of the Fed distorting price signals by keeping interest rates below the rate it would be Ina free market?"

      None. I have argued this several times, as have Dennis Robertson, GLS Shackle, Ludwig Lachmann, and Tyler Beck Goodspeed, among others. The Keynes story and the Hayek story are compatible. (That doesn't mean either is true!)

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  4. "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. "

    I would concentrate on 5. A general reduction of production what fall back on the general release of labor, land and capital which would suddenly be available in excess. Which means new producers can snatch them for a low price, and if established producers don't care to lower the price for their produced goods, they will. Of course this takes time. The only ways out for Keynesians, in my view untenable, are:

    1: That established businesses would not release their factors of production. They would keep them on their books even if they don’t need them, except workers of course, they get fired. Workers rather like to die than take a lower paying job. That unused land and capital isn’t sold implies that firms much rather like to maximize losses than profits. (Of course there actually is a situation possible when firms don’t sell their land and capital. This is when they expect the Keynesians to stimulate demand for their products. But in this case they are not maximizing losses). Meaning there is no natural readjustment happening at all.

    2: This process takes so long that Keynesians can step in and shorten this process. This assumes though that this process is redundant and that the reason for the crisis was unmotivated, that all the right goods were produced in the right amount, time, place and manner. And that their stimulus doesn’t change that structure significantly. However who can proof that?

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  5. *A general reduction of production *would* fall back... *

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  6. Thanks a lot, Gene!

    But where would you put the distinctive models of interest rates? The 'loanable funds' (wich some austrians accept as a macro tool) and the 'liquidity preference' model? Are they logical derivations from the different premises?

    And I entirely agree with your "NOTE" (if I'm not mistaken, Buchanan also argued around those terms).

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    Replies
    1. Bernardo, I think the liquidity preference theory gets you an interest rate that does not adjust in the "right" direction, so we get quantity adjustments instead.

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  7. "Here is the final spot for a genuine argument against Keynes, and once again it turns out to be an empirical matter: do price adjustments take place rapidly enough in a largely unfettered market that quantity adjustments will play a relatively minor role? "

    Why does it have to be a "largely unfettered market"?

    Surely, the relevant concept is: real world markets -- if we want to know whether Keynesian analysis applies to the real world.

    The empirical evidence here is simply overwhelming, if you are really interested to look:

    http://socialdemocracy21stcentury.blogspot.com/2014/02/callahan-on-price-rigidity.html

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    Replies
    1. LK: 'Why does it have to be a "largely unfettered market"?'

      1) Please realize that I am *not* arguing either side here, just trying to set out both fairly.

      2) The reason for unfettered is that many anti-Keynes economists (Hutt comes immediately to mind) would argue, "Sure these adjustments are slow today... but that is because of min. wage laws and union legal advantages and generous unemployment benefits and pricing cartels... etc. Get rid of that stuff and the market would adjust just fine."

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    2. OK, fair enough, but even if we subtract governments and unions, we are still left with the reality of the private sector itself largely shunning flexible prices and preferring mark-up/administered prices.

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    3. Yes, LK, but I am not trying to argue either side here, just present them!

      Delete

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