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Is it Really that Broken?

by on March 3, 2011

Over at Facts and Other Stubborn Things, Daniel Kuehn put up a post linking to a number of Post-Keynesian blogs, most of which I am familiar with (with the exception of Econospeak). The ones that I am familiar with are all great, especially Social Democracy for the 21st Century, which I read daily. John Harvey’s blog, Post-Keynesian Observations, is also excellent (although he doesn’t post nearly enough).

Anyway, John Harvey introduced himself in the comments section of Daniel’s post and also spelled out a few Post-Keynesian themes. One thing he said was this:

From the PK perspective, the existence of uncertainty means that there is no tendency for capitalist economies to automatically move toward expansion and full employment.

This is a theme I hear constantly from those with PK inclinations. I ran across the same sort of outlook in one of Robert Skidelsky’s latest articles where he writes that

Keynes’s perspective on global imbalances was formed not just by the disturbances of the interwar years but by his reading of monetary history. He thought that throughout history the desire to hoard savings had been stronger than the desire to invest them, because at all times vague panic fears lie below the surface, denting our optimism and creating a permanent bias towards preserving existing value rather than creating new value. This was his explanation of why the world had stayed poor for so long…But normally people preferred to hoard rather than invest their money, that is to say there was a permanently high level of liquidity preference, which exerted a permanent upward pressure on interest rates.

What I take from this is that because people are uncertain about the future, they have a strong, and erratic, tendency to increase their demand to hold money which puts upward pressure on interest rates and ensures the economy could fall precipitously into a downturn at any given moment. Okay, that’s all fine and good. That certainly sounds plausible.

And then you look at history.

Looking at all the gains we have made from the industrial revolution to the present (the technology, the increase in living standards and real wages, etc), is one’s initial reaction that we’ve had an investment problem? Does it really look like we live in a world where it is normal for savings to run ahead of investment? A world where the economy doesn’t “move toward expansion”?

Granted, we’ve had episodes of downturns and those clearly haven’t been good for economic growth, but the gains we’ve made during the “normal” or “boom” periods have been phenomenal, to say the least. Even prior to the 1900s, when Keynesian policies were virtually nonexistent, it wasn’t as though we were all starving in the streets. The increase in real wages and the growth in output from the 1800s to the 1900s were staggering. The gains made during normal periods clearly outweighed the losses during downturns.

That is what I don’t get about Post-Keynesianism. They criticize the neoclassical synthesis and the Keynesian camps it has gone on to produce for relegating Keynes’ General Theory to a  theory applicable only during specific times and under specific conditions (sticky wages, etc). Yet, that view of Keynesianism is the one that seems to make the most sense historically. It just doesn’t seem obvious to me (no expert on any of this, of course) that the economy is fundamentally broken. Perhaps the tendency to move towards equilibrium breaks during downturns, but things seem to get coordinated pretty well the rest of the time. People don’t seem to have a natural inclination to hoard, other than during specific circumstances like recessions.

The whole PK outlook seems pretty doom and gloom, really. If one was intimately familiar with the PK literature but knew nothing of the success of market economies in the west, one could be forgiven for imaging we could have never left grinding poverty without constant government intervention. Yet, market economies received little government help until the Great Depression and we saw living standards increase faster than in any period in history prior to that. In other words, the market functioned quite well (in most of the ways the classical economists said it would) except during downturns. That seems to me a pretty good argument against the PK notion that classical rules never apply (as though they were Euclidean rules in a non-Euclidean world, to echo Keynes). It seems that a stronger argument can be made that Keynes’ theory applies during downturns, and that’s about it.

I suspect I may be missing something here. I hope some PK comes along and shows me where I went wrong, if they can even discern what I’m trying to articulate in the first place. In the meantime I shall continue to contemplate this.

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From → Economics

4 Comments
  1. Thanks for linking to me! As you probably picked up, I agree with your suspicions about Post Keynesianism.

    One valid critique of the neoclassical synthesis as not being particularly “Keynesian” is that it reintroduced the Wicksellian idea that interest rates are determined in the loanable funds market (keeping Keynes’s point about the money market, of course – otherwise it wouldn’t really be Keynesian at all!). Hicks and others tried to do this while Keynes was still alive, and he flatly rejected it.

    The thing is, Keynes himself was never entirely doom and gloom! He said we would be unlikely to be consistently at full employment, and unlikely to be in deep depression, but that we would continue to grow (see Economic Possibilities for Our Grandchildren for an optimistic growth story!), with a moderate underutilization of labor and other resources.

    One thing that I think deserves more attention is old overproductionist ideas that might speak to the sort of intermediate performance that you reference here. Keynes understandably focuses on the interest rate, but his real goal was to separate in people’s minds the interest rate from the marginal efficiency of capital. Interest rates are artificially high because of liquidity preference, but underemployment can also result when the marginal efficiency of capital drops suddenly. It could be from a financial crisis, but it could also be from simple overinvestment dynamics like inventory cycles and accelerator models. Overproductionism is generally frowned upon these days, but I’m not sure it always should be.

  2. “It just doesn’t seem obvious to me (no expert on any of this, of course) that the economy is fundamentally broken. Perhaps the tendency to move towards equilibrium breaks during downturns, but things seem to get coordinated pretty well the rest of the time.”

    Actually that is doubtful. Post Keynesianism shows us that there is no tendency to full employment/high employment equilibrium.

    Just because an economy has positive GDP growth does not necessarily mean it is producing optimal growth.

    What people often don’t understand is that an economy with high or significant unemployment is mired in a sub-optimal equilibrium. This is a real cost. It means we are all poorer because of it.

    The 19th century is littered with periods of sub-optimal equilibrium:

    http://socialdemocracy21stcentury.blogspot.com/2011/01/us-gnp-estimates-in-recession-of-1890s.html

    “People don’t seem to have a natural inclination to hoard, other than during specific circumstances like recessions.”

    It’s not really about hoarding money in the literal sense, if we mean keeping your money under the bed.

    It is about (1) failure to invest by business and (2) unwillingness of banks to lend when there is a severe shock to the economy or expectations.

    Banks can “hoard” by keeping excess reserves at the Fed and not lending.
    What has happened over the past 3 years is a stunning confirmation of this.
    The neoclassicals thought quantitative easing (QE) would boast aggregate demand. It hasn’t really – just as it failed in Japan from 2001 onwards. Virtually all the new money from QE is “hoarded” at the Fed.

  3. “Yet, market economies received little government help until the Great Depression and we saw living standards increase faster than in any period in history prior to that.”

    The 19th century was certainly a period of laissez faire relative to the post-1945 era. But a number of government interventions did exist back then – infant industry protecionism, public works, central banks in some countries. The US and Germany – the 2 really big success stories of the 19th century – developed with a large measure of state intervention. Germany’s case is notable. I recommend:

    Ha-Joon Chang, Kicking Away the Ladder: Development Strategy in Historical Perspective, London, 2002.
    Ha-Joon Chang, Bad Samaritans: Rich Nations, Poor Policies, and the Threat to the Developing World, London, 2007.

  4. Sam permalink

    Thank you for the references, Mr. Keynes. I will definitely look into them.

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