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The Economics of Keynes

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The Economics of Keynes The Economics of Keynes The Economics of Keynes A New Guide to The General Theory Mark Hayes Senior Research Fellow, Homerton College, University of Cambridge, UK Visiting Fellow, Durham Business School, University of Durham, UK Newcastle Business School, Northumbria University, UK NEW DIRECTIONS IN MODERN ECONOMICS Edward Elgar Cheltenham, UK • Northampton, MA, USA Contents Contents of Appendices vii Foreword ix Preface xi FIVE PROPOSITIONS OF THE GENERAL THEORY 1 PROLOGUE 2 P.1 Equilibrium 3 P.2 Competition 9 P.3 Money 14 P.4 Expectation 16 P.5 Liquidity 20 APPENDIX TO THE PROLOGUE 24 1. TWO THEORIES OF EMPLOYMENT 46 1.1 General Theory or Special Case? 48 1.2 The Classical Theory of Employment 50 1.3 The Point Of Effective Demand as the Position of System Equilibrium 54 1.4 Summary 59 APPENDIX TO CHAPTER 1 62 2. DEFINITIONS AND IDEAS 69 2.1 Defining Price and Quantity 70 2.2 Expectation as Determining Output and Employment 73 2.3 The Investment-Saving Identity 78 2.4 Summary 83 APPENDIX TO CHAPTER 2 86 v vi The Economics of Keynes: A New Guide to The General Theory 3. THE PROPENSITY TO CONSUME 119 3.1 Average and Marginal 120 3.2 Consumption and Employment 124 3.3 Income, Effective Demand and the Multiplier 125 3.4 Summary 127 APPENDIX TO CHAPTER 3 129 4. THE INDUCEMENT TO INVEST 138 4.1 A Hierarchy Of Liquidity 139 4.2 Stocks and Flows 144 4.3 The State of Long-Term Expectation 147 4.4 The Nature of Liquidity 151 4.5 Summary 154 APPENDIX TO CHAPTER 4 156 5. EMPLOYMENT, MONEY AND THE PRICE-LEVEL 174 5.1 The Equilibrium Sub-System of The General Theory 175 5.2 The Influence of Money-Wages on Employment 177 5.3 The Influence of Employment on Money-Wages and Prices 179 5.4 Money and the Price-Level 181 APPENDIX TO CHAPTER 5 184 6. POLICY IMPLICATIONS 197 6.1 Notes on the Trade Cycle 198 6.2 Other Remedies for Chronic Under-Employment 200 6.3 Political Implications 203 6.4 Conclusion 205 EPILOGUE 206 E.1 Stagflation 208 E.2 Full Employment 213 E.3 Growth and Innovation 219 E.4 Conclusion 221 APPENDIX TO THE EPILOGUE 223 References 238 Index 247 Contents of Appendices PROLOGUE AP.1.1 Keynes and Marshall 24 AP.2.1 Perfect competition 25 AP.2.2 Keynes’s agents 28 AP.2.3 Capital-goods and capital markets 30 AP.2.4 The independence of supply and demand 33 AP.2.5 The degree of competition 34 AP.3.1 Unit of account, store of value and means of payment 36 AP.3.2 Endogenous money 37 AP.4.1 Expectation and expectations 39 AP.4.2 Expectation and probability 39 AP.5.1 Fundamental uncertainty 43 1. TWO THEORIES OF EMPLOYMENT A1.2.1 Involuntary unemployment 62 A1.3.1 The relative prices of the principle of effective demand 63 A1.3.2 Keynes and Walras 67 2. DEFINITIONS AND IDEAS A2.1.1 Homogeneous labour 86 A2.1.2 Keynes and Sraffa 86 A2.1.3 More on user cost 88 A2.1.4 The linear Z function 91 A2.2.1 Long-period employment 94 A2.2.2 Production time and convergence to long-period equilibrium 96 A2.2.3 Expectations and realised results 101 A2.3.1 The Keynesian cross 106 A2.3.2 Keynes’s income vs. Gross National Product 108 A2.3.3 Saving and finance 108 A2.3.4 Equilibrium income vs. income as an equilibrium value 113 vii viii The Economics of Keynes: A New Guide to The General Theory 3. THE PROPENSITY TO CONSUME A3.1.1 Patinkin and the proportional multiplier 129 A3.2.1 Factor income and effective demand 130 A3.3.1 The multiplier as a condition of market-period equilibrium 132 A3.3.2 Hansen’s versions of the multiplier 135 4. THE INDUCEMENT TO INVEST A4.2.1 The marginal efficiency of capital and user cost 156 A4.3.1 Fundamental value and conventional value 159 A4.4.1 Liquidity and the ‘liquidity’ of organised investment markets 164 A4.4.2 The meaning of the stability of value 166 A4.4.3 Actuarial vs. liquidity risk 169 5. EMPLOYMENT, MONEY AND THE PRICE-LEVEL A5.1.1 Hicks’s IS-LM diagram 184 A5.1.2 The AD/AS diagram 185 A5.2.1 The money-wage in an open economy 187 A5.3.1 Measuring changes in the price-level 188 A5.3.2 The long period, the short term and the period of production 190 A5.3.3 ‘True’ inflation at full employment 191 A5.3.4 The employment function 192 A5.4.1 A mathematical slip 195 EPILOGUE AE.1.1 Real wages and money-wages 223 AE.2.1 Liquidity risk and corporate finance 224 AE.2.2 The reform of company law 230 AE.3.1 Involuntary unemployment and global poverty 233 AE.4.1 Keynes and Pigou 236 Foreword It is both a privilege and a pleasure to write a Foreword to Mark Hayes’s splendid monograph on the approach and method of The General Theory and, especially, on what they both owe to Keynes’s upbringing as a Marshallian. There are (at least) two ways of doing serious works of interpretation. The first is to develop on the basis of past training and reading the thesis to be exposited. The ‘scholarship’ can then be put in afterwards, both as good manners and also, perhaps, to give an appearance of having built on what has gone before. The second is to concentrate on primary sources – in Hayes’s case his deep understanding of the writings of Marshall and Keynes – in order to explain the development of original ideas in landmark texts, here, of course, The General Theory . Hayes’s monograph is almost entirely an example of the second approach and this is one of its strengths. He understands thoroughly Marshall’s value theory and monetary theory. He resurrects the almost forgotten market period in Marshall’s analysis of value and price setting and shows the absolutely central, vital role it plays in the development of Keynes’s analysis in The General Theory. That is not to say that the short period and Keynes’s own concept of the long period are not important. They are. But the decision- makers in Keynes’s narrative must base their short-period expectations on the information contained in market periods and thereby set in motion processes that converge to a position of long-period equilibrium only if a given state of expectation persists. Hayes also resurrects the significance of the distinction between the two concepts of aggregate demand in The General Theory for a proper understanding of Keynes’s procedures and results. This is more than welcome, for the first concept – what business people expect about prices and sales before making production, employment, and accumulation decisions – has virtually disappeared from text-book expositions of Keynesian economics. Yet without it, it is not possible logically to show how the second concept – the planned expenditures on investment and consumption goods as seen by the onlooking macroeconomist – plays its part in the determination of the point of effective demand. ix x The Economics of Keynes: A New Guide to The General Theory Hayes’s subsequent explanations of the analysis and contributions of The General Theory are built on these basic, central, core foundations. Not only does this allow us to understand more deeply The General Theory itself, it also allows us to see why Keynes’s contributions and approach are still so relevant today for our understanding of the workings of modern economies and our suggestions for realistic, humane and practical policies. Hayes’s volume is a work of exemplary scholarship, the outcome of prolonged and deep thought. Alas, all the incentives in modern academia pull against work such as this being done. It is to the author’s great credit that he has resisted them in order to give us this volume of lasting significance. G.C. Harcourt Jesus College Cambridge Preface This book is an essay in the explanation of The General Theory of Employment, Interest and Money (Keynes, C.W. VII, hereafter The General Theory , or G.T. in chapter and page references). It is not a concordance (such as Glahe’s very useful book, 1991) nor a commentary in the biblical sense, nor a study in the history of economic thought, nor a full survey of the derivative literature. It is in the nature of a travel guide, which describes and explains the significance of the main features of a town or country, rather than a street map or architectural history. A travel guide is no substitute for a visit, but it can make the visit more fruitful. In this case, the features described are the six Books of The General Theory to which the central chapters of this book correspond. The Prologue addresses the tacit assumptions or axioms on which The General Theory is based, which travellers must appreciate if they are not to lose their way. The Epilogue considers the progress and direction of the continuing research programme and policy agenda based on The General Theory, and the extent to which they require modification of Keynes’s axioms. The book is addressed mainly to the advanced student of orthodox (‘Classical’) economics, for whom these days The General Theory is almost certainly foreign territory. Under the ‘Classical’ rubric defined by Keynes (G.T.
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