Instability at the Cowles Commission (1939-1948)

Instability at the Cowles Commission (1939-1948) 05. 16. 2019 Michaël Assous (Lumière-Lyon 2 University, Triangle) and Vincent Carret (Lumière-Lyon 2 University, Triangle)1 Abstract: Stability analysis touched off extensive discussions at the Cowles Commission between 1939 and 1948. Oskar Lange, later followed by Lawrence Klein and Don Patinkin, among others, claimed that static analysis attempting to prove the existence of a stationary equilibrium with unemployment was a dead end, and he drew attention to the need of a shift toward a dynamic approach exploring stability properties of full employment equilibrium. In presence of excess supply of goods and labour with flexible money wages and prices, the message was that macroeconomic pathologies are better regarded as disequilibrium dynamics when full employment equilibrium is unstable - Lange and Klein - or when it is stable - Patinkin. The objective of this paper is to examine this modelling strategy advocated by economists of the Cowles Commission in the 1940s who formed an integrated group with a specific political vision. Key words:instability, Cowles Commission, dynamics, Paul Samuelson, Oskar Lange, Lawrence Klein, Don Patinkin JEL classifications:B2 History of economic thought since 1925: B22 Macroeconomics; B23 Econometrics and Quantitative and Mathematical Studies; B41 Economic Methodology 1 E-mail: [email protected]; [email protected] 1 1. Introduction Stability analysis took an interesting turn at the end of the 1930’s. Under the lead of Alvin Hansen, Paul Samuelson and Oskar Lange, that analysis was progressively disconnected from business cycle studies. Samuelson’s tools (1941, 1942, 1944, 1947) were soon adopted by Lange. Lawrence Klein and Don Patinkin followed up at the Cowles Commission, whose activities between 1939 and 1948 were deeply impacted. The present study starts by a somewhat controversial proposition. Contrary to the view that Samuelson was only interested in stable systems (Weintraub (1991), Backhouse (2017) or Boianovsky (2019)), it is argued that Samuelson believed that economies were prone to instability. To make this clear, it is required to pay attention his plea for the development of “meaningful theorems” derived from static comparative analysis. A careful reading of his early works reveal that Samuelson’s arguments were consistent with the idea that the economy was unstable in the case of flexible prices. Indeed, his conception of comparative statics required that the system studied is stable. But Samuelson never examined a full employment equilibrium with flexible prices. One can thus only conclude that he thought such equilibrium was unstable. Nevertheless, one must admit that Samuelson did not feel the need to elaborate more on this subject. This was however the case for many of his colleagues; Alvin Hansen (1941), his mentor at Harvard, had for his part decided that the issue was settled. Prices and wages flexibility were no guarantee that full employment will be reached. This is due to the fact that there may not be any positive rate interest equating saving and investment at a full employment level. Others, compelled to admit that such an equilibrium necessarily exist in reaction to Pigou’s critiques (1941, 1943), still argued it was unstable. 2 This was the view chiefly advocated by Oskar Lange who from 1941 combined Samuelson’s stability analysis and Hicks’s general equilibrium theory. Because Lange was, in the early 1940’s, a major figure at the University of Chicago, and an influential member of the young Cowles Commission, his ideas had an immediate impact. In particular, Lawrence Klein and Don Patinkin, two promising researchers, developed Lange’s arguments. The former, the student of Samuelson and herald of the Keynesian Revolution (1944, 1948) expanded the idea of instability in empirical studies (1947, 1950). His legacy at the Cowles Commission is unquestionable (Pinzon Fuchs, 2017). His debt though toward Lange and his endorsement of his worldview still need to be addressed. On the other hand, Patinkin (1948, 1949) buried the idea of instability. He accepted Pigou’s argument and the idea - already present in Lange’s work, but often unnoticed - that involuntary unemployment corresponded to a disequilibrium position. His stand was that disequilibrium dynamics boils down to an analysis of the convergence toward a stable position, the only remaining factor justifying state intervention being the sluggishness of that adjustment. There is thus a real gap between Patinkin on one side and Lange and Klein on the other. This meant ruling out Lange’s political vision which legitimized central planning, The paper finally discusses how this treatment of instability was connected to the macroeconomic foundation issue. Unlike Samuelson, Lange was not reluctant to resort to the same tools to deal with micro and macro issues, again this is related to his political commitment. This narrative is one of a group whose consistency is assessed through the examination of an interaction of its members. 3 2. Paving the way to instability analysis: 1939-1943 This section focuses on Samuelson's stability analysis and his works inspired by Hansen, later used and extended by Oskar Lange. In the span of about three years at the beginning of the 1940’s Lange proposed a new vision of the employment problem based on disequilibrium and instability. The Hansen-Samuelson-Lange connection On December 28, 1940, Paul Samuelson, Alvin Hansen and Oskar Lange took part in a the same session of the 1940 Econometric Society meeting in New Orleans. This session was particularly important, as it brought together three authors whose paths and ideas proved to be tightly connected. Hansen introduced his forthcoming book Fiscal Policy and Business Cycle, Samuelson provided a paper on Say’s law and Lange presented a paper entitled “Price Flexibility, Interest and Full employment”. Samuelson took an active part in Hansen’s seminar given at Harvard in the late 1930’s. In close collaboration with Samuelson, he developed a specific interpretation of Keynes’s General Theory that definitely contributed to move macroeconomics - still emerging in the late 1930s - from a business cycle perspective to an equilibrium one (Backhouse, 2017)2. Samuelson’s (1939a) first works, while he was still a graduate student, consisted of an analysis of the combination of the multiplier and accelerator used to highlight a variety of dynamic trajectories. Soon, Samuelson realized that:“The acceleration principle can determine the nature of the oscillations but not the average level of the system” (Samuelson, 2 Although Hansen is often seen as “the American Keynes”, he did not strictly abide to Keynes’s theory. See for instance the collection of articles published after Hansen’s death in n°1, vol. 96, Quarterly Journal of Economics, 1976. 4 1939b: 791, underlined by the author). Consequently, cycles analysis boils down to the study of the mechanisms of convergence and divergence toward a stationary state. From then on, stability analysis could be studied apart from cycles. Hansen, as evidenced by chapter 12 of his 1941 book, adopted the same view but went a step further and added that there may not exist a price system that could also “provide full employment.”3 (Hansen, 1941: 288). There may be no positive value of the rate of interest able to equilibrate saving and investment at full-employment income and flexibility of money wages are of no help to lead to it. Worse, pushed to its limits, such an adjustment would break down the economy. To fully grasp Samuelson’s take on that issue, it is worthwhile to pay attention to the dynamical systems he developed at the same time. At the annual Cowles Commission Conference in Colorado Springs, in 1940, he presented a preliminary draft of his path-breaking 1941 Econometrica article, later integrated in the second part of his classic Foundations of economic analysis (1947). Samuelson urged his contemporaries to develop tools appropriate to deal with global systems and market interdependencies, tools distinct from those used to examine “maximum conditions within the firm or household” (Cowles th Commission 6 Annual Conference, 1940: 44). This, he argued, meant to examine stability properties of aggregative models based on differential equations. It was only at this condition that one could derive “meaningful theorems” based on static comparative exercises. A prerequisite, he added, to such exercises was to work with stable systems, i.e. systems whose dynamic paths would converge to a stationary state. 3 Pigou later directed his attacks mainly against Hansen in 1943 and precisely referred to that passage 5 It is at that point that Samuelson referred to what he dubbed the “Keynes-Lange model” - a term he later used in his Foundations (Samuelson, 1947: 354) - and discussed the efficiency of monetary and fiscal policies. At no time, though, Samuelson used that model to discuss the effects of a change in money wages. In fact, nowhere in his published works of this period do we find such an analysis. This is, we think, no coincidence. If one admits that full employment equilibrium is unstable, comparative statics exercises stop making sense. Thus, one can conclude that Samuelson believed that full employment equilibrium of such a system was very likely unstable. So, when Samuelson states that “positions of unstable equilibrium, even if they exist, are transient, nonpersistent states, and hence on the crudest

Load more