Thursday, January 28, 2016

Keynes rejected Wage and Price Flexibility as the Path to Full Employment even in Theory

This is a major error of neoclassical theory, and the mistaken view some people still attribute to Keynes: that wage and price flexibility in theory is still a reliable and effective mechanism for reaching full employment, even if the real world has wage and price rigidities. In fact, Keynes rejected that view.

Curiously, even some Institutionalist economists have failed to understand it. For example, even Gardiner C. Means – the American Institutionalist who developed administered price theory – was unclear about what Keynes’ fundamental arguments were in the General Theory, and whether the theory depended on inflexible wages and prices.

This is illustrated by a fascinating piece of forgotten history told by Means himself: his visit to John Maynard Keynes in July 1939:
“In the summer of 1939, on my way to a holiday in Norway, I made it a point to visit Keynes with the specific purpose of asking him to what extent his explanation of persistent unemployment rested on an assumption of wage-rate or price inflexibility. His answer was a categorical: ‘Not at all.’ I asked the question in several different ways in order to make sure there was no failure of minds to meet and the answer was always the same. I said, ‘Suppose that prices and wage-rates met the classical assumption of perfect flexibility so that, if there were excessive unemployment, the price-wage level would fall frictionlessly. Then with the nominal money stock remaining constant, wouldn’t the rise in the real value of the money stock create added demand which would tend to absorb unemployed workers?’ But still the answer was no. Once interest rates had fallen to their limit there would be no further corrective. We were in complete agreement that, in practice, neither prices nor wage-rates were as flexible as classical theory assumed, but he insisted that his theory of unemployment did not depend at all on this fact.” (Means 1976: 61–62).
You couldn’t have a clearer statement by Keynes himself about what the essence of his theory was. But, despite these emphatic statements by Keynes, Means was dissatisfied with Keynes’ replies.

Later, Means (1976) defended the neoclassical synthesis interpretation of the General Theory contrary to the explicit answers Keynes had given to him in 1939, because Means continued to believe in the efficacy of the real balances effect (Means 1976: 63), which only goes to show how even some Institutionalists – as well as neoclassical Keynesians – failed to understand the fundamental message of the General Theory.

BIBLIOGRAPHY
Means, Gardiner C. 1976. “Which was the True Keynesian Theory of Employment?,” Challenge 19.3 (July/August): 61–63.

16 comments:

  1. So if not sticky wages, what is the real cause of unemployment?

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    1. Failure of business subjective expectations and failure to invest. The unemployment level is largely caused by demand for output, not by supply and demand for labour as in marginalist supply and demand curve thinking. But failures of expectations can happen for many, many different reasons. You have to look at historical contexts.

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    2. But surely you can have collapsing output without rising unemployment (e.g., Indonesia, 1997)? And what do you mean by "demand for output"?

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    3. (1) we are talking in *general* terms. Exceptions don't disprove a general trend or state of affairs. E.g., most people are literate in Canada. Do examples of some few illiterate people in Canada disprove that statement?

      (2) Demand for output? Aggregate demand for goods and services, including consumer goods and capital goods. Clear?

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    4. But then the theory has to explain why the exceptions aren't fatal to it and why they might actually be expected by it, etc. I still prefer the labor market approach.

      And that could mean either quantity demanded/supplied or NGDP. I think you meant the former.

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  2. Isn't that because Michal Kalecki convinced JMK about it?

    I could be wrong.

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    1. Indeed you're wrong. Keynes' "General Theory" is an attempt to explains unemployment with flexible prices. But it is riddled with logical problems because it is a "representative agent" model.

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  3. Further ...

    "Keynes however got stuck on the
    effects of wages on the short-period equilibrium in an abstract Marshallian model. Kalecki
    was able to demonstrate more clearly the complex real income effects of wage changes."

    https://www.vu.edu.au/sites/default/files/cses/pdfs/toporowski-paper.pdf

    My knowledge of history is not good so I am relying on Toporowski.

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  4. I think Keynes is not really convincing. If money is a good, then increasing its "price" will eventually decrease the expected (in broad sense) return of holding it. Hence one can't argue that the problem is the holding of money AND that deflation wouldn't EVENTUALLY (once expectations turn bullish) solve it.

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    1. That is just the discredited real balances effect/Pigou effect. Keynes refuted the efficacy of this effect in Chapter 19 of the GT:

      http://socialdemocracy21stcentury.blogspot.com/2014/01/the-general-theory-chapter-19-changes.html

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    2. It is not the "real balance effect". You should re-read what i've said.

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    3. "If money is a good, then increasing its "price" will eventually decrease the expected (in broad sense) return of holding it. "

      So what is this? Deflation increasing the real value of money resulting in people buying more consumer goods with their money?

      If so, this is the real balances effect/Pigou effect.

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    4. It's simple portfolio adjustment, not real balances or pigou effect. And those who do this will probably buy bonds or stocks, not consumer goods.

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    5. In essence, you can't believe all these propositions together:

      1) distribution of assets (except money) among agents doesn't matter for "output" 2) "output" is being reduced by the fact that money is kept "unused" by some people 3) these people would release money if they feared inflation 4) they'll fear inflation after a sufficient appreciation of money.

      Keynes's "General Theory" is unconvincing because it tries to keep all these propositions together.

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  5. In other words: i think Keynes ideas can make sense only if they're formalized with models that are 1) dynamic and 2) "disaggregated" (the distribution of assets among agents DOES matter).

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