“economics of keynes”

““Economics of Economics of Keynes”Keynes”

Intermediate MacroeconomicsIntermediate MacroeconomicsECON-305 Spring 2013ECON-305 Spring 2013

Professor DaltonProfessor DaltonBoise State UniversityBoise State University

Neoclassical SynthesisNeoclassical Synthesis By Mid-1960s the economics profession By Mid-1960s the economics profession

was dominated by a synthesis of was dominated by a synthesis of orthodox IS-LM Keynesian and classical orthodox IS-LM Keynesian and classical long-run Growth economics with a long-run Growth economics with a smattering of monetarist ideas thrown insmattering of monetarist ideas thrown in

Keynesian economics was seen as a Keynesian economics was seen as a special case of a more general modelspecial case of a more general model

Keynes status as a theorist had been Keynes status as a theorist had been minimizedminimized

The Economics of KeynesThe Economics of Keynes Clower, “The Keynesian Counter-Revolution: A Clower, “The Keynesian Counter-Revolution: A

Theoretical Appraisal,” Theoretical Appraisal,” The Theory of Interest The Theory of Interest RatesRates, Hahn and Brechling, ed. (1965), Hahn and Brechling, ed. (1965)

Leijonhufvud, “Keynes and the Keynesians: A Leijonhufvud, “Keynes and the Keynesians: A Suggested Interpretation,” Suggested Interpretation,” AERAER (May 1967) (May 1967)

Leijonhufvud, Leijonhufvud, On Keynesian Economics and On Keynesian Economics and the Economics of Keynesthe Economics of Keynes (1968) (1968)

Clower and Leijonhufvud, “The Coordination of Clower and Leijonhufvud, “The Coordination of Economic Activities: A Keynesian Perspective,” Economic Activities: A Keynesian Perspective,” AERAER (May 1975) (May 1975)

Coordination IssuesCoordination Issues Unemployment and “effective Unemployment and “effective

demand failures” are demand failures” are disequilibriumdisequilibrium situations arising situations arising from coordination failuresfrom coordination failures

Keynes’ revolution was directed Keynes’ revolution was directed at Walrasian General Equilibrium at Walrasian General Equilibrium analysisanalysis

The Walrasian SystemThe Walrasian System ““Auctioneer”Auctioneer”

Searches for the price vector P that clears Searches for the price vector P that clears all marketsall markets

No trades at non-equilibrium pricesNo trades at non-equilibrium prices Economic agentsEconomic agents

Price-takers, quantity-makersPrice-takers, quantity-makers Stock-flow liquidityStock-flow liquidity

All goods equally liquid at equilibrium P, so All goods equally liquid at equilibrium P, so all asset values can be equally realizedall asset values can be equally realized

The Walrasian SystemThe Walrasian System Two-good system (L and G)Two-good system (L and G)

Auctioneer initially sets prices at (W/P)Auctioneer initially sets prices at (W/P)11 and Pand P1; 1; suppose values s.t. in L there is a suppose values s.t. in L there is a notional D < S, ESnotional D < S, ESL L and in G there is a and in G there is a notional D > S, EDnotional D > S, EDGG..

Auctioneer adjusts (W/P) down and P up Auctioneer adjusts (W/P) down and P up until equilibrium is established.until equilibrium is established.

In equilibrium, effective and notional In equilibrium, effective and notional demand and supplies are the same.demand and supplies are the same.

The Walrasian SystemThe Walrasian SystemThe Auctioneer takes account The Auctioneer takes account

of of notional desires notional desires to buy and to buy and sell by noting the excess sell by noting the excess demands and supplies and demands and supplies and turns them into turns them into effective effective messagesmessages by by only permitting only permitting trades at equilibriumtrades at equilibrium

The Clower-The Clower-Leijonhufvudian Leijonhufvudian

SystemSystemWhat Keynes Really What Keynes Really

MeantMeant

The CL “Keynesian” The CL “Keynesian” SystemSystem

Keynes’ mission was to kill off Keynes’ mission was to kill off the Auctioneer myth and raise the Auctioneer myth and raise the issue of the issue of information and information and

coordination problemscoordination problems of real of real economieseconomies


Without a Walrasian AuctioneerWithout a Walrasian Auctioneer Economic agents are price-makersEconomic agents are price-makers Trades can take place at non-Trades can take place at non-

equilibrium pricesequilibrium prices buyers and sellers can be buyers and sellers can be

constrained in carrying out some plansconstrained in carrying out some plans some goods are more liquid than some goods are more liquid than

others, since others, since not allnot all assets’ full market assets’ full market values can be realizedvalues can be realized

““Money buys goods Money buys goods and goods buy and goods buy

money; but goods money; but goods do not buy goods.”do not buy goods.”


In non-clearing markets without an In non-clearing markets without an auctioneer, one has to make a auctioneer, one has to make a distinction between notional distinction between notional (unconstrained) and effective (unconstrained) and effective (constrained) demands and supplies.(constrained) demands and supplies.

Dual-Decision Dual-Decision HypothesisHypothesis

Plans to buy and sell are not realized Plans to buy and sell are not realized simultaneously; the decision to sell is simultaneously; the decision to sell is not automatically transformed into a not automatically transformed into a decision to buy; the sale must be decision to buy; the sale must be realized before a purchase is made.realized before a purchase is made.

The Dual Decision HypothesisThe Dual Decision Hypothesis Planned (notional) purchases are not Planned (notional) purchases are not

made unless planned sales have been made unless planned sales have been realized (made effective).realized (made effective).

Dual-Decision Dual-Decision HypothesisHypothesis

Only signals transmitted areOnly signals transmitted are effective messages backed effective messages backed

by means of paymentby means of payment (money). Effective demands (money). Effective demands can diverge from Notional can diverge from Notional

demands.demands.


Two-good system (L and G)Two-good system (L and G) Suppose (W/P)Suppose (W/P)11 > (W/P) > (W/P)ee so that there exists so that there exists

an ESan ESLL.. Some labor sellers are constrained in their Some labor sellers are constrained in their

demand for goods.demand for goods. Effective DEffective DGG < notional D < notional DGG.. There is no incentive to raise P and encourage There is no incentive to raise P and encourage

production. If P doesn’t increase, (W/P) production. If P doesn’t increase, (W/P) doesn’t fall!doesn’t fall!

Unemployment but Unemployment but notnot equilibrium. equilibrium.

“Price-incentives may be effective in all markets and all prices may be “flexible” and a market system may still go hay-wire in its groping for the coordinated solution.”- Leijonhufvud, “Effective Demand Failures,” p. 111-112

Though prices are flexible, prices do not change, even though notional excess demands and supplies exist, because the desires are not made effective.

Prices may be “right,” but transacted amounts persistently differ from desired rates of sales and purchases.

Prices that were “right” may move away from their equilibrium values, generating price signals that are false and make coordination failure worse.


Keynes recognized the difficulties of Keynes recognized the difficulties of finding Pfinding P

Keynes saw Q adjustments as Keynes saw Q adjustments as occurring before and faster than P occurring before and faster than P adjustmentsadjustments (reversing Walrasian adjustments)(reversing Walrasian adjustments)


IS-LM gets Keynes wrongIS-LM gets Keynes wrong Key elements of IS-LM Key elements of IS-LM notnot in Keynes in Keynes

Rigid wages, liquidity trap, interest-inelastic Rigid wages, liquidity trap, interest-inelastic investmentinvestment

Keynes aggregates bonds and capital Keynes aggregates bonds and capital goodsgoods IS-LM aggregates consumption goods and IS-LM aggregates consumption goods and

capital goodscapital goods


C& L Claim: IS-LM gets Keynes wrongC& L Claim: IS-LM gets Keynes wrong Two Key problemsTwo Key problems

1. Offer of L by unemployed ineffective 1. Offer of L by unemployed ineffective because does not constitute an effective because does not constitute an effective demand for goods; Workers are unwilling demand for goods; Workers are unwilling to be paid in goods in a money economy. to be paid in goods in a money economy.2. Temporal problem that an increase in 2. Temporal problem that an increase in saving does not send a signal to produce saving does not send a signal to produce more in the future… “future demands are more in the future… “future demands are not effective demands.” not effective demands.”


Is Clower and Leijonhufvud’s Keynes Is Clower and Leijonhufvud’s Keynes in Keynes?in Keynes? Keynes long struggle was to escape Marshall, Keynes long struggle was to escape Marshall,

not Walras.not Walras. Walrasian model was developed post-Keynes.Walrasian model was developed post-Keynes. Important to understanding Neoclassical Important to understanding Neoclassical

Synthesis debate, but perhaps not the Synthesis debate, but perhaps not the Keynesian episode.Keynesian episode.

Second ThoughtsSecond Thoughts How applicable is Dual Decision How applicable is Dual Decision

Hypothesis version of Keynes to real Hypothesis version of Keynes to real economies?economies?

Notion of corridorNotion of corridor Inside, price adjustments dominate quantity Inside, price adjustments dominate quantity

adjustments and we are in a classical world of adjustments and we are in a classical world of self-equilibrating marketsself-equilibrating markets

Outside, quantity adjustments dominate price Outside, quantity adjustments dominate price adjustments and in a Keynesian world of adjustments and in a Keynesian world of persistent disequilibriumpersistent disequilibrium

Second ThoughtsSecond Thoughts Keynes’ worldKeynes’ world

Pure flow model of realized sales Pure flow model of realized sales determining current income which determining current income which determine current expendituredetermine current expenditure

As soon as some market does not clear, As soon as some market does not clear, the dominance of quantity adjustments the dominance of quantity adjustments causes multiplier repercussionscauses multiplier repercussions

Second ThoughtsSecond Thoughts Real worldReal world

Modern economies are stock-flow Modern economies are stock-flow economieseconomies

Stocks are buffers between physical and Stocks are buffers between physical and financial inflows and outflowsfinancial inflows and outflows

Money-stock of liquid assetsMoney-stock of liquid assets an important buffer that allows expenditures an important buffer that allows expenditures

to be maintained when receipts fallto be maintained when receipts fall this is the reason for their existencethis is the reason for their existence

“Conclusions: (a) in such economies [stock-flow], we must expect the propagation of shocks impinging on flow to be heavily dampened – as long as the shocks are not of greater magnitude than anticipated by transactors in making their decisions on the levels of buffer stocks to maintain; (b) such economies are, therefore, much more “robust” than pure flow models would suggest – within “the corridor”; if disturbances are of unanticipatedly large magnitude, buffer stocks may be exhausted – at which point, the…”tight” income-constraint takes over.”

- Leijonhufvud, “Effective Demand Failures,” p. 117

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