In conclusion
• … the foregoing theory is moderately conservative
• The State will have to exercise a guiding influence on the propensity
to consume partly through its scheme of taxation, partly by fixing the
rate of interest, and partly … in other ways.
• … [it is] unlikely that the influence of banking policy on the rate of
interest will be sufficient by itself to determine an optimum rate of
investment.
• [T]herefore, a somewhat comprehensive socialisation of
investment will prove the only means of securing an
approximation to full employment.
• … beyond this no obvious case is made for a system of State
Socialism … If the State is able to determine the aggregate amount
of resources devoted to [investment] and the basic rate of reward to
those who own [capital], it will have accomplished all that is
necessary.
• …if our central controls [establish] full employment as nearly as is
practicable, …then there is no objection to the classical analysis
of the manner in which private self-interest will determine what
in particular is produced, in what proportions the factors of
production will be combined to produce it, and how the value of
the final product will be distributed …
1926: Economic Journal, Only
constant returns compatible with
perfect competition.
1951-73: Collected Works of Ricardo
1960: Production of Commodities by
Means of Commodities: Prelude to a
Critique of Economic Theory
Joan Robinson
1903 - 1983
Piero Sraffa
1898 - 1983
Keynes’ Circus
James Meade
1907 - 1995
"I have my heart to the left
and my brain to the right."
E. A. G. Robinson
1897 - 1994
Richard F. Kahn
1905 - 1989
Co-author of General Theory?
Michal Kalecki:
A Parallel Development of the General Theory?
•
•Engineering education, Warsaw Poly
•Polish business cycle institute
•Sweden (1935), England (1936 – 1945)
•International Labor Organization; United Nations New York (till 1955)
•Warsaw professor
Michael Kalecki
1899 - 1970
• Keynes: A deviationist from Marshall
• Kalecki: A deviationist from Marx
• Macroeconomics of class conflict
• “When workers spend what they earn, capitalists earn
what they spend” Proba teorii koniunktury (An essay on the theory of
the business cycle), Warsaw: 1933
• I  Y (a multiplier process)  Profit  S = I
» As in General Theory, investment spending drives
the macroeconomy … and generates fluctuations
Kalecki’s Economics
• Capitalist share (1 - α) determined by monopoly power
• Capitalist Profit depends on Capitalist Spending
Profit = Capitalist Spending = c0 + mpc x Profit + I  Profit = (c0 + I)/(1 – mpc)
• Capitalists earn what they spend
• Recall widow’s cruse from Keynes’ Treatise on Money
• When capitalists’ mpc = 0 and workers’ mps = 0, economy’s mps = (1 – α)
and investment multiplier = ΔY/ΔI = 1 / (1 – α)
• Investment is own undoing: I = m x Profit – m x K
– As capital stock increases, borrowers and lenders risks increase
• If the entrepreneur is not cautious enough in his investment activity, it is the creditor
who imposes on his calculation the burden of increasing risk…Anticipation of Minsky
• The tragedy of investment is that it causes crises because it is useful…it is not the
theory [Kalecki’s] that is paradoxical but its subject—the capitalist system.
• Attack on Pigou (real balance) effect
– Falling wages and prices  “catastrophic increase” in debt burden
 “wholesale bankruptcy and a confidence crisis.”
• Recall Fisher’s debt-deflation theory of depression  anticipation of Minsky
• G must offset vagaries and secular decline of I
Kalecki’s Economics
• G must offset vagaries and secular decline of I
but…
• Big business opposes full employment (stimulus) programs:
– Dislike of government intervention on principle
– Dislike of public investment and subsidized consumption
“You shall earn your bread in sweat”
– Dislike of full employment
• Disciplinary role of “the sack”
 Political business cycle: countercyclical G reversed at peak
– Military Keynesianism half-acceptable
• No such thing as the long-run independent of its short periods
 A dynamic macroeconomics
Keynes’ General Theory
• What did he say?
• Different things at different times
» On tariffs On saving
• What did he mean?
Y=C+I
C = C(Y) …Propensity to consume  passive response to income
I = I(i) …Marginal efficiency of capital + animal spirits  instability
S = I …spending multiplier … Income adjusts, not wages and prices
L = L(Y,i) … Liquidity preference function
interest rate determined in money market, not Scredit = Dcredit , not Ssaving = Dinvestment
…the transition from a lower to a higher scale of activity involves an increased demand
for liquid resources which cannot be met without a rise in the rate of interest, unless the
banks are ready to lend more cash…If there is no change in the liquidity position, the
public can save ex ante and ex post and ex anything until they are blue in the face
without alleviating the problem in the least. The “Ex Ante” Theory of the Rate of Interest,
Economic Jrnl, 1937.
… In the world of the classical economy, … why should anyone outside an insane
asylum wish to use money as a store of wealth? …The possession of actual money
lulls our disquietude; and the premium which we require to make us part with money is
the measure of the degree of our disquietude. The General Theory of Employment,
QJE, 1937.
Keynes on Uncertainty
• By “uncertain” knowledge, let me explain, I do not mean merely
to distinguish what is known for certain from what is only
probable. The game of roulette is not subject, in this sense, to
uncertainty…Or, the expectation of life is only slightly uncertain.
Even the weather is only moderately uncertain. The sense in
which I am using the term is that in which the prospect of a
European war is uncertain, or the price of copper and the rate
of interest twenty years hence, or the obsolescence of a new
invention, or the position of wealth-owners in the social system
in 1970. About these matters there is no scientific basis to form
any calculable probability whatever. We simply do not know.
Nevertheless, the necessity for action and for decision compels
us … to do our best to overlook this inconvenient fact and
behave exactly as we should if we had behind us a good
Benthamite calculation of a series of prospective advantages
and dis advantages, each multiplied by its appropriate
probability, waiting to be summed.
• The General Theory of Employment, QJE, 1937.
The Neoclassical – Keynesian Synthesis
Short – run  Keynesian Unemployment
Long – run  Classical Full Employment
Mr. Keynes and the Classics: A suggested simplification,
Econometrica, 1937
Goods Market: I = S
Money Market: L = M
 ISLM macromodel
•Macro- equilibrium
•Policy tool
Sir John Hicks
1904 - 1989
i
LM
IS
Y
Confidence and Effective Demand in Keynes’ Economics
UNCERTAINTYRush to liquidity in a crisis only
reduces prices of securities
 i UP
“Quasi –
rents”
Yields/Profits
Interest Rate
Price of Capital Asset, Pk
(What it’s worth)
vs.
Price of Investment, PI
(What it costs to build)
Investment Spending
Multiplier
Effective Demand, Output and Employment
Stabilizing an Unstable Economy
Financial Instability Hypothesis:
•Hedge finance
Two types of risk affect the volume of investment.
•Speculative finance …The first is the entrepreneur's or borrower's risk
•Ponzi finance
and arises out of doubts in his own mind as to the
probability of his actually earning the prospective
yield for which he hopes. If a man is venturing his
own money, this is the only risk which is relevant.
…But where a system of borrowing and lending
exists, a second type of risk is relevant which we
may call the lender's risk. GT, Chapter 11.
Price of capital assets
Hyman Minsky
1919 - 1996
Student of Simons/Schumpeter
A Minsky Cycle
Borrower’s Risk •Displacement (invention, easy money)
•Boom…successful speculation
•Euphoria…financial innovation
•Profit taking
PK
•Panic
PI
Internal funds
Io
I1
Investment
When expectations are disappointed,
investment collapses … but debts
remain
Mehrling on Minsky
• How to infer financial conditions:
– Speculative financing requires periodic refinance
So Increased financial fragility  Increased difficulty rolling over loans
 Increased demand for bank loans…But banks finance “speculatively”
 Problems of bank refinancing
• Evolution of financial fragility:
– Post WWII, Treasury bills ruled  refinancing “automatic” [the Accord]
– Banks drew down their T-bill holdings  Money market financing
• But Fed not responsible for money market
• Fed policy of “brinksmanship”—lender of last resort only in crisis
Increased volatility of short-term rates
Higher s-t rates  refinancing by pledging ever greater future cash amounts.
So refinance increases fragility rather than restores robustness.
Natural thrust toward fragility is amplified, not dampened, by financial system.
Refinance becomes impossible for some overextended units  crisis erupts.
They default  upsetting efforts of others to refinance.
OR they attempt to “make position by selling position”  fire sale
 Undermine collateral support for the existing debt structure.
Mehrling on Minsky
• Periods of tight liquidity  short rates rise (incentive for stretching liquidity)
– Value of today’s cash flows rises relative to cash flows in the future.
• Demand price of capital assets (Pk) falls
• Supply price of investment goods (Pi) rises
(interest is a cost of production).
– The incentive to invest is reduced.
• The greater danger:
» collapse of investment spending
» reduced aggregate income
» cash flows elsewhere in the economy fall short of expected
levels
» hedge finance units  speculative units
» speculative units  Ponzi units,
» the fragility of the system increases.
– An investment slump might amplify the financial problems of a few units and
bring the whole system down in a cascade of debt deflation.