Post-Keynesian
Macroeconomic methodology
Cambridge, 26. January 2010
Jesper Jespersen
Roskilde University
E-mail: Jesperj@ruc.dk
1. Post-Keynesian methodology: a Critical
Realist perspective
2. Post-Keynesian macroeconomic theory:
making ‘uncertainty’ epistemological
relevant:
a. the Principle of Effective Demand
b. liquidity preference theory
What is Post-Keynesian
(macro)economics?
• A broad ranging approach on how to
understand the dynamics of the real-world
economy - considered as a whole:
1. Methodology – the (re)search for a
relevant method to establish
2. Real-world related Theories and Models +
3. Empirical Tests of our Findings +
4. Reasonable judgements
(with inspiration from Keynes and many
Inspiration from Keynes’s view on
real-world economics:
[Real-world]…
…’[E]conomics is essentially a moral
science and not a natural science... [I]t
deals with introspection and values... and
with
• Motives (incentives),
• expectations,
• psychological uncertainties.’
 Microeconomic foundation
Keynes’s Methodology:
• Economics is a science of thinking in terms of
models joined to the art of choosing models
which are relevant to the contemporary world.
• It is compelled to be this, because, unlike the
typical natural science, the material to which it is
applied is, in too many respects, not
homogeneous through time (CWK, XIV: 296)
• It seems to me … that you [Roy Harrod, jj] do not
repel sufficiently firmly attempts ... to turn
[economics] into a pseudo-Natural-science.....’
Two fundamentally different methods in
macroeconomics:
• On the one side are those who believe that the
existing economic system is, in the long run, a
self-adjusting system, (CWK, XIII: 486)
• On the other side of the gulf are those that reject
the idea that the existing economic system is, in
any significant sense, self-adjusting (Ibid.: 487)
• The gulf between these two schools of thought is
deeper, I believe, than most of those on either
side of it are aware of.
• On which side does the essential truth lie? That is
the vital question for us to solve. (Ibid.: 488)
Said by Keynes in 1934
Method has implication for theory!
• The strength of the self-adjusting school
depends on it having behind it almost the whole
body of organised economic thinking of the last
hundred years (CWK, XIII: 488)
• There is, I am convinced, a fatal flaw in that part
of orthodox reasoning which deals with the
theory of what determines the level of effective
demand and the volume of aggregate
employment (Ibid.: 488)
Methodology (continued):
• I shall argue that the postulates of classical
theory are only applicable to a special case only
and not to the general case, the situation which it
assumes being a limiting point of the possible
positions of equilibrium.
• Moreover, the characteristics of the special case
assumed by the classical theory happen not to
be those of the economic society in which we
actually live, with the result that its teaching is
misleading and disastrous if we attempt to apply
it to the fact of experience. (Keynes, 1936: 3,
my highlighting).
Hence, Post-Keynesian economics
have to deal with methodology:
• How to model the consequences of
uncertainty?
• Does macroeconomics need a specific
microeconomic foundation?
• How to avoid the fallacy of composition?
(the outcome is different from the sum of the
parts) – the economy as a whole
• Trend and cycles cannot be separated in an
open and path-dependent system
• Context matters
 Methodology is a major dividing line when
these questions are answered
• Post-Keynesian economics is when
uncertainty and money are taken seriously
• It penetrates economic decision making
and behaviour at all levels – micro/macro
and short or long run.
• Hence, uncertainty and money are
inescapable phenomena in
macroeconomics
• We know this from e.g.
Liquidity preference theory
The theory of effective demand
The post-Keynesian economists
have to be conscious about
methodology!
Methodological requires thinking about:
1. Ontology - object
2. Epistemology - method
3. Outcome - results
Three worlds of Popper
• World 1 – Reality: ontology
• World 2 – the analytical level, where
method matters: epistemology
• World 3 – the strategic level, where
analytical results are used for politics:
judgements
WORLD 1
The real level:
(Reality)
The cognitive veil
Figure 2.1: Critical Realism methodology (Retroduction)
Ontology
History
Mappi
ng
Tendencies
Tests
WORLD 3
The operational level:
recommendations
WORLD 2
The analytical level:
Landscape
Theory/Model
Results
Figure 2.2: Stratified reality grounded in Critical Realism
Reality divided into three strata
Empirical stratum
Data – Imprecise measurements
Factual stratum
Events and tendencies
The deep stratum
Causal mechanisms, power structures and institutional relations
Figure 3.1: Macroeconomics is a sub-disciplin of social sciences
Frame of nature
Macroeconomics
Law
Sociology
Society as a whole
Political science
Jesper’s methodological
’iceberg’
World 1
data
World 2
clock-work
agents
Market
System
World 3:
Predicting the
marketsystem
Inspiration: Martin Hollis
actors
Power,
structures,
culture
Understand
reality
reflexive
organism
Figure 2.3: Two different methodologies
Post-Keynesian methodology –
Critical Realism/retroduction
Reality
(World 1)
Analysis
(World 2)
Policy-recommendations
(World 3)
General equilibrium methodology –
Hypothetical deduction
Axioms
(World 2)
Analysis
(World 2)
Results =
policy-recommendations
(World 2)
Why Critical Realism(I)?
• There is an emerging consensus that the Post
Keynesian approach is consistent with much of
critical realism, with open-system theorizing
applied to an economy understood as an
organic, open system. Different forms of
abstraction are relevant to different questions,
and different economies; and indeed the study
of actual economies required before abstraction
can occur involves the application of different
disciplines (Dow, 1996:79).
Why Critical Realism(II)?
• Finally, since Post Keynesian theory starts
with observation, the position on empirical
matters must be discussed. First, rejecting
the subjective/objective dual…. 'Facts' can
be observed with some degree of
objectivity… Since the group of theories
includes formal models which are
susceptible to empirical application, Post
Keynesians do not reject econometrics
(ibid.: 80)
Why Critical Realisme (III)?
1. Understanding Reality
2. Unescapable uncertainty, the future is
unknowable
3. Individuels are context dependent and
interrelated because of uncertainty
4. Hidden structures and powers matter
5. Actual performance is path-dependent
6. Hence, open system analysis without a
predetermined outcome is needed.
Open System Ceteris ParibusMethod
• The object of our analysis is, not to provide a
machine, or method of blind manipulation, which
will furnish an infallible answer, but to provide
ourselves with an organised and orderly method
of thinking out particular problems;
• and, after we have reached a provisional
conclusion by isolating the complicating factors
one by one, we then go back on ourselves and
allow, as well as we can, for the probable
interactions of the factors among themselves.
This is the nature of economic thinking (Keynes,
1936: 297).
Post-Keynesian economics is a
social science :
As Keynes remarked:
…’[E]conomics is essentially a moral
science and not a natural science... [I]t
deals with introspection and values... and
with
• Motives (incentives),
• expectations,
• psychological uncertainties.’
• Keynes’s perception was that economies
did not behave in the way economists said
they did, that something vital had been left
out of their accounts, and it was this
missing element which explained their
malfunctioning;
• Keynes accused economists of his day of
abstracting from the existence of
uncertainty – human beings take decisions
in ignorance of the future. (Skidelsky,
1992: 538-9)
Macroeconomic implications of
taking uncertainty seriously
• Here uncertainty makes a crucial
difference, because any microeconomic
decision or activity is characterized by lack
of knowledge, but you have to act – so
what do you do?
Look at Figure 1 – The structure of
uncertainty
Figure 1: The anatomy of uncertain individual knowledge
(un) known
(un) likely
Expectations
Future
Uncertain
knowledge
(un) known
(un) likely
Actions
Consequence
• Uncertainty makes macro-behaviour
different from (n * individual micro),
because:
• Households and firms don’t behave
independently
• They follow conventions
• Or they act intuitively on new information
(animal spirit)
• Or they learn from past experiences
Hence, there is no such thing as an
atomistic market (theory)
I will now concentrate on
Macroeconomic: Effective Demand
& Liquidity Preference
• There is, I am convinced, a fatal flaw in
that part of orthodox reasoning which
deals with the theory of what determines
the level of effective demand and the
volume of aggregate employment
Where has ‘macro-demand’ gone?
because ‘You will not find it [effective demand]
mentioned even once in the whole works of
Marshall, Edgeworth and Professor Pigou, from
whose hands the classical theory has received
its most mature embodiment’. (Keynes, 1936:
32).
This really is a puzzle, because neoclassical micro
theory is, if anything, about supply and demand,
Until you realize, that at the macro level there was
no room for macro-demand, when uncertainty is
squeezed out of the analysis.
Figure 2: Uncertainty explains the complexity of ’effective demand’
Z-curve: Expected Aggregate costs
(incl. Profit): imperfect competition,
mark-up:
D-curve: Expected proceeds from
aggregate (macro)demand
Effective Demand
Macrobehaviour of business
sector
Aggregate credit facilities: the
working of the banking system
Expected availability of supply factors:
labour, capital, technology
environmental conditions
Instead we are looking for:
An open, integrated market system ruled by
aggregate - macroeconomic behaviour:
Liquidity preference:
There is, however, a necessary condition
failing which the existence of a liquidity
preference for money as a means of
holding Wealth could not exist.
This necessary condition is the existence of
uncertainty as to the future of the rate of
interest (Keynes,1936: 168)
So, what to do in practice?
• We make a macroeconomic landscape
• We have to make semi-closures,
provisional stability (fixed expectations)
• Using the Open System Ceteris Paribus
method developed by Mark Setterfield
Figure 3.2: The macroeconomic landscape
Exports
Market for goods and services
(GDP)
Goods and services
Foreign sector:
Balance of payments:
Current account
Capital account
Exchange rates
Imports
International
capital flows
Loan
Real investments
Wage
incom
e
Gross profit
Consumption
Public sector
Labour market:
Employment
--------------------------------Unemployment
Financial markets:
Money, bonds and shares
Unemployment
benefits
Tax
Income transfers
Excessive
profits
Rate of
interest
Central Bank
Firms
Housing- market
Households
Mortgages
Financial savings
Interv
ention
in
curren
cy
marke
t