In a normal week I, like many, bump into lots of interesting and worthwhile materials; from now on, I’ll try to link my week’s favourites each Sunday, my “Sunday bites”. Today we’ve
Today we’ve Where does Post-Keynesian economics come from?, We are all protectionist and Paul Krugman vs. DSGE models (fun).
Where does Post-Keynesian economics come from?
Tom Palley holds an introductory lecture on heterodox economics (see video), and in a brief history of economic thought, he traces back the various contributions to Post-Keynesian economics.
First, he identifies four core features of Post-Keynesian economics:
- fundamental uncertainty: you can’t contract your way out of a recession (Arrow-Debreu model is ontologically wrong);
- effective demand, with changing output response (the closer you get to full employment the greater will be the price response to a demand increase)
- unemployment is not a consequence of nominal rigidities;
- the real wage is not equal to the marginal productivity of labour (we’re not on the labour supply schedule).
He goes on explaining his stylised history of economic thought, with two schools (German Historical School and Anglo-Saxon School) originating from the Mercantilists, the Arithmetic (Petty) and the Physiocrats (Quesnay). Keynes is put in the Anglo-Saxon school but linked with its malcontent-line (Malthus and underconsumptionists).
Post-Keynesian economics builds in some fundamental insights of the German Historical school, while Smith on the one hand, and Locke and Hume on the other, are respectively the founding fathers of neoclassical macroeconomics (the invisible hand = the price system in the 1st welfare theorem) and monetary macroeconomics (quantity theory of money). Whereas Smith is largely consistent with Post-Keynesian economics, Locke and Hume as progenitors of the quantity theory of money are not.
Then there’s a split of the ASS over the possibility of involuntary unemployment: Malthus challenges Say’s Law holding that there can be gluts (at least in the industrial sector), Ricardo makes full employment the default economics assumption (the biggest mistake according to Keynes). Marginalism and the Lausanne School (Walras and Pareto) follow Ricardo, with the first applying to individual choice (Jevons, Mill, Edgeworth, Menger and Marshall) and production theory (Clark), the second to general equilibrium. All this formed neoclassical general competitive equilibrium theory (Hicks’ “Value and Capital”, and Arrow&Debreu’s proof of general equilibrium), to which classical macroeconomics adds two features: money (which is neutral <– QTM) and loanable funds theory (the goods market clearing mechanism).
Keynes broke decisively with classical macro, while more ambiguously with the neoclassical microeconomics. He introduces fundamental uncertainty to explain why money is needed and why you can’t contract your way out of a recession and rejects loanable funds theory (disproving Say’s Law => possible gluts); his liquidity preference theory makes interest rates a monetary phenomenon. As to neoclassical microeconomics he breaks decisively “only” with one aspect, namely with the price system’s clearing capacity at an aggregate level (ch. 19 GT). Post-Keynesians try to further strengthen Keynes’ break with classical macro but believe there’s a need for a deeper break with neoclassical micro.
The second dimension of Post-Keynesian economics is the recovery of some ideas of the German Historical School, which see the economy as working within a certain institutional and historical framework. The 3 core concepts are hysteresis (changes are not easily reversible as in comparative statics), path-dependence and cumulative causation. In this school, we have:
- classical Marxism: a non-equilibrium theory (capital accumulation increasing the capital intensity and thereby lowering the profit rate triggers cyclical crises) with the labour theory of value (plus reserve army of unemployed) at its core.
- modern Marxists (Kalecki, Sweezy, Baran, and Steindl) abandons the LTV and TRPF emphasising monopoly and market power with functional income distribution affecting aggregate demand and thereby output and employment.
- neoclassical Marxists focus on methodology and deal with microeconomics.
- 20th century Austrians (van Mises and van Hayek) are the progenitors of modern European neoliberalism. The central claim is that deregulated markets are the best protection of liberty and that combined with self-interested profit and utility maximisation delivers optimal outcomes. It differs fundamentally from competitive equilibrium theory as the Austrians see the economy in a constant flux and reject the concepts of equilibrium and disequilibrium.
- American Institutionalists maintain that institutions shape transactions to deliver socially desirable outcomes.
Now, we have a variety of Post-Keynesian economics (effective demand is the common denominator):
- Keynesian Institutionalism: Galbraith embraces Keynesian fiscal policies as a stabilizing tool and focuses on the impact of corporations on the economy.
- Minsky applies the process of creative destruction (from Schumpeter) to finance that creates boom-bust cycles by affecting investment fluctuations (stability breeds instability).
- Neo-Kaleckians refine Kalecki’s insights and distinguish between wage-led, profit-led and conflictive regimes.
- SSA school still emphasises over-accumulation as the cause of crises.
- Money* and fundamental uncertainty are critical to fundamental Keynesians (Davidson and Shackle).
- ISLM Neo-Keynesians (Hicks, Samuelson and Tobin). Palley holds that the ISLM model is wrongly demonized, as the specification flaws (money exogeneity and real balance effect / Pigou wealth effect) have been conflated with the framework, which per se is powerful and useful.
- Kaldorians emphasize endogenous money, endogenous growth theory, cumulative causation theory, non-equilibrium, non-linear macroeconomics.
- Sraffians, whose critique originates from Ricardo (=> impossibility of establishing value without a theory of distribution): if production uses capital, one cannot establish its value without knowing its return, in other words, it’s impossible for capital to establish its own return.
*Keynes said that money has near zero elasticity of production (an unemployed cannot produce it) and near zero elasticity of substitution (demand increases don’t lead to a price increase and thus to switching to other goods).
We are all protectionist
In this (chill and humorous) lecture, Ha-Joon Chang debunks free trade myths, showing that we – the industrialised countries – all went up the ladder thanks to protectionism and that free trade countries were an exception, namely Netherlands, Switzerland (until WW1) and Hong-Kong. For more, we’ll have to read his books “Bad Samaritans” and “23 things they don’t tell you about capitalism” (here a passage).
Paul Krugman vs. DSGE models (fun)
In this post, Paul Krugman unleashes his frustration about the uselessness of DSGE models, sadly defended by Blanchard.