Effective Demand: Securing the Foundations

Abstract

This paper is one of three contributions to a symposium commenting on papers previously published by the other authors. Allain (Allain, O. (2009) Effective demand and short-term adjustments in the General Theory, Review of Political Economy, 21, pp. 1–22) argues that Keynes elides a distinction between aggregate demand and global expenditure that is necessary to explain the formation of price expectations by individual entrepreneurs. Allain's conclusions depend upon redefinitions of aggregate and effective demand and the consumption function. Hartwig (Hartwig, J. (2007) Keynes vs. the Post Keynesians on the principle of effective demand, European Journal of the History of Economic Thought, 14, pp. 725–739) argues that entrepreneurs must take into account the state of the economy as a whole, in order to form price expectations independently and not as a market equilibrium determined by aggregate supply and demand. This leaves demand price expectations to be determined outside the principle of effective demand. Neither author does full justice to Keynes's own treatment. We still need to agree by what mechanism individual entrepreneurs form a collective and mutually consistent state of expectation in The General Theory.     

Is ex‐ante ex‐post analysis irrelevant to Keynes's theory of employment?

Ex‐ante ex‐post analysis has become a standard tool in macroeconomics. Yet Keynes dismissed it. We argue that Keynes's dismissal of ex‐ante ex‐post analysis is not an oddity but an indication of the originality of his theory of employment compared to standard macroeconomics. First, the principle of effective demand does not amount to a process that determines employment and income at the point of intersection of the traditionally defined ex ante supply and demand functions. Second, the finance motive allowed Keynes to confirm the identity of aggregate supply and demand already asserted in The General Theory. This latter conclusion is puzzling, however, since the principle of effective demand presupposes the possibility of a discrepancy between supply and demand. We suggest that Keynes's theory of employment is linked to a theory of income distribution whereby profits are a redistributed share of factor income which is transferred to firms when prices exceed factor costs. The identity and the equilibrium condition then relate to separate measurements of income and output, factor cost and prices.     

Explaining the aggregate price level with Keynes's principle of effective demand

The mainstream view of Keynes's principle of effective demand is that it states something about quantities—and about quantities only. The principle is held to determine the levels of output and employment in a world not governed by Say's law. This paper argues that the principle of effective demand goes beyond this to explain not only ‘real’ activity levels but also the aggregate price level. A variant of the post-Keynesian D/Z-model is brought together with Marxian reproduction schemes to derive this result.     

On Keynes' inverse relation between real wages and employment: a debate over excess capacity ∗

This article examines Keynes's argument in favour of an inverse relation between employment and the real wage rate. In examining the debate over the inverse relation that took place during the 1930s the article argues that the failure of Keynes's critics to persuade him to relinquish the inverse relation can be traced to his own unrecognized use of a concept of marginal productivity different from theirs but that the larger unresolved issues persisting throughout that debate and continuing till the present are those relating to the formulation of ‘excess capacity’ during a depression and the specification of the supply side of the underemployed economy. Drawing on that debate but contrary to Keynes's own response, the article will propose a respecification of excess capacity such that the labour market directly incorporates aggregate demand independently of changes in the price level, and where an increase in employment is not predicated on a reduction in real wages even in the presence of (neoclassical synthesis) diminishing returns.     

A historiographical exhumation of J.A. Hobson's Over-Saving Thesis: General theory versus historiography

Abstract

The discussion of J.A. Hobson's understanding of over-saving has been largely confined within John Maynard Keynes' famous critique in the General Theory. I argue that gauging Hobson's contribution by ‘general theory’, that is, by an ahistorical, non-evolutionary yardstick, is to miss the larger part of Hobson's achievement. Hobson's conception of over-saving was contained within an evolving historiography of capital accumulation and took on various meanings depending on whether Hobson was discussing a competitive or monopolistic environment. I show that Keynes' ‘corrected’ version of over-saving was implicitly contained within Hobson's analysis of an evolving monopolistic industrial structure.     

Comments

This paper argues for a fundamental reorientation of fiscal policy from the current aggregate demand management model to a model that explicitly and directly targets the unemployed. Some advantages notwithstanding, aggregate demand management has a number of serious drawbacks that merit its reconsideration. This paper identifies these shortcomings and builds the case for a targeted demand management approach that can deliver economic stabilization through full employment and better income distribution. This approach is consistent with the original Keynesian policy recommendations and offers a reinterpretation of Keynes's proposal for the modern context with the help of the work of Hyman Minsky.     

Keynes and a post-Keynesian controversy over the effect of debt on income expansion

The paper considers arguments of Robertson (1938) and Asimakopulos (1983) that the Keynesian multiplier expansion of output may be constrained by debt implicitly incurred in the financing of autonomous investment necessary to start the multiplier process. The task of this essay is to show that within the ‘short-period’ and static analytical framework of Keynes, this line of reasoning regarding the adverse effects of debt on multiplier-induced expansions of output is unwarranted. Nevertheless it is concluded that if the Keynesian framework is abandoned in favour of a dynamic framework in the manner of a steady trend rate of growth - a choice dependent on how one conceives of the economy, as inherently static or dynamic - then such arguments have troubling implications. In particular, the dependence of Keynes's approach on credit and hence debt forges links between ‘short-periods' whose distinctness from one another is crucial to Keynes's result.     

Permanent On-The-Spot Job Creation—The Missing Keynes Plan for Full Employment and Economic Transformation

The paper rejects the conventional view that Keynes had an aggregate demand approach to full employment. Instead, it proposes that he advocated a very specific labor demand targeting approach that would be implemented both in recessions and expansions. Modern policies, which aim to “close the demand gap” between current and potential output are inconsistent with Keynes's work on theoretical and methodological grounds. There is considerable evidence to suggest that a permanent program for direct or (in his words) “on-the-spot” job creation is the missing Keynes Plan for full employment and economic transformation. The current crisis presents the social economist with a unique opportunity to set fiscal policy straight along the original Keynesian lines. The paper suggests what specific form such a policy might take.     

SUBSIDIES AS OPTIMAL FISCAL STIMULI

Theoretical macroeconomic models typically take fiscal policy to mean tax‐and‐spend by a ‘benevolent government’ that exploits potential aggregate demand externalities inherent in the imperfectly competitive nature of goods markets. Whilst shown to raise aggregate output and employment, these policies crowd‐out private consumption and typically reduce welfare. On account of their widespread use to stimulate economic activity, we consider the use of ‘tax‐and‐subsidize’ instead of ‘tax‐and‐spend’ policies. Within a static general equilibrium macro‐model with imperfectly competitive goods markets, we examine the effects of wage and output subsidies and show that, for a small open economy, positive tax and subsidy rates exist which maximize welfare, rendering no intervention suboptimal. We also show that, within a two‐country setting, a Nash non‐cooperative symmetric equilibrium with positive tax and subsidy rates exists, and that cooperation between governments in setting these rates is more expansionary and leads to an improvement upon the non‐cooperative solution.     

Sraffa,Keynes and 'The Years of High Theory'

This paper argues that Shackle's interpretation of 'the years of high theory' is flawed. Shackle (1967) sees Sraffa's critique of the Marshallian theory of value only as a step in the development of the theory of imperfect competition. In the same vein, Shackle reduces the message of Keynes's General Theory to the claim that unemployment results from the existence of uncertainty and irrational expectations. Thus, Shackle leaves open the possibility that both Sraffa's critique of Marshall and Keynes's theory of effective demand do not question the internal coherence of neoclassical theory, but instead merely assert that market imperfections render it irrelevant for the analysis of the real world. This paper argues, in contrast, that the theories of Sraffa and Keynes should be interpreted as radical departures from marginalism, and represent a return to the surplus approach of classical political economy.     

Keynes,Employment Policy and the Question of Public Debt

This article provides a simple formalization of income–expenditure equilibrium in accordance with the Principle of Effective Demand, but augmented to explicitly incorporate public debt. This is utilized to explore the conditions required for simultaneous achievement of full-employment growth and a sustainable public debt trajectory—the latter understood as stabilization of the ratio of public debt to aggregate income, at some desired level. In the spirit of Keynes's economics, demand-led, full-employment growth, driven by government spending, is reconciled with public debt sustainability so understood. The policy implications, illustrative of Keynes's policy views, are then drawn out.     

KEYNES ON WAGE FLEXIBILITY AND THE AUSTRALIAN WAGES SYSTEM*

Keynes' General Theory briefly discusses the Australian wages system, as an example of a system in which an attempt was made to fix real wages by law. Keynes argues that such a system, strictly enforced, generates an unstable unemployment equilibrium or highly volatile money wages and prices. This paper clarifies Keynes' views on the Australian system, with a view to their wider relevance for the significance of real and money wage flexibility and inflexibility in Keynes' economics. The most striking finding is that money wage stickiness is a conclusion, not an assumption, of Keynes' theory of employment.     

Money,Investment and Consumption: Keynes's Macroeconomics Rethought

The dominant supply-side foundation for explanations of the growth potential of an economy is losing its persuasive power in the face of persistent losses in output and employment experienced by mature economies in the aftermath of the financial crisis. There is now an opening for eclectic approaches that consider the interaction between supply-side and demand-side factors in shaping macroeconomic outcomes. In this paper, we develop a model that reflects such an approach to interpreting differential productivity growth over the long run, and then present empirical results for several countries. On the supply-side, the model considers the linkage between the intensity and efficacy of the accumulation process and the gains of productivity in terms of a Kaldorian Technical Progress Function. Then, drawing on the Evsey Domar's Keynesian notion of dynamic equilibrium as the growth rate that reconciles additions to capacity with the absorption of aggregate output by demand, we derive a locus for a ‘Domar equilibrium path’. Imbalances caused by excess aggregate supply or demand, and by the effects of ‘shocks’ are presented and discussed using a simple graphical framework. In the empirical analysis, an error-correction model is applied to the fundamental relationship between the rate of growth of product per work-hour and the rate of capital accumulation. The results suggest that the differences in productivity growth among countries are can be explained in terms of the efficiency of their ‘accumulation paths’.     

The Robertson connection between the natural rates of interest and unemployment

The paper explores the connection between the natural rates of unemployment and interest first put forward in the literature by Dennis Robertson in the 1930s. This looks at monetary dynamics in the business cycle and assesses the Robertsonian contribution to developments in macroeconomics before and after Keynes's General Theory. Robertson showed how unanticipated price level changes affect supply and demand in the labour market, as well as the saving–investment process in the credit market. Robertson's approach to economic policy was that of getting the relations right between cyclical changes in prices, output and employment and their long-run equilibrium values over time.     

Of clouds and clocks and Keynes: conceptions of reality and the growth of knowledge function of money ∗

In this paper, John Maynard Keynes' General theoryand the concept of money are given an evolutionary interpretation. This interpretation is based on Karl Popper's delightful essay ‘Of clouds and clocks: an approach to the problem of rationality and the freedom of man’. The essay presents two things: Popper's conception of indeterminism and his general theory of abstractions. Popper's general theory concerns the role of abstractions and rule-governed, hierarchical systems of abstractions in structuring an indeterministic and uncertain world. He applies his general theory to science.Popper maintains that science is an abstract, rule-governed, linguistic process that facilitates criticism as a way of learning about our world. Popper calls this the growth of knowledge function of science. Popper's general theory can be applied to Keynes' General theory. Following Popper, I argue for a conception of the economy as a rule-governed, monetary language of commerce that facilitates critically minded inquiry in the domain of ordinary economic transactions. A monetary system facilitates the growth of commonsense knowledge in the economy. I call this the growth of knowledge function of money. An awareness of indeterminism and a growth of knowledge like function of money seem to pervade Keynes' General theory.     

Mr Keynes,the Classics and the new Keynesians: A suggested formalisation

Abstract

The paper suggests a new Keynesian model of the General Theory. A reduced form entails a diagram with three curves relating employment and the real wage, which represent the two fundamental classical postulates and the principle of effective demand. This diagram illustrates better than IS–LM the generality of Keynes's theory, clarifying the distinction between voluntary and involuntary unemployment. Other significant features are the role of the distribution of expected interest rates among heterogeneous agents, whether dispersed or concentrated, in shaping the LM curve, as well as the role of wage competitiveness constraints as a foundation of Keynes's relative wage hypothesis.     

The Dynamics of Inflation and Employment in the Full-Employment Zone: A Theoretical Analysis*

The paper is concerned with an economy in which some sectors reach full employment before others as demand expands. The position of short-run equilibrium of employment and excess demand is determined by the intersection of the aggregate demand schedule and the short-run output function, which shows the level of output induced by different levels of aggregate demand. The dynamics of the short-run equilibrium position are explored. It is shown that equilibrating forces due to relative price changes must predominate over disequilibrating forces due to the redistribution of income, in the absence of exogenous shocks and induced cost inflation. The latter is shown to be subject to a multiplier effect. The paper ends by drawing the policy implications of the analysis. It refutes the acceleration thesis by showing that the level of the real wage does not tend to change under excess demand and argues that if the economy is taken into the full employment zone forces will be set to work which tend to remove the bottlenecks.     

Sectoral Changes in Employment: An eclectic perspective on ‘good’ jobs and ‘poor’ jobs

The linkage Keynes established between the volume of employment that business firms require to make a particular number of jobs available provides an operational perspective about the way in which labor markets work. The aggregate supply or Z function is, in fact, a job offer curve. The most significant insight to derive from this curve is that job offers are inseparable from the economy's aggregate expenditure (or demand) level. This interdependency of aggregate supply and aggregate demand is necessary to understand the functioning of labor markets in the real world. This paper argues that a disaggregated model which encapsulates the economy's price-taking and price-making sectors offers a promising analytical tool to gain perspective about ‘good jobs’ and ‘poor jobs’ in post-Fordist economies. It is maintained that the sectoral deployment of workers reflects whether employing firms, as price-makers, can capture the increasing returns inherent in modern technology.     

Joan Robinson and the three cambridge revolutions

Joan Robinson's association with three Cambridge ‘revolutions’—imperfect competition, effective demand and capital theory—is examined in the context of her personal and intellectual partnership with Richard Kahn, John Maynard Keynes and Piero Sraffa. Initially, imperfect competition appeared to have successfully extended marginal analysis to all market forms. It also allowed Richard Kahn and Joan Robinson to persuade Keynes to present the main argument of The General Theory in terms of aggregate demand and aggregate supply. By the early 1950s, however, Joan Robinson had rejected the Marshallian methodology and had become a strenuous censor of neoclassical theory. In this paper the origin of her critique is traced to her reading of Sraffa's Introduction to Ricardo's Principles.     

Money as an Institution of Capitalism: Some Notes on a Monetary Theory of Uncertainty

Dillard notes that to consider money as an institution of capitalism means to emphasize that money is an essential element in explaining fluctuations in income and employment. He states that Keynes's liquidity preference theory offers a sound explanation of money as an institution of capitalism. Keynes's explanation is based on a necessary condition, independent of money: the presence of uncertainty. The objective of the paper is to elaborate a different explanation of the role of money, based on Keynes's 1933 and 1937–39 works, according to which the presence of money constitutes the necessary condition to justify the importance of uncertainty.