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Keynes's General Theory, chapter six
Keynes does all this huffing and puffing about terms and finally he stumbles into his mention of Hayek. Hayek had written some now-obscure articles about net investment and measures of the capital stock, reprinted in Profits, Interest, and Investment. (Here is an excellent Lawrence H. White essay on this part of Hayek's thought.) Keynes wants to show he doesn't have to worry about these debates. Keynes is also trying to liberate himself from his previous (1930) two-volume Treatise on Money, a disappointing work. At the end of section (i) you get the clincher: "For this reason, and also because I no longer require my former terms to express my ideas accurately, I have decided to discard them -- with much regret for the confusion which they have caused."
Again, in part ii the bombshell comes, unannounced. Keynes decides that he will declare savings to be a "mere residual." Consumption and investment alone will determine income and savings is defined as whatever is left over to make the national income equations balance.
At the time this was considered by many to be an enormous sleight of hand. The Austrian and Swedish traditions focused on the question of whether planned savings was going to equal planned investment and what happens if not. Keynes has just banished such questions to the woodshed and he has done so by a terminological maneuver.
Whether or not you think that the Austrian and Swedish traditions lead anywhere fruitful, Keynes is on shaky ground here. He is using definitions to favor one causal account of macro over another. That's not right. You can still make a plausible argument that Keynes is right on empirical grounds that planned savings is not an important force for understanding business cycles. But so far no such empirical argument has been clinched.
In the second to last paragraph Keynes realizes that in his system savings does not and cannot constrain investment. He notes that if animal spirits were wild enough, the price of output could fluctuate between zero and infinity. Neither interest rates nor savings plans perform any of their traditional constraining or equilibrating functions. At least Keynes realized how far out on a limb he was going.
Due to popular request, we'll resume with the Keynes symposium in January but take a break for the close of the semester.
Posted by Tyler Cowen on December 15, 2008 at 11:05 PM in Books, Economics | Permalink
Comments
Keynes has more people fooled than Jesus.
Posted by: David Koresh at Dec 16, 2008 2:22:55 AM
This bombshell has caused great problems all over the world, if you care about heterodox economics. There are classes of models that ignore completely the role of savings, even if the economy is above potential.
Vulgar keynesianism, Krugman would say.
That kind of models uses the famous relationship: Y = C + I + G + (X-M) to claim that any reduction in consumption can only cause an equal reduction in income, therefore, a higher savings rate can only reduce income, and have NO effect in investment decision.
Posted by: Rafael at Dec 16, 2008 7:29:46 AM
Or, as Hayek never tired of saying, Keynes had walked off a cliff -- into a bizzaro post scarcity world. Decree that savings and produced means of production aren't part of the explanans of economic patterns, and you've entered a world were all goods are mana from heaven and everything single things is effectively oversupplied in a costless "glut". (See Hayek's discussion in 4 of _The Pure Theory of Capital_, where he discusses the Keynesian post scarcity model.)
In alternative words, Keynes has created a bizzaro world where "Say's Law" has been refuted by the fiat of definition (talk about Cambridge epistemology!) and neither the empirical world nor the theorizing economists are constrained by the scarcity of causally inter-related produced means of production with systematically changing valuations.
And note well, when Keynes wrote,"For this reason, and also because I no longer require my former terms to express my ideas accurately, I have decided to discard them -- with much regret for the confusion which they have caused", Hayek essentially gave up on the idea that Keynes was a serious scientists who wouldn't abandon his most labored theoretical constructions at the drop of the hat to take up another line of argument, as the political needs of the moment demanded it. From Hayek's perspective, Hayek had made the mistake of taking Keynes seriously, labored hard to show Keynes the error of his ways, and Keynes simply said "never mind" -- and went on to construct even more elaborate and ludicrous theoretical expediencies justifying his political policies of the moment.
Hayek's conclusion? Keynes would say "never mind" again, throwing everything overboard when his policy needs changed, turning any prior criticism of Keynes into a giant waste of time. And so Hayek ignored the temporary technical details of Keynes' work -- and instead attacked Keynes and the rest of the profession at the most fundamental level, in his papers on how to do science in the field of economics, e.g. Hayek's papers "Economics and Knowledge" and "Scientism and the Study of Society", and chapters 1, 2, and 3 of _The Pure Theory of Capital_ -- ideas Hayek later revisited in his Nobel Prize lecture.
What Hayek never anticipated was that Keynes would never have a chance to change his mind again, do to his sudden death, nor that the whole world of politics would embrace vulgar Keynesianism, and in a related development the economists inside government and in the university would embrace various mathematical forms of Keynes as the central totems of "scientific" macroeconomics.
Tyler writes:
"In the second to last paragraph Keynes realizes that in his system savings does not and cannot constrain investment. He notes that if animal spirits were wild enough, the price of output could fluctuate between zero and infinity. Neither interest rates nor savings plans perform any of their traditional constraining or equilibrating functions. At least Keynes realized how far out on a limb he was going."
Posted by: Greg Ransom at Dec 16, 2008 2:05:37 PM
On his blog Bob Murphy gives the temporary special case policy politics behind the writing of Keynes' _General Theory_, as Hayek viewed it:
http://consultingbyrpm.com/blog/2008/12/hayek-tells-bill-buckley-that-even.html
>>Hayek explains that in Great Britain during World War I, the pound was cut loose from gold, leading to large increases in prices and wages. Then after the war, the British government wanted to return to pre-war parity. Prices generally came down, but nominal wage rates remained high. Thus, workers saw a huge increase in their real wages because of the efforts at deflation (needed to go back on the gold standard at the old parity).
So, in order to prevent widespread unemployment (i.e. allow British workers to be competitive with the rest of the world), they either had to lower nominal wages or raise prices again. Hayek explains that the first option was politically unpopular, and also was--according to a complicated argument from Keynes' General Theory--not even effective. (I.e. Keynes argued in his book that even if all nominal wages fell, that might end up reducing overall prices and hence not lead to a fall in real wages.)
But now the awesome part. Hayek says that Keynes' theory was, at best, appropriate for the specific deflationary environment of the 1930s. After the war had passed, the great danger was inflation. And--according to Hayek--Keynes himself agreed with this, and even promised to rein in his foolish disciples if they ever got the crazy notion to advocate pump-priming in an inflationary environment. But alas, Keynes died six months after pledging this to Hayek.<<
Posted by: Greg Ransom at Dec 16, 2008 3:06:02 PM
>>He notes that if animal spirits were wild enough, the price of output could fluctuate between zero and infinity.<<
Don't the last few months provide a little evidence to support that ?
Posted by: Nigel at Dec 17, 2008 6:02:19 AM
Greg, you and Hayek are mostly right. But not quite. What Keynes did was to freeze the capital structure in Chapter 4. Hence there is not no scarcity, there is a ceiling. Labour remains variable though. Therefore all problems can be accounted for by appealing to means of artificially increasing employment.
Regarding Bob Murphy's post. He is right in his description of the British Great Slump. It was very different from the Great Depression which started eight years later. Much of the problem though was not in competition with the rest of the world. It was in contracts. Many sorts of arrangements had being made depending on the devalued pound. When Churchill took the pound back to its pre-war level in 1922 those arrangement continued. Wages contracts often continued for example. Also, savers, had during WWI and after accounted for the fall in the value of money and saved more.
With this in mind read Chapter 3, it makes much more sense.
Posted by: Current at Dec 17, 2008 1:08:08 PM
A curious fact is that in at least the US national income and product
accounts, savings is in fact a residual. Very messy trying to figure
out what planned savings really is from those accounts.
It is probably a sign of a truly hard core Keynesian (or sub-category of
Post Keynesian) when one really does deny any autonomy to savings. Clearly
actual savings does end up being affected by what goes on in the broader
macroeconomy, but I, for one, am certainly willing to grant some meaning
to peoples' marginal propensity to save, which as the textbooks tell us
happens to equal 1 - mpc. Certainly we do see some different attitudes and
propensities to save in different societies and in the same society over time,
with this propensity having declined in the US in the last few decades for a
variety of reasons.
One outcome of that decline was the disproof of Ricardian Equivalence. Reagan
cut income taxes in the 1981, which should have led to a rise in the savings
rate, according to Robert Barro. Instead, the rate fell. I remain mystified
why Barro is such a widely respected economist with him being high on every year's
list for getting the Nobel (presumably for Ricardian Equivalence), although some
of his later work
on growth theory is not too bad.
Posted by: Barkley Rosserr at Dec 17, 2008 5:17:22 PM
Annotated copy of General Theory from UNC student, 1940
I picked up a copy of General Theory on Amazon.com, evidently from a student at University of North Carolina, Chapel Hill, in 1940.
The student was Leonard Arrington, who resumed getting a PhD in economics after WW-II, and became the Mormon historian who organized records for a couple decades before convincing elders to open the archives.
That thoroughness was reflected in Arrington's marks in the General Theory, with fountain pen underlinings to the last page!
I infer that this book was so revered that Arrington's professor (did real professing) covered General Theory from first to last page, rare in a college course.
Some of Arrington's marginal comments added context of the ongoing depression and context of WW-II.
One comment still strikes -- he couldn't tell if Keynes "foreign investment" meant foreigners investing in the U.S. or U.S. investors investing in foreign countries.
Arrington also commented about disparities of income aiding GDP, and crop failures aiding trade.
I get three views from one book -- wonderful.
Posted by: Jameson Burt at Jan 13, 2009 11:57:14 AM
Amazon should have charged Jameson an extra for the precious annotations. A Brazilian would say that Jameson "was born with his ass facing the moon" = lucky.
Posted by: Monica at Feb 9, 2009 1:45:10 PM
