Macroeconomic Analysis in the Classical Tradition

The Impediments Of Keynes's Influence

James C W Ahiakpor

• Publisher: Routledge
• Year: 2021
• ISBN:
  9781000360417
• Edition: 1
• Topic: Economics
• Subtopic: Economic History
• Index: Economics

Macroeconomic Analysis in the Classical Tradition explains how the influence of Keynes's macroeconomics, including his changed definitions of some key macroeconomic concepts, has impeded many analysts' ability to readily resolve disputes in modern macroeconomics.

Expanding on his earlier work— Macroeconomics without the Errors of Keynes (2019)—the author delves into more aspects of macroeconomic theory and argues for a revision of Keynes's contribution to the field. Attention is given to theories and concepts such as Say's Law, the quantity theory of money, the liquidity trap, the permanent income hypothesis, 100% money, and the Phillips curve analysis. The chapters work to build a careful critique of Keynes's economics and make the case that the classical macroeconomics of Smith, Say, Ricardo, Mill, and others could help resolve present-day policy disagreements and redefine macroeconomic priorities.

This book provides essential reading for advanced students and scholars with an interest in the foundations of Keynes's theories and current debates within macroeconomic policy.

1 Introduction

The pervasive impediment of Keynes’s influence in modern macroeconomic analysis

Ten years after the publication of his very influential General Theory of Employment, Interest, and Money (1936), Keynes (1946) disowned some of the arguments being made in his name by several of his ardent followers, especially Joan Robinson, Richard Kahn, and Nicholas Kaldor. Keynes lamented “how much modernist stuff, gone wrong and turned sour and silly, is circulating in our system” (1946: 186). In the article, Keynes also recalls his statement in the House of Lords that he was attempting “to use what we have learnt from modern experience and modern analysis, not to defeat, but to implement the wisdom of Adam Smith” (ibid). Keynes earlier declared, “I am not a Keynesian” (Hutchison 1981: 123). Also, after a 1944 dinner meeting in Washington, D.C., Keynes told his wife, Lydia Lopokova, and Austin Robinson at breakfast that “I was the only non-Keynesian there” (Hutchison 1977: 58). However, it appears Keynes did not connect the new language (definitions) he had introduced into modern macroeconomic analysis with the tenacity of his followership.

As previously discussed in Ahiakpor (1998b, 2003b, and 2019), Keynes’s changed meaning of such important economic terms as saving, capital, investment, and money from their classical definitions (see Jacob Viner 1936, A.C. Pigou 1936, and Frank Knight 1937) was mostly responsible for his ardent followers’ persistence in their views. This even as Keynes (1937b) acknowledges that “the clue to the peculiarity of my new doctrine is to be found in my definitions of Income, Saving, Investment and such other terms” (249–50). His followers did not, and many still do not, question the accuracy or appropriateness of his new definitions. For example, Michael Lawlor ignores practically everything written in criticism of Keynes’s General Theory and claims, “My reading of Keynes manifestly does find him to be a variety of what I suppose is now called ‘Post Keynesian’” (2006: 5). That is the variety of Keynesians who do not accept the market equilibrating process of supply and demand analysis. Thus, Lawlor describes his research project as, “How Keynes Came to Be a Post Keynesian” (ibid).¹

Milton Friedman also failed to take into account his teachers’, Jacob Viner (1936) and Frank Knight (1937), criticisms of Keynes for having changed the meaning of economic terms. Thus, employing Keynes’s new meaning of concepts, Friedman declares, “Rereading the General Theory … has … reminded me what a great economist Keynes was and how much more I sympathize with his approach and aims than with those of many of his followers” (1970a: 134).² This after his observing that “The General Theory is a great book, at once more naїve and more profound than the ‘Keynesian economics’ that Leijonhufvud contrasts with the ‘economics of Keynes’” (ibid: 133). These observations follow Friedman’s (1968b: 15; italics added) earlier declaration that “in one sense, we are all Keynesians now; in another, no one is a Keynesian any longer. We all use the Keynesian language and apparatus; none of us any longer accepts the initial Keynesian conclusions.” Friedman’s dissent on “Keynesian conclusions” derives from his faulting Keynes’s explanation of the Great Depression as having indicated the impotence of monetary policy to revive an economy from a depression (1970b, 1997).³ Nevertheless, he notes, “Keynes’s bequest to technical economics was strongly positive” (1997: 13).

Judge Richard Posner’s 2009 declaration that he had become a Keynesian after reading the General Theory is another excellent example of how Keynes’s changed meaning of economic terms has been greatly influential in gaining him followership.⁴ Posner, for decades, had been hailed as a prominent member of the economic libertarian philosophy movement. He associated himself with the Chicago School of Economics (of which Milton Friedman was a leader) and ran a joint blog, “The Becker-Posner Blog,” with the Nobel Economics laureate, Gary Becker, between December 2004 and May 2014. Posner’s account of the novelties he found in reading the General Theory includes (a) Keynes’s declaring “consumption is the sole aim and object of economic activity,” but without Posner’s acknowledging Adam Smith (WN, 2:179 ) earlier having made the same observation,⁵ (b) Keynes’s treatment of saving as non-spending but as cash hoarding and thus injurious to an economy’s growth, (c) Keynes’s treatment of consumption as the driver of an economy’s growth, along the lines of the discredited expenditure multiplier process,⁶ (d) Keynes’s treatment of investment as only the purchase of physical goods, unrelated to the issuing and purchasing of financial assets, (e) Keynes’s treatment of government expenditure as not depending upon the public’s income through taxation and issuing debt (bonds), (f) Keynes’s treatment of interest rates as being determined by the supply and demand for central bank money rather than by the supply and demand for credit, of which variations in central bank’s money supply are a minor part, (g) Keynes’s emphasizing the pervasiveness of uncertainty about the future, and (h) Keynes’s inviting control over the economy by government bureaucrats; they necessarily must suffer the same ignorance about the future as private business operators.

It also has not helped the correct appreciation of classical macro-monetary analysis that Keynes attributed two incorrect assumptions to it, namely, (a) that there is always full employment of labor and (b) business people form expectations about the future with complete certainty or that they have perfect foresight. The full-employment assumption greatly has helped to distract attention from classical economic analysis since the occurrence of involuntary unemployment tends to be the norm in practically all market economies. However, A.C. Pigou’s (1941) strong denials of the relevance of the full-employment assumption to classical macroeconomics analysis appear to be undermined by his Lapses from Full Employment (1945). The latter book appears to argue that, but for the lack of free competition among workers for jobs and fluctuations in the labor money demand function, there will always be full employment: “In stable conditions, apart from frictions, immobility [among wage-earners] and so on, thorough-going competition among wage-earners would ensure the establishment and maintenance of full employment except in circumstance which we are very unlikely to meet with in fact” (1945: 25). Pigou even entertained Keynes’s (1936: 263–4) argument that, for a reduction in money wage rates in a period of high unemployment, nominal interest rates also must fall if the rate of unemployment is to decrease (Pigou 1945: 12–17).⁷ A more helpful explanation would have been to show the irrelevance of the full-employment assumption to the classical theories that Keynes claimed needed it for their validity, including the theory of interest rates, determination of the level of prices—the Quantity Theory of Money—and inflation, the forced-saving doctrine, and Say’s law of markets.⁸

The second assumption, the alleged certainty of expectations about the future, has tended to persuade many that Keynes’s macroeconomics is more relevant to the world of uncertainty than classical analysis. Now it is common knowledge that some pay astrologers to foretell the future while many economic forecasters tend to be in demand as business consultants or by the news media to foretell the future of the economy. This even though classical analysis includes sellers’ adjustment of their supplies to actual market conditions when reality conflicts with their expectations, e.g. Smith’s (WN, 1, 63–70) description of producers’ adjustment of their supplies to the “effectual demand.” Smith also explains,

The establishment of any new manufacture, of any new branch of commerce, or of any new practice in agriculture, is always a speculation, from which the projector promises himself extraordinary profits. These profits sometimes are very great, and sometimes, more frequently, perhaps, they are quiet otherwise.

(WN, 1: 128; italics added)

Similar discussions of producers revising their production plans to suit market conditions in conflict with their expectations are discussed in the context of the law of markets by Jean-Baptiste Say, David Ricardo, James Mill, and John Stuart Mill, e.g. “the calculations of producers and traders being of necessity imperfect, there are always some commodities which are more or less in excess, as there are always some which are in deficiency” (J.S. Mill 1874: 67; italics added). Alfred Marshall (1920: 289) also declares that “we cannot foresee the future perfectly.”

However, without Keynes’s contemporaries having countered sufficiently his misrepresentations of classical macroeconomic analysis regarding the above two assumptions, it has been hard to stem his onslaught on the relevance of classical analysis at all times. Thus, one of the main reasons Richard Posner gave for his conversion to Keynesianism was economists’ inability to predict the onset of the 2008 financial crisis—“The vast majority of them had been blinded by the housing bubble and the ensuing banking crisis; and misjudged the gravity of the economic downturn that resulted” (2009: 28).⁹

As discussed in Ahiakpor (2019, Chapter 1) the greatly favorable treatment of Keynes’s macroeconomics in Joseph Schumpeter’s highly influential History of Economic Analysis (1954) in contrast with that book’s derisive treatment of classical macroeconomic-monetary analysis (Hume, Smith, Say, Ricardo, and J.S. Mill) also has helped to impede the correct understanding of classical analysis. Thus Schumpeter coins “The Ricardian Vice” derisively to mean “an excellent theory that can never be refuted and lacks nothing save sense” ([1954] 1994: 473; see also 541, 618, 653n, 668) to describe most of classical analysis. But with respect to Keynes, Schumpeter turns the “Ricardian Vice” into a praiseworthy characteristic—being attractive and convincing:

Keynes was Ricardo’s peer in the highest sense of the phrase. But he was Ricardo’s peer also in that his work is a striking example of what we have called above the Ricardian Vice, namely, the habit of piling a heavy load of practical conclusions upon a tenuous groundwork, which was unequal to it yet seemed in its simplicity not only attractive but also convincing.

([1954] 1994: 1171; italics added)

Schumpeter also praised Keynes for having “freed [economists] from scruples [regarding ‘functions of inequality of income concepts’]. His analysis seemed to restore intellectual respectability to anti-saving views and he spelled out the implications of this in Chapter 24 of the General Theory” ([1954] 1994: 1171).

Now the classics taught that saving, which is the purchase of interest- and/or dividend-earning financial assets, and not cash hoarding, contributes to economic growth. Alfred Marshall (1923: 46; italics added) also explains that “in ‘western’ countries even peasants, if well to do, incline to invest the greater part of their savings in Government, or other familiar stock exchange securities, or to commit them to the charge of a bank.” But in Keynes’s definition, saving is merely non-consumption (1930, 1: 172; 1936: 61–5, 74, 210), and equivalent to cash hoarding (1936: 166–7). Investment, on the other hand, means only the purchase of capital goods (1936: 62). Thus, Keynes’s definitions prevented him from recognizing the validity of the classical argument that saving promotes investment and economic growth. Keynes (1930, 1936) instead came up with his paradox of thrift, in which increased saving decreases an economy’s growth; Ahiakpor (1995) elaborates.

Schumpeter failed to recognize the error of Keynes’s definitions and argued instead that Smith and A.R.J. Turgot’s linking savings with investment was “their most serious shortcoming” ([1954] 1994: 324, n. 2). Schumpeter also bemoans the classical argument that saving supplies “capital,” arguing: “What a mass of confused, futile, and downright silly controversies it would have saved us, if economists had had the sense to stick to those monetary and accounting meanings of the term [capital] instead of trying to ‘deepen’ them” ([1954] 1994: 323). He could have benefited from John Stuart Mill’s (Works, 2: 70–2) “third fundamental theorem regarding Capital,” for example. Thus the Keynes–Schumpeter view of saving and investment has become a standard critique of classical analysis by most modern macroeconomists.¹⁰

Schumpeter also praised the impact of Keynes’s macroeconomic analysis:

Particularly in its bearing upon saving, interest, and underemployment, this message seemed to reveal a novel view of the capitalist process not only … to the public and “writers on the fringes” but also to many of the best minds in the sphere of professional analysis—a novel view that was as attractive to some as its was repellent to others … an achievement, frank recognition of which is the greatest and most deserved of the compliments that may be paid justifiably to the memory of Lord Keynes.

([1954] 1994: 1180–1)

Schumpeter indeed concludes his chapter on Keynes with: “In a history of economic thought Keynes’s policy recommendations—time-bound as they were—and certain characteristically Keynes’s doctrines—which are losing their hold already—may be much more important” (ibid: 1184).

It has been a long struggle to publicize Keynes’s misrepresentations of classical macroeconomic analysis against such powerful influence as Schumpeter’s. Thus, a referee for the proposed manuscript for this book reacted to my explaining Schumpeter’s praise of Keynes’s work to the detriment of the classics by declaring it as “completely false.” Referring to Schumpeter’s application of the “Ricardian Vice” to Keynes, but without the label, the referee argues,

Schumpeter strongly objected to Keynes’ theory (his review of the General Theory is worldwide famous for being a spiteful and harsh criticism) and his History of economic analysis states that the General Theory was “a striking example of […] piling a heavy load of practical conclusions upon a tenuous groundwork.” The doubt arises about the author ever really read Schumpeter at all.¹¹

Indeed, other than Keynes’s money (cash) supply and demand ...