Money, Uncertainty and Time

Giuseppe Fontana

• Publisher: Taylor & Francis
• Year: 2008
• Print ISBN: 9780415588737
• eBook ISBN: 9781134466306
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This excellent new book from one of the brightest young economists, Giuseppe Fontana, involves a compendium of issues surrounding uncertainty, money and time. Fontana shines a post Keynesian light onto statements and claims made by well-known neo-classical authors and as such leaves readers with an interesting and informative book to be read a

1 Introduction

Money, uncertainty and time

This book starts from a simple observation, namely that Keynesian economics, broadly defined as the theoretical approach that seeks inspiration in Keynes’s writings, has made important contributions to the economics discipline, and it remains a driving force in the development of new theories and methods of analysis. For instance, in his Nobel Prize lecture in December 2001, George Akerlof explained that the research programme for which he received the prestigious prize was nothing but the development of behavioural macroeconomics in the original spirit of Keynes’s General Theory (1936) (Akerlof 2002: 411). He also referred to the diminished authority of Keynesian economics from the late-1960s and 1970s together with the resurgence of Classical economics as a significant development in the history of the economics discipline. For all the progress on the microeconomic foundations of price and wage decisions, New Classical macroeconomics failed to account for real-world phenomena such as involuntary unemployment and rising income inequalities (see also Stiglitz 2002: 489). Akerlof concludes his review of modern theories that explicitly attempt to provide explanations for, and solutions to, these real-world phenomena by stating that Keynes’s work was a major driving force in the development of New Keynesian theories, and more generally the greatest contribution to behavioural economics before the present era. This profound vitality of Keynesian economics is indicative of the significance of Keynes’s insights into the working of modern economies. It confirms the high reference power of economic ideas that have had to face, and consequently be adapted to, a variety of often very different historical circumstances.

The term Keynesian economics has usually been used to label the core theoretical ideas of Keynes’s magnum opus, The General Theory of Employment, Interest and Money (1936), and its policy implications (Eatwell 1987: 46–47, Kregel 1987a). More precisely, Keynesian economics has usually been associated with the tendency to replace changes in the interest rate and other prices, with changes in the level of national income as the main factor of adjustment between investment and saving. In Keynesian analysis, income effects take priority over price changes in the process of formation of the overall level of output and employment. This idea was directly derived from the principle of effective demand, which downplayed the price mechanism, and promoted, via the multiplier analysis, the link between autonomous expenditure (e.g. investment) and income. This view leads to the conclusion that in a market economy there is no automatic tendency either in the short or long period¹ ensuring that the level of output corresponds to the full employment level. The economy could thus reach an equilibrium position with output far below capacity.

In terms of policy formation, this means that it should be the responsibility of the government to intervene in the economy by managing, via fiscal and monetary policies, a level of aggregate demand that would generate full employment. The distinctive features of Keynesian economics can thus be summarised into three basic propositions (Fontana and Gerrard 2006).

Proposition I (the possibility of involuntary unemployment): the economy does not automatically and effectively self-adjust towards the social macroeconomic optimum.

Proposition II (the principle of effective demand): aggregate demand plays an important role in determining the adjustment path of the economy.

Proposition III (the principle of policy effectiveness): fiscal and monetary policies are effective for determining, under certain circumstances, the level of output and employment in the economy.

Propositions I—III serve two purposes. First, they are useful for defining Keynesian economics vis-à-vis Neoclassical economics. From this perspective, Keynesian economists are dissenters who question the characteristic Neoclassical proposition that market economies automatically self-adjust to the full employment level of output. In Neoclassical economics involuntary employment is a logically untenable position (Dixon 2000). Could not unemployed workers obtain a job if only they were willing to reduce their reservation wage? The answer of Keynesian economists to this question is no. Involuntarily unemployed workers are willing to accept, but cannot obtain, jobs identical to those currently held by workers with identical ability. Involuntary unemployment is a meaningful concept, and it gives strength to the principles of effective demand and policy effectiveness.

Second, Propositions I—III are an effective way to introduce the particular contributions made by different interpreters of Keynesian economics. For instance, the distinct position of the scholars discussed in this book, the Post Keynesian economists, is to accept the possibility of involuntary unemployment (Proposition I), and to argue that aggregate demand affects the adjustment path of the economy, which also impacts on any equilibrium position which may or may not be reached (Proposition II). Furthermore, Post Keynesian economists maintain that aggregate demand has long-run effects on economic activities; hence by managing fiscal and monetary policies, the government can generate a satisfactory level of output and employment (Proposition III). By contrast, New Keynesian economists qualify their interpretations of the Keynesian propositions in terms of the distinction between short-run and long-run models. In the former, New Keynesian economists support Propositions I—III, but in the latter they revert to the Neoclassical principle that market economies automatically self-adjust to the full employment level of output. For this reason, New Keynesian economists are usually sceptical about the long-run real effects of changes in the components of aggregate demand, and the role of stabilisation policies, more generally. In brief, Propositions I—III serve the dual objectives of broadly defining Keynesian economics vis-à-vis Neoclassical economics, and of allowing for different interpretations of Keynesian economics. This second objective has an immediate application for the purpose of this introductory chapter, since it helps to explain the fact that the nature of Keynesian dissent has always been a source of debate.

Keynes himself presented the publication of the General Theory as a challenge to the economic establishment, a frontal attack on Classical theory (Keynes 1935a). However, in the same book Keynes asserts that ‘if our central controls succeed in establishing an aggregate volume of output corresponding to full employment as nearly as is practicable, the Classical theory comes into its own again from this point onwards’ (Keynes 1936: 378). This seductive, if arguably contradictory, position towards Classical and then Neoclassical economics has also been an important feature of the historical development of Keynesian economics. Over the past decades, several economists have claimed to be inspired by Keynes’s ideas, but many more have clearly also been so inspired. Several approaches have been put forward claiming to have made important contributions to the development of Keynesian economics. Yet, during this time wide divergences have emerged over the degree to which Neoclassical economics must be rejected or extended in order to accommodate the Keynesian Propositions I—III.

On one side, it has been argued that the different interpretations of Keynesian economics reflect the evolution of the economic discipline. As the discipline has evolved, the nature of the Keynesian dissent vis-à-vis Neoclassical economics has changed. On the other side, it has been suggested that the sheer scale and complexity of Keynes’s writings explain the emergence of several Keynesian approaches. Different Keynesian scholars have been inspired by different writings and, as in the case of the General Theory, even by different chapters of the same work. Whatever the cause, the vigour and changing forms of Keynesian economics are indicative of the high reference power of the three Keynesian propositions. This also means that it is beyond the scope of this book to present and evaluate in any depth the numerous and influential contributions that have usually been associated with Keynesian economics. The objective of this book is indeed more modest. The book looks at a specific research programme within Keynesian economics, namely the Post Keynesian approach. Even with this limitation, the scope of the book would still be vast, so the book mainly aims to provide a coherent framework for assessing recent contributions to the monetary stream of Post Keynesian economics. In the next section some possible reasons for the emergence of several approaches to Keynesian economics are briefly discussed, before concluding with an overview of the book’s content.

The changing nature of the Keynesian dissent

The nature and origin of the Keynesian dissent vis-à-vis Neoclassical economics has always been a source of much debate. A common explanation for this debate is the lack of common purpose in Keynesian dissent, which simply illustrates the way in which a discipline like economics evolves over time (e.g. Laidler 1999). According to this evolutionary view, before attaining recognition into mainstream economics, it is obvious that the relationship between any new theory and existing theories needs to be explored. Then, the novelty and importance of the new theory must be conveyed to other practitioners, and finally to policy-makers and the public at large. Therefore, in the process of being absorbed into mainstream economics the new theory loses some of its original features, and new attributes are added. From this perspective, it is not surprising that Keynesian ideas as represented by Propositions I—III have taken on forms that Keynes may have not foreseen, or that he may not have encouraged (see, for a similar conclusion, Coddington 1976). Along these lines, it is also argued that this process of absorption of Keynesian ideas into economics is a dynamic ever-changing process. In other words, if economics is continually evolving, it is natural that the nature and the forms of dissent within the discipline would also change over time.

However, this book subscribes to the view that there is much more to Keynesian dissent than is allowed by an evolutionary explanation. The ‘Cambridge—Cambridge Capital Theory Controversies’ over the concepts of aggregate capital and the economic meaning of capital are a case in point. Cohen and Harcourt (2003) have argued that the Capital Theory Controversies highlighted more than the logical problems of using the concept of aggregate capital in price theory. What was really at stake was the problematic issue of different ideologies and visions in economics. How best could the accumulation process in a capitalist society be envisaged and modelled? On one side, there was the Keynesian tradition pointing towards the role of competing social groups in the economic process. This was the world of entrepreneurs and capitalists defining the so-called monetary context of behaviour (Fontana and Gerrard 2002b), in which accumulation, production and exchange activities are undertaken to achieve monetary, not commodity, returns (Keynes’s M-C-M′ economy; see Keynes (1979: 81), and related discussion in Chapter 5 below). On the other side, there was the Neoclassical tradition of the utility-maximising agent. In the orthodox spirit of this tradition, the capital theory controversies prompted refinements and further amendments to the original price theory.

For the closest colleagues and followers of Keynes the outcome of these controversies called into question the general use of the Neoclassical approach to economics. In particular, Joan Robinson lamented that the original purpose of Keynes’s work had been completely misunderstood. Keynes had presented the General Theory as the final result of a long struggle to escape from the old Neoclassical modes of thought and expression (Keynes 1936: xxiii). As Keynes explained in the one-page-long Chapter 1 of the General Theory, the fatal flaw of the Neoclassical approach lay in the nature of the axioms that were necessary to demonstrate the self-correcting tendency of the economic system. These axioms have been asserted, more often implicitly than explicitly, as universal truths. By contrast, the restricted applicability of these axioms meant that important economic phenomena such as prolonged mass unemployment could not be explained by Neoclassical theory. For this reason, Keynes felt the need to develop a less restrictive, axiomatic theory of unemployment, namely the General Theory.

I have called this book the General Theory of Employment, Interest and Money, placing the emphasis on the prefix general. The object of such a title is to contrast the character of my arguments and conclusions with those of the classical theory of the subject…. I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case…. 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….

(Keynes 1936: 3, italics in the original)

Robinson argued forcefully that what the process of absorption into the mainstream had done was to transform the General Theory and related writings into a special case of the general Neoclassical theory of employment, interest and money. Keynesian economics had become synonymous with the economics of depressions and equilibrium unemployment. Keynesian economics was simply the application of the general Neoclassical theory to the restrictive case of less-than-full-employment equilibrium (Robinson 1971, see also Davidson 1994: 292, Pasinetti 1999: 22).

Another explanation for the lack of commonality in Keynesian dissent is the scale and complexity of Keynes’s writings.² The Collected Writings of John Maynard Keynes number 30 volumes. Moreover, the interpretation of this large number of writings entails a lot of difficulties, not least because of the peculiar tradition of studying economics at Cambridge. Several scholars have often argued that, like many of his Cambridge colleagues, Keynes had a very practical view of economics (Harcourt 1998: 335, see also Kaldor 1982a: 3, Pasinetti 2005). Keynes was mostly concerned with the effective working of actual economic systems within a well-defined institutional structure. His analysis proceeded more on the basis of intuition than of a rigid theoretical system. For the sake of exploring his intuition, Keynes would thus accept established theories, without questioning their fundamental principles, until such questioning was forced on him by the search for consistency between the established model and his own intuitive reasoning. Therefore, his writings relate sometimes to first principles, sometimes to practical circumstances and sometimes to both. This multidimensional aspect of Keynes’s writings has therefore allowed scholars to focus on different parts of his writings or, as is the case of the General Theory, on different chapters of the same work. As a result of this heterogeneity of sources, the Keynesian challenge to the Classical concept of the invisible hand has assumed a variety of forms and meanings, including IS-LM Keynesianism, Disequilibrium Keynesianism, New Keynesianism and Fundamentalist Keynesianism. And it does not stop there. Today, Fundamentalist Keynesianism is called Post Keynesianism, which in a broad definition includes Neo-Ricardian Keynesianism, Kaleckian Keynesianism, Monetary Circuit Keynesianism and, for want of a better name, Non-ergodic/ Monetary Keynesianism³ (Hodgson 1989, King 2003). An example may help to illustrate how the multi-dimensional aspect of Keynes’s writings has affected the different nature of these ‘Keynesianisms’.

Coddington has used the term ‘Fundamentalist Keynesianism’ to describe the work of Post Keynesian scholars like Joan Robinson and George Shackle, who believed that the analysis of the effects of uncertainty on investment in Chapter 12 of the General Theory was the essence of Keynes’s theory (Coddington 1976: 1259–1263). In this case, Coddington is making a dual claim. First, for Post Keynesian economists, the writings of Keynes are related mostly, if not exclusively, to first principles. Second, uncertainty is a first principle informing Keynes’s dissent against the invisible hand theorem, and hence it represents the guiding principle for the development of the Post Keynesian dissenting view. Other commentators have preferred to underplay the role of first principles, and focused on the practical circumstances that have guided some of the most popular writings of Keynes. In particular, it is well known that by the early 1930s Keynes felt that worldwide mass unemployment was a serious and persistent problem in urgent need of a new economic solution. For this purpose, he embarked on the writing of the General Theory. The possibility of mass unemployment, now as then, has thus become one of the main features of the Keynesian dissent. As uncontroversial as this proposition could be, it has become a source of great dispute between New Keynesian and Post Keynesian economists. For example, Dixon (2000) describes the New Keynesian dissent in terms of theoretical explanations for the existence in our modern economies of nominal rigidities and less-than-perfect information that give rise to the phenomenon of involuntary unemployment (among other phenomena). According to Dixon, the appeal to the Keynesian result of involuntary unemployment has set the agenda for the New Keynesian dissent. In this sense, whatever the nature of the first principles adopted, New Keynesian scholars believe that the real world keeps on revealing itself more on the side of Keynes than on the side of Neoclassical economics. It may indeed be argued that New Keynesian economics shares the same first principles as Neoclassical economics, but it differs from the latter since it considers nominal rigidities and less-than-perfect information as stylised macroeconomic facts in urgent need of (microeconomic) explanations (Rotheim 1998). For this reason, most Post Keynesians have called into question the Keynesian dissent in New Keynesian economics. According to Davidson and Post Keynesian economists more generally, the Keynesian dissent is related to first principles, and therefore the New Keynesian attempt to forge Keynesian results from the axiomatic principles of Neoclassical economics is wrong-headed. As Davidson has aptly put it, where is the Keynesian beef in New Keynesian economics (Davidson 1994: 290)? In short, differences over the degree to which Neoclassical economics must be rejected or extended in order to accommodate Keynesian ideas can be explained to a certain degree by the multi-dimensional aspects of Keynes’s writings. Since those writings are related in part to first principles, and in part to practical circumstances, different Keynesian economists have given different weight to these two features in their theories.

This multi-dimensional aspect of Keynes’s writings has been a controversial issue not only between different Keynesian schools, but also within some of them. In particular, it has led to the emergence of a variety of theories and methods of analysis within Post Keynesian economics. Coddington has expounded the view that Fundamentalist Keynesians relate Keynes’s writings mostly, if not exclusively, to first principles (Coddington 1976). This view is now well accepted by Post Keynesian scholars (e.g. Gerrard 2003). However, what those first principles are and how they should be used for the development of the Post Keynesian dissent is not yet clear. In particular, are these first principles related to economic theory, methodology or policy issues, or to all of these facets together? The aim of this book is to provide an answer to these questions by arguing that money, uncertainty and time are three important first principles of Post Keynesian dissent and that these principles are related to economic theory and methodology.

Outline of the book

The book is divided into three parts. Part I sets the frame of reference for the remaining chapters of the book. It deals with the historical development of Post Keynesian economics and the lessons that can be learned from its successes and failures. In the previous section it has been argued that Keynesian economists are dissenters who question the characteristic Classical/Neoclassical proposition that market economies automatically self-adjust to the full employment level of output. In Chapter 2 the nature of the Post Keynesian dissent is analysed in its historical evolution through what have been labelled the ‘romantic age’ and the ‘age of uncertainty’. The former describes the period of optimism and excitement of the 1960s and 1970s, when Post Keynesian economics was considered to be an original theoretical system on the brink of replacing the dominant Neoclassical paradigm. The latter refers to the period of doubt and deep internal divisions, which followed the intense debate of the 1980s and early 1990s on the methodolical features of Post Keynesian economics. For this reason, Chapter 3 is devoted to the intimate relationship between theory and methodology in economics. In particular, Chapter 3 d...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• List of illustrations
• Acknowledgements
• Preface
• Foreword by Geoff Harcourt
• 1 Introduction: Money, uncertainty and time
• PART I Keynes, the ‘Classics’ and the modern Keynesian dissent
• PART II From rationality to unemployment and the Monetary Circuit
• PART III Understanding endogenous money
• Bibliography