Classical Keynesianism, Monetary Theory, and the Price Level

By Sidney Weintraub

Since I wrote my small volume on A General Theory of the Price Level, etc., I have often been asked for a fuller statement of my views, or my attitude on various matters treated only briefly at that time….I hope that the collection of essays that are contained herein fill in many of these gaps and answer the major part of the queries that admit of such elaboration.”

In my opinion there are two contending theories of the price level: that deriving from the Equation of Exchange in one or another of its forms, and that based on cost, especially wage, phenomena. Thus the debate must be resolved primarily between two major sets of ideas on the subject of inflation. In this light it would be a welcome event, if those Keynesians in economics, who long ago abandoned the various versions of the Quantity Theory of Money and have little truck with the cost theory of the price level, would at least re-examine their views on this subject. It is my deep conviction that most of the literature oriented toward what has been regarded as Keynesian thinking has had very little to contribute toward understanding price level phenomena despite superficial appearances toward the contrary. The importance of this assertion cannot be overstated for, in bulk, this literature is already voluminous and in teaching importance it represents the dominant modern fashion. Yet, in my opinion, on the fundamental problems of price level inflation and deflation, I believe it to be wholly barren and devoid of substance. Perhaps these essays will reveal the stark nakedness of the concepts in the price dimensions that interest all of us.—Sidney Weintraub

• Language: English
• Publisher: Papamoa Press
• Release date: Dec 5, 2018
• ISBN: 9781789126044

Sidney Weintraub

Sidney Weintraub (1914-1983) was an American economist and one of the most prominent American members of the Post Keynesian economics school. He was the co-founder and co-editor of The Journal of Post Keynesian Economics in 1978. His views included criticism of monetarism and the neoclassical synthesis, and promotion of the tax-based incomes policy (TIP). Born on April 28, 1914 in New York City, Weintraub studied for one year at the London School of Economics (1938-1939) and received his Ph.D. from New York University in 1941. He then worked at the Federal Reserve Bank of New York until 1943, when he was drafted into the U.S. Army. In 1945 he joined the faculty of St. John’s University in Brooklyn, New York. In 1950 he joined the faculty of the University of Pennsylvania, and in 1957 he was awarded a Ford Foundation fellowship to travel to Europe. He taught at the University of Waterloo from 1969-1970, and from 1972-1973 he wrote a weekly column for the Philadelphia Bulletin. During his expansive career, Weintraub gave over 500 guest lectures in the U.S., Canada, and Europe, and published 18 books, over 80 scholarly articles, and more than 50 popular articles. He married Sheila Tarlow in August 1940, and he is the father of mathematical economist E. Roy Weintraub. Sidney Weintraub died in Philadelphia on June 19, 1983, aged 69.

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Text originally published in 1961 under the same title.

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CLASSICAL KEYNESIANISM, MONETARY THEORY, AND THE PRICE LEVEL

BY

SIDNEY WEINTRAUB

TABLE OF CONTENTS

Contents

TABLE OF CONTENTS 3

PREFACE 5

Chapter 1—Classical 45° Keynesianism: A Plea for Its Abandonment 7

THE 45° CROSS 11

THE LM-IS CURVES 21

AN ALTERNATE BRAND OF KEYNESIANISM 24

SUMMARY 26

Chapter 2—The Keynesian Theory of Inflation: The Two Faces of Janus? 27

THE 45° LINE AND THE KEYNESIAN EQUILIBRIUM CROSS 29

AGGREGATE MONEY DEMAND AND AGGREGATE MONEY SUPPLY FUNCTIONS 35

THE BASIS AND POLICY CONSEQUENCES OF THE DIVERGENCE IN VIEWS 38

Chapter 3—The Theory of the Price Level and the Analysis of Inflation 40

THE WAGE-COST MARK-UP EQUATION 44

SUMMARY 57

Chapter 4—The Equation of Exchange and the Theory of the Price Level 58

THE ULTIMATE QUANTITY THEORY IN EOE RECOMMENDATIONS 75

A NOTE ON THE CAMBRIDGE CASH-BALANCE EQUATION 77

Chapter 5—The Impact of Monetary and Fiscal Policy 78

CONCLUSION 91

Chapter 6—Monetary Policy, 1957–59 92

OTHER ISSUES 94

LOOKING AHEAD 97

Chapter 7—The Theory of the Consumer Price Level 98

Chapter 8—Excess Demand or Deficient Demand? 111

Chapter 9—Wage Policy: The Strategic Variable for Price Level Stabilization 118

Chapter 10—A Review of Reviews 131

Chapter 11—The WCM Truism in Growth and Accumulation Theories 143

CONCLUSION 151

REQUEST FROM THE PUBLISHER 152

PREFACE

Since I wrote my small volume on A General Theory of the Price Level, etc., I have often been asked for a fuller statement of my views, or my attitude on various matters treated only briefly at that time. Inevitably, over the four days during which the manuscript was composed, many aspects were treated slightly or not at all.{1} I hope that the collection of essays that are contained herein fill in many of these gaps and answer the major part of the queries that admit of such elaboration. It should be clear at the outset that, so far as I am aware, I have not seen fit to alter my general position in any major particular even after assessing the criticisms that have appeared.

In my opinion there are two contending theories of the price level: that deriving from the Equation of Exchange in one or another of its forms, and that based on cost, especially wage, phenomena. Thus the debate must be resolved primarily between two major sets of ideas on the subject of inflation. In this light it would be a welcome event, if those Keynesians in economics, who long ago abandoned the various versions of the Quantity Theory of Money and have little truck with the cost theory of the price level, would at least re-examine their views on this subject. It is my deep conviction that most of the literature oriented toward what has been regarded as Keynesian thinking has had very little to contribute toward understanding price level phenomena despite superficial appearances toward the contrary. The importance of this assertion cannot be overstated for, in bulk, this literature is already voluminous and in teaching importance it represents the dominant modern fashion. Yet, in my opinion, on the fundamental problems of price level inflation and deflation, I believe it to be wholly barren and devoid of substance. Perhaps these essays will reveal the stark nakedness of the concepts in the price dimensions that interest all of us.

The discussion of what I have called Classical Keynesianism thus occupies the first two essays. While there is considerable overlap between the statements, considering that they were written at different dates and for separate expository purposes, I have nevertheless permitted them to stand without removing any of the repetition: on the positive side this should make the basic argument a good deal clearer, for both items cover the same problems from a slightly different point of view. After all, despite the duplication, page-wise they constitute only a fractional counterweight to the constant reiteration of Classical Keynesian themes.

Chapter 3 contains a restatement of my own cost theory, followed by an elaboration of the doctrines that derive from the Equation of Exchange. Though familiar ideas are involved here, I think some new points (or less familiar ones) are developed. Thereupon there are two chapters that deal with the price level impact of monetary policy and of fiscal policy: the influence of the latter, at the theoretical level, is shown to involve fairly simple extensions of the main argument.

There may be more to engage the analytic-minded in Chapter 7 where separate relations for the consumer and the capital goods price levels are presented. The elements deduced prove to be rather intriguing, for they tie the arguments closely to important concepts of macroeconomics. Considering the stress placed throughout on wage costs as the prime mover in price level phenomena, Chapter 9 emphasizes this view once again and makes the important distinction, too frequently overlooked by those searching for the causes of inflation, between a cause and a strategic control variable. For policy we must locate the important control levers and devise institutional instruments for operating on those elements which are decisive in governing economic phenomena toward accomplishing the ends we set out.

Reviewers who have had the opportunity and freedom of criticism of finding flaws and defects in the earlier statement of my views will not, I am sure, begrudge me the opportunity for some brief rebuttal after reflecting on their carefully taken objections. Needless to say, I am unable at all points to find common ground for agreement with my critics. But through such give-and-take some greater clarity of opposing views will be secured toward ultimate resolution of the issues. Or is this a vain hope in a forensic subject such as ours, with its strong deference to tradition, its attachment to existing conceptions, and its constant appeal to an authoritative past expression of ideas?

The concluding essay purports to show how the same fundamental ideas basic for understanding the price level are implicit in the theory of growth and capital accumulation as currently developed by Mrs. Robinson and other Cambridge Keynesians. It is possible that the explicit use of some simple formulae involving the truistic interdependence of real wages, capital per head, and capital-output elements, will facilitate understanding of some of the basic ideas in growth and perhaps be conducive to additional progress in this domain.

I hesitate to implicate, by an expression of indebtedness, several friends who have given me the benefit of their thinking on ideas incorporated in the pages below. Nevertheless, my thanks goes to them, and this blanket expression will serve to convey it. Likewise, I am appreciative of the secretarial staff of my university department for the assistance rendered in transforming an indecipherable manuscript into readable copy: I know I can obtain unanimous agreement on this point!

SIDNEY WEINTRAUB

University of Pennsylvania

Chapter 1—Classical 45° Keynesianism: A Plea for Its Abandonment

The purpose of this essay is to assess what has come to be a fairly universal teaching tradition, to judge by the textbooks directed to our students and the papers prepared by economists in communicating with their colleagues. The main reference will be to the ubiquitous and commonplace diagrams containing the 45° line and the equilibrium Keynesian-cross. The latter has been described as being comparable in importance to the intersection of supply and demand curves—the Marshallian-cross—and thus of far-reaching significance for understanding the economic process.{2}

It will be argued below that this apparatus is of limited usefulness, and is inadequate for the macroeconomic studies for which it was devised. Further, because it is conducive to some false inferences on public policy, the time has come for its abandonment as a major teaching and conceptual vehicle. Fortunately, for the visual and analytic purposes served by it, there is at hand another geometrical technique that is free of its inherent defects.

After a critique of the 45° diagram, a presumably more general apparatus consisting of the almost equally familiar IS-LM curves, which purport to show the simultaneous determination of interest rates and income levels, will be subject to a similar scrutiny and review. In one respect, because of one significant omission, it will be argued that this apparatus is even more defective than the simpler diagram.

See Paul A. Samuelson, The Simple Mathematics of Income Determination, in Income, Employment and Public Policy, Essays in Honor of Alvin H. Hansen (New York, Norton, 1948), p. 135. Professor Hicks has also written in similar terms in his little volume on A Contribution to the Theory of the Trade Cycle (Oxford, Clarendon Press, 1949), p. 15.

WIDESPREAD USE OF THE APPARATUS. It is no secret that the widespread use of these diagrammatic tools is largely attributable to the perceptive and influential writings of Professors Hansen, Hicks, Lange, and Samuelson, all eminent and highly respected names in our profession. Beyond this recognition of origins I shall not refer to their contributions in detail for, if I am correct, whatever inadequacy is now revealed in their original and remarkable creations belongs currently to a wider audience. Their influence has been so pervasive and substantial that the set of ideas has become institutionalized as a habit of thought much broader than any individual expression of it. The general conception and pattern of ideas is now regarded as Keynesianism itself; for reasons that will emerge shortly I prefer to identify this version of Keynes as Classical Keynesianism or Classical 45° Keynesianism, in deference to the famous diagram.

Almost inevitably, and without further apology, in order to make a point rather than to dissect any single specimen of the ideas, a stereotype of the thought-pattern will be delineated and made an object of study. At those places where I regard the apparatus as particularly vulnerable it would be an easy matter to document the propositions by referring to some of the more authoritative statements of the cognate analysis. So if I refrain from making copious references it is not because these do not exist but rather because illustrations are almost too plentiful.

WHAT KEYNES REALLY MEANT. I have called the position to be scrutinized Classical Keynesianism; there is no doubt that it passes for Keynesianism today, as the scriptures for the faith erected in his name.{3} Yet it is possible to think that much of it has little to do with Keynes himself; in many respects his great book is free of some of the elements that have since been taught in his name—even though in some (unguarded? or unsuspected?) moments he may have lent his approval to these interpretations of his own thought system. My own opinion is that he has not been faithfully presented in the typical Keynesian models, and that these are not the most suitable synopses for the transmission of his ideas.{4} Still, I shall make no effort to refer to Keynes even though I think the tenor and the text will sustain me; I am aware that other Keynesians can select other passages to corroborate their doctrinal position so that such controversies on what Keynes really meant, like those on what Marx—or Marshall—really meant, are likely to be peculiarly barren and futile. It is with Keynesianism then, not with Keynes, that I am concerned. For myself I acknowledge full indebtedness to his tremendous work, rather than to deny or camouflage it as is becoming fashionable. My ideas, like those of all modern Keynesians, emanate from it. The plea to return to the path of (analytic) rectitude and virtue also draws its sustenance from it.

A BARTER ECONOMY ANALYSIS. It can be charged that the dominant brand of Keynesianism, and it is the American version of Keynes that is now the Classical form in which the diagrammatic apparatus governs the direction taken by the argument, has accomplished a literal return to a barter economy where the veil of money and the complications of a price system have been removed. Even a superficial examination of its form reveals that all its analyses devolve about a real system that is relieved of the basic characteristics of a money economy. Typical models operate without any price level conception worthy of the name, for they are constructed in terms of constant prices so that the elemental real phenomena are never buffeted about by price inflation or deflation. They never suffer from any of the stresses and strains of changing absolute or relative prices.

An economy in which price levels never change is possessed, I suppose, of the attributes of neutral money: monetary or price level disorders are never permitted to become part of the substance of economic life. A study of such an economy is in fact merely a study of a barter economy. This is the end to which the 45° line has led, to play an ironic jest on Keynes, and practiced in his name by many modern Keynesians. It is not surprising that in this milieu there has been some revival of interest in Say’s law, and we are being more frequently reminded once again, as was the case in the 1920’s, the economy is self-righting with only some inflexibilities acting as frictional nuisances and serving to support the underemployment-equilibrium impressions of Keynes. A barter economy, or a monetary economy with an invariant price level, can indeed occasion an optimistic view on the nature of the modern economic problems.

THE 45° CROSS AND INFLATION. To develop my major arguments, attention will be focused about the theoretical and practical inadequacy of the 45° cross diagram: it could also be directed at the mathematical functions underlying it though I think it best to deal with the elemental ideas rather than to try to impart life and meaning to the usual shorthand symbols. Emphasis will be placed on the diagram’s shortcomings as an analytic tool for illuminating the concepts of inflation and of money income determination, and, above all, for dealing with the key phenomenon in an age of inflation; namely, the price level, which acts upon and strongly contributes to the determination of the rate of interest. It is also believed that the multiplier theory, and the effect of commonplace and important types of economic change on the multiplied money income, employment, and real income position, has been hindered as a consequence of the endless and repetitious concern with merely real-income-multiplier relationships.

It is also contended that the Keynesian analytic engine that has been running full throttle in the literature has: (1) obstructed a meaningful synthesis of macroeconomics and microeconomics; (2) impeded the development of a theory of money wages and distribution, in both of which price levels play a part, and (3) placed beyond reach the elucidation of certain employment and distributional consequences of technological change. If valid, these are serious objections to the techniques of Classical Keynesianism and deserve attention. Needless to say, not all the points can be discussed in these pages yet more than a suggestion of a solution will be offered.

DEMAND-PULL VERSUS COST-PUSH. One additional introductory comment may be offered along the same lines. At the current stage of economic discussion one of the sorriest episodes, in my view, and one which threatens the breakup of the Keynesian school in fact because of the insufficiency of its basic theory, has been the noisy confusion of its assorted adherents piping the several voices they have acquired in discussing the inflation issue. Here, the monolithic unanimity with which its members once spoke in approaching the unemployment issue in the past has been ruptured and the group has splintered off and then reassembled among two camps, each marching under separate banners, with one reading demand-pull, and the other captioned cost-push. (Of course, there are some eclectics, as they are called, who parade with both legions.) As in the play, it is in this dispute that we catch not the conscience but the spirit of Classical Keynesianism, for here it bares its theoretical soul.

We should make no mistake about this; it is this rift in the school that once spoke as one on depression policy, and now has two heads on inflation that threatens to divide, if not destroy, modern Keynesianism.{5} For it has been on the subject of inflation that the school has become embroiled in controversy and the profession has been held up to some ridicule before the ordinary man who concludes that while it is all a very difficult subject one may pick an economist at random to sanction any preconceived position.

THE 45° CROSS

Fig. 1 contains the familiar 45° line and the associated consumption and investment functions that play so prominent a part in our textbooks, our teaching, our thinking, our semester examination, and, not to be neglected, our policy prescriptions. It is the analysis surrounding this diagram that constitutes Classical Keynesianism. This truly has become the mischievous dragon that has mesmerized our analytic senses.

Measured horizontally is real income, or dollar amounts of real output measured in terms of constant prices. Real consumption and real investment, or dollar amounts reflecting only output changes and not price changes, are measured vertically. As drawn, there is the typical C-function sloping upwards to the right, and on which there is superimposed a constant real amount of investment outlay (I), making a combined total of C + I real outlays at each horizontal volume of real output (Y).{6}

The usual discussions, occupying several pages in even our most elementary textbooks, elaborate in some detail the reasons for the position and the nature of the slope of the consumption function, identifying the latter as the marginal propensity to consume. The determinants of the volume of real investment are similarly described, with the combined C + I curve explained as accomplishing a macroeconomic income-output equilibrium at that Y level at which the C + I curve intersects the 45° line. This is the Keynesian-cross, revealed at a real output of Y1 in Fig. 1.

In all too many expositions the equilibrium Y1 is presented as a matter of inevitability, so that one is left to wonder about the possible likelihood of realization of other Y, or C + I, levels. Rarely does the explanation run in a stability context, of a tentative approximation to equilibrium in the fashion of price theory involving the Marshallian-cross. More will be said on this shortly.

It is at just about this stage that the policy implications are taught. The student is told that if Yf denotes the full employment real income, then the equilibrium at Y1 is too constrained, that it is an underemployment equilibrium because the level of consumption and investment (and government outlay in the fuller explanation) is too small to prevent unemployment. Measures to raise C or I, or both, are outlined in order to lift the economy out of its deflationary doldrums.

If C + I are at the (C + I)ʹ curve level, so that the intersection of the aggregate demand function and the 45° line occurs to the right of Yf, we are told that there is inflation, for inasmuch as output cannot advance beyond Yf only price level upheavals are possible. For this situation we are advised of a series of steps that can be taken to reduce (C + I)ʹ to less explosive levels.

In brief, these are the arguments. If they are not, then the expositors are to blame for this is what students—and teachers—absorb from the conventional chapters. All of it has an alluring symmetry that commends it to our teaching and to our students. Deflation on one side of Yf; inflation on the other. As it stands it becomes plain for even the poor student to see that deflation is due to inadequate demand while inflation, with rising price levels, is attributable to excess-demand, to a demand-pull. As a not uncommon variant it is also popular to talk of a deflationary-gap when Y lies westward of Yf and an inflationary-gap when the positions are interchanged.

THE PERVERSE POLICY RECOMMENDATIONS. Bluntly stated, it is my belief that all this is