Post-Keynesian Theory Revisited: Money, Uncertainty and Employment

By Matteo Iannizzotto

With its emphasis on the centrality of fundamental uncertainty and the resulting desire for liquid assets, post-Keynesian economics offers important insights into understanding how modern economies work, placing money and banking at their heart, exactly as any realistic account would do.

In this advanced introduction, Matteo Iannizzotto revisits the contributions of post-Keynesian ideas to such central issues as the inescapable condition of uncertainty in economic decisions, the theory of liquidity preference, effective demand, endogenous money supply, and the financial instability hypothesis. In each case, the author traces the foundations in the work of Keynes and presents the strength of post-Keynesian ideas of later authors like Kaldor, Minsky and Weintraub in comparison with the corresponding models of mainstream economics and shows their greater explanatory power particularly in the light of the recent global financial crisis.

• Language: English
• Publisher: Agenda Publishing
• Release date: Apr 30, 2020
• ISBN: 9781788213196

Matteo Iannizzotto

Matteo Iannizzotto is Associate Professor in Macroeconomics at Durham University.

Book preview

Post-Keynesian Theory Revisited

Post-Keynesian Theory Revisited

Money, Uncertainty and Employment

Matteo Iannizzotto

© Matteo Iannizzotto 2020

This book is copyright under the Berne Convention.

No reproduction without permission.

All rights reserved.

First edition published in 2020 by Agenda Publishing

Agenda Publishing Limited

The Core

Bath Lane

Newcastle Helix

Newcastle upon Tyne

NE4 5TF

www.agendapub.com

ISBN 978-1-78821-149-9

British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from the British Library

Typeset by Newgen Publishing UK

Printed and bound in the UK by TJ International

Contents

Preface

Acknowledgements

List of figures

1. Introduction and history

Recovery from the neoclassical synthesis

Recovery from Keynes himself

Extensions

A map with crucial names and dates

Hamlet without the prince

Revisiting post-Keynesian theory

2. Flavours of uncertainty

Definitions and early twentieth-century foundations

Ergodic and non-ergodic

Human abilities

Conclusion

3. Conventions and the thirst for liquidity

Nihilism, as if assumptions and the epistemic interval

Conventional judgement

Liquidity preference

Capacity utilization

Nominal contracts

Conclusion

4. Effective demand

Say’s law

Aggregate supply and aggregate demand under barter

The point of effective demand in Marshallian (Keynesian) form

The point of effective demand in Kaleckian form

A comparative assessment

Conclusion

5. Time and money

A durable good

The marginal efficiency of investment

A continuum of assets

Liquidity preference

Conclusion

6. Banks

Problems

A useful diagram

The accommodationist or horizontalist view

The structuralist view

Conclusion

7. Destabilizing stability

Hyman Minsky

An economy doing well

The Minsky moment

The global financial crisis as a flight to liquidity

An evaluation and conclusion

8. Where to now?

Inflation

Government expenditure and debt

Growth

A final word

References

Index

Preface

I must confess to being a late convert to post-Keynesian economics. It never featured in any of my undergraduate or postgraduate studies. My earliest recollection of coming across any of its proponents was at a Royal Economic Society conference at which one of the keynote addresses was given by Paul Davidson. That evening, I remember confessing to an established professor I was with to not knowing anything about post-Keynesians, and his reassuring me that it was not something I needed to worry about. There matters rested until staffing changes at Durham meant a reallocation of authors and topics in an introductory course of history of economic thought, so that John Maynard Keynes came into my part of the syllabus. I thought I knew what Keynes had said, but, obviously, set about reading up on the topic again. It was then that I realized that what I thought he had said was mostly inaccurate, if not wrong altogether. I also realized how much I had missed out and how valuable that was. The rediscovery of Keynes himself was one of the first steps. It was reading up on Keynes that led me to the post-Keynesians, in particular Davidson on rational expectations, which was very much a chance find, and John King on micro-foundations. From then on it has been my personal journey of discovering a literature that I truly wish had featured earlier in my economic education. The more I read, the more I found that interested me. Much as John Hicks wrote to Davidson in private correspondence (about ergodicity), sometimes one needs a specific word for one’s thoughts to find shape. It was the same for me: many doubts, which I had somehow suppressed on various elements of mainstream economic theory, I found had already been addressed by post-Keynesians, often, but not always, following a lead from Keynes himself.

The next stage in my post-Keynesian journey came when the newly instituted third-year undergraduate optional module dedicated to this heterodox school came to be vacant without ever having run. I was called to step in. In this, as in many other things, I owe a huge debt of gratitude to my then colleague Dr Mark Hayes, who had proposed the module and done the preliminary work for bringing it into existence, but had found himself unable to deliver it in the end. Mark’s legacy in Durham has been my precious possession since, and, in many ways, what follows is the product of that legacy.

Obviously, some things have turned out to be more convincing than others, and, inevitably, my own interests have shaped which strands of post-Keynesian literature I have explored more deeply. But two central themes that first drew me to it have proved the most enduringly convincing. The first is that macroeconomics cannot be reduced just to an aggregation of microeconomics. Having always preferred a macro point of view, the reductionist approach that has come to prevail in mainstream economics since the 1980s has found me unsympathetic and increasingly unconvinced by its often very dogmatic stance. In post-Keynesian theory the fallacy of composition, that the whole is more than the sum of its parts, resurfaces so often, and in so many guises, that its calls found in me a very receptive audience. The second theme is that a monetary economy is intrinsically different from the real-barter one of neoclassical theory, and how abstracting from monetary and financial considerations condemns its theoretical representations to unhelpful and implausible abstractions. I had always found the notion of money illusion very puzzling and the barter equivalence features of mainstream models very unrealistic. Evidently, on both counts, I was not alone, and I really wish I had found that out much earlier. In the monetary and financial strand of post-Keynesianism I found what I had vaguely felt for years but struggled to put into words, let alone into a presentable theoretical statement.

By the time students in Durham elect to do post-Keynesian economics they have done macroeconomics in their first and second year (with me), and can therefore be assumed to be familiar with an IS–LM model, the Keynesian cross diagram and the general principles of neoclassical economics such as utility and profit maximization. They are also familiar with rational expectations, real business cycle theory and the main results of new Keynesian economics. That is the background knowledge I can assume as I lecture. As this book grew out of my lectures, I have assumed that the reader has some prior knowledge of economic theory to the level of a first-year undergraduate course, and therefore not as advanced. Some knowledge of history of economic thought may also help, but it is not that essential.

There are admittedly many strands in post-Keynesian theory, and I certainly have no chance of covering them all, given the overall dimensions and the stated aims of this book. What I have endeavoured to do in what follows is, primarily, to retrace my own personal journey of discovery of post-Keynesianism. Inevitably, this implies following my predilection for the central themes of money and finance and their quintessentially macroeconomic perspective. There are many areas that could have been further explored, and I do suggest a couple at the very end of the book. In a way, this could be described as the book I wish I had come across much earlier in my economic education, and it is meant for current young economists as a short rendition of post-Keynesian themes that may, hopefully, make them wish to see more and in much greater detail than I can possibly manage here.

Acknowledgements

Although I take responsibility for all errors and misinterpretations, I am indebted to Victoria Chick at University College London, Brian Snowdon at Durham University and, last but not least, my father for having so carefully read the first draft of the manuscript and questioned and corrected many important points that needed further elaboration. I also acknowledge with thanks the comments of an anonymous reviewer. James Boreham and Lewis Willcocks, both former students of mine, made helpful comments at earlier stages of the work. My then head of department at Durham, John Ashworth, encouraged me to pursue this book when it was first proposed, and his input came at exactly the right time. The relationship with the publisher is always important, and I could not have wished for a better one than the one I have with Alison Howson of Agenda Publishing. She has made everything so much more pleasant, and for this I am really grateful. The process of writing a book is always fraught with misgivings and changes of direction, and it could not be borne without the help of friends, Roberta Bassi, Robert Hanson and Robert Schütze being the most obvious ones. But my greatest debt is undoubtedly to my own students, past and present, as individuals and collectively gathered either as the Durham Society for Economic Pluralism or under the umbrella of the degree of philosophy, politics and economics. It is to them that I dedicate these efforts.

Matteo Iannizzotto

University of Durham

Figures

1.1 A map of the post-Keynesian school

3.1 Capacity utilization

4.1 A diminishing returns production function

4.2 Say’s law

4.3 The point of effective demand (Marshallian/Keynesian)

4.4 The point of effective demand (Kaleckian)

4.5 Income distribution in the Marshallian/Keynesian diagram

4.6 Income distribution for different aggregate supply functions

5.1 A durable good

5.2 An increase in investment reduces the marginal efficiency of investment

5.3 Investment demand schedules or marginal efficiency of capital schedules

6.1 Banking sector diagram

6.2 Central bank reaction function

6.3 Stepped supply of credit

6.4 Increase in liquidity preference

7.1 Interaction between bank loans and investment demand

7.2 An economy doing well

7.3 The boom continues

7.4 The Minsky moment

7.5 Cycles in investment and employment

7.6 The global financial crisis as a liquidity preference shift

1

Introduction and history

The post-Keynesian school is a heterodox school of economics the scope and objectives of which can be summarized as Thomas Palley (1996: 9) does when he claims that "[t]‌he Post Keynesian project represents both a recovery and an extension of the economic paradigm developed by Keynes (emphasis added). Both terms, recovery and extension", require some explanation and qualification.

Recovery from the neoclassical synthesis

In the first instance, the message of the General Theory of Employment, Interest and Money (Keynes 1936) has to be recovered from the limiting interpretation that it was given pretty much as soon as it was published, when crucial choices were made the overall effect of which could arguably be described as the domestication and eventual dismissal of anything truly revolutionary. This is the general body of literature that has come to be known as the neoclassical synthesis and that constituted, and to an extent still does, the bulk of taught undergraduate macroeconomics. In summary, it broadly comprises the IS–LM model developed independently by several, most notably John Hicks in Britain and Alvin Hansen in the United States, combined with a supply side represented by the Phillips curve. Its most influential statement arguably comes in Paul Samuelson’s textbook Economics (1948), which has had many subsequent editions since its first publication in 1948. It could be described as the most widely read and adopted textbook in the entire discipline of economics, and therefore its influence is enormous. What Samuelson wrote was an interpretation of Keynes that was not at odds with the rest of economic theory developed until then. This is why it can be described as a synthesis, in that it provides a way of reconciling the novel statement of why an economy would settle at an under-employment equilibrium in the short run only. The longer run was determined exactly as classical (and neoclassical) theory had done, however, so that the Keynesian contribution had not been one of a paradigm shift, or of a scientific revolution, but, instead, one of qualifying the overall statements, which remained classical in their method and outlook. So, in the end, the General Theory was not actually general at all, in this view. It was very much a special case of the truly general theory (the classical one), justified by the imperfections and frictions of the shorter time frame of the analysis and the inflexibility of some variables, such as prices and wages, within that time frame.¹

This entire literature, which claimed the status of mainstream pretty much all the way to the advent of monetarism in the late 1960s, has come to be described in the colourful language of Joan Robinson (Robinson 1962: 690) as bastard Keynesianism. This implicitly defines one of the historical tasks of the post-Keynesian school, namely arguing how and why the neoclassical synthesis was an unfair and misleading representation of what Keynes had written, and how what had been left out was relevant and important in understanding the workings of a modern capitalist economy. A typical such statement is given by Hyman Minsky when he says that the neoclassical synthesis had neglected or lost … a major part of the substance of the General Theory (Minsky 1975: viii)

It should be understood that the task inevitably has two sides: a destructive one, in demonstrating why mainstream theory is wrong; and a constructive one, in replacing the refuted elements with new ones based on what Keynes actually wrote, rather than on the translation of it that Samuelson (and others) had provided.

Recovery from Keynes himself

It may seem absurd and unnecessary, but there is undoubtedly a case to be made for Keynes’ theory to be recovered from his own writing. The issue is that Keynes, famously, changed his mind over the years. There is – as Rod O’Donnell (1989) has claimed – a general continuity and underlying consistency of thought, but it is undeniable that on several specific theoretical points there are irreconcilable shifts, though this is understandable over such a long and prolific publishing career.² So, a judicious choice has to be made especially when, for instance, connecting the earlier monetary writing of the Treatise on Money (Keynes 1930) to the later statements of the General Theory.

Second, Keynes’ theorizing was a means to an end. Even when he claimed, in the General Theory or in journal articles, purely to be debating theoretical points with his fellow economists, there is no question that the underlying emphasis was for him one of policy. Disputes on theory were necessary in order to make the argument for policy action more compelling and convincing. And the argument on policy was indisputably driven by what may be called an ethical imperative. It was his perceived moral duty to act in matters of economic policy (be it reparations after the First World War, the resumption of the gold standard or the depression of the 1930s), for the relief of the economic suffering of his fellow men. This ethical imperative is an obvious subtext, and it is the justification for the second volume of his biography by Robert Skidelsky being aptly entitled The Economist as Saviour (Skidelsky 1992). The implication of this, however, is that the historically determined policy context sometimes obscures and blurs the truly revolutionary statements of economic theory. In a way, the pure theory in Keynes – pure in the sense that it is purged of its immediate policy relevance – has to be extracted and restated so as to be understood, and potentially criticized, regardless of the hic et nunc context that brought it to life in the first place.

The third reason why the theory has to be recovered is Keynes’ own rhetoric. He is justly celebrated as an extremely elegant and persuasive writer, but his rhetorical choices quite often end up having the effect of making persuading fellow economists more difficult. The obvious example is the habit, in which he often indulged, of describing diagrams without actually drawing them. There is an important point here, namely that Keynes’ rhetoric is an implicit rejection of the formalistic approach for its own sake (see O’Donnell 1997). Thus, there is no case to be made for translating the entirety of the General Theory into equations and diagrams, because such an act would destroy much of the most fruitful analysis, which exists, necessarily, in purely verbal form. Nonetheless, there are many diagrams that really ought to have been drawn, and properly discussed, before moving on to refining and qualifying them with the inevitable limitations. A case can therefore be made for filling out these analytical gaps, not in order for them to take the place of a direct reading of the original, but for them to act in support of it.³

In summary, what can be said is that Keynes should be read in the original, as it is so rarely done, but it is nevertheless undeniable that the original needs to be interpreted. Not surprisingly, the literature on interpreting Keynes is now vast. As an example, John King (2002: 184) claims to have, in his own post-Keynesian bibliography, as many as 248 entries