Sunday, March 27, 2011

Post Keynesian Economics in One Lesson

First of all, it is important to understand what Post Keynesian economics is and is not. Post Keynesian economics is an American phenomenon that originated with the work of Paul Davidson, and which has been subsequently developed by people like Hyman Minsky, Victoria Chick, Fernando Carvalho, and Fiona Maclachlan. Post Keynesians are not Sraffians, Institutionalists, or Kaleckians (Marxists). Their relationship to these schools is observed only in connection to their opposition to neo-classical economics and their shared political leanings.

Post Keynesian economics is essentially the theory of the instability of financial markets. That is all. I will walk the readers through what I take to be the most important points, and then provide a list of readings at the end.

1.) A world of uncertainty gives money value beyond the utility it provides as a medium of exchange. Central to Post Keynesian economics is the use of money as a store of value.

2.) Now the properties of money, and its use as a store of value, have the potential to cause massive unemployment. The first property is a zero elasticity of productivity, which means that if individuals desire to hold money as a store of value, firms cannot employ labor to produce more money. Industry cannot meet this demand. The second property is a zero elasticity of substitution, which means that as the price of money rises in response to an increased demand, individuals cannot substitute other assets for money as a store of value. This destroys Say's Law. And the third property is a zero cost of transferring money from the medium of exchange function to the store of value function.

3.) Now different assets have different attributes, and the desire to maximize one's total yield depends on the relative values of these different assets. These attributes involve monetary yields minus carrying costs (q-c), capital gains (a), and the power of disposal of an asset during volatile and uncertain times, i.e. its "convenience yield" (l) --- this gives us the equation: a+q-c+l.

4.) Two sectors of capitalist economies can now be distinguished in terms of these different yields: the financial sector and the industrial sector. The basic idea here is that these two sectors rarely interact in the way neo-classicals believe. Speculators and savers deal on the financial side, while capitalists operate on the industrial side. Speculators, for example, while owning titles to capital goods, haven't the first clue as to how to use these capital goods or how long they will continue to be profitable. These are the concerns of the capitalist, who must rely on its expected profitability in the long-term since that is what affects his decision to invest. This creates a great deal of instability.

5.) As a consequence, the portfolio balance decisions of these two sectors are oriented towards different aims. For the financial sector, the aim is to achieve short-term capital appreciation via spot market purchases and sales (a) while seeking comfort in the fact that an organized market for securities exists if conditions should suddenly change (l). For the industrial sector, the aim is to earn profit from long-term income flows (q-c). This is also where the distinction between speculation and enterprise can be found. Transactions on the financial side occur independent of investment activity. Their aim is to profit from the change in interest rates. This is destabilizing because the different views of capitalists and speculators can cause massive instability in the system. If, for example, speculators continue to transact with the expectation of continued capital appreciation while capitalists (entrepreneurs) take a more pessimistic view of long-term investment, then, no matter how high stock prices rise, investment will not take place. If, on the other hand, speculators take a dim view of the possibility of capital gains in securities, then liquidity preference will rise and so will the interest rate, making the prospect of capital investment increasingly worse, drying up investment and causing unemployment.

6.) Finally, the existence of financial assets also serves to destory the link between saving and investment (represented by Austrians in the loanable funds model). The basic idea is that new savings are swamped in their effect on the rate of interest by transactions among existing wealth-holders in financial markets.


That is the essence of Post Keynesian economics. Needless to say, this is very different from Austrian economics. For Austrians, you have the loanable funds model, increases in the money supply causing disequilibrium in the loanable funds model, and then recession.

As for reading:

on (1), I would read anything by G. L. S. Shackle to get you in the mood of understanding and appreciating the role uncertainty plays in capitalist economies. In particular, I would recommend Shackle's chapter 12 in the Years of High Theory book.

On (2), anything by Paul Davidson is good. I would consult his several articles published in the Journal of Post Keynesian Economics.

On (3), Fernando Carvalho has an excellent book entitled "Mr. Keynes and the Post Keynesians." I would read chapter 5 very closely in that book.

On (4-5), Paul Davidson's book "Money and the Real World" is really good, in particular his chapters 4, 10, 11. Also, I would recommend Dudley Dillard's student-friendly "The Economics of John Maynard Keynes" book.

On (6), Fiona Maclachlan's "Keynes' General Theory of Interest" book is really good.

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