Post Keynesian Economics

Over the last twenty-five years, there has developed a vibrant community of economists who label themselves as Post Keynesians. This group of economists lays claim to a pedigree that includes Keynes, Kalecki, Kaldor, and Joan Robinson. It also has the beginnings of an institutional base, as reflected in such journals as the Journal of Post Keynesian Economics, The Cambridge Journal of Economics, Metroeconomica, and the Review of Political Economy. However, despite this institutional progress, Post Keynesians are often accused of lacking intellectual coherence, and of representing a collection of idiosyncratic theories that are united only in their criticism of the mainstream. This perception of Post Keynesian economics is fostered in part by the absence of comprehensive formalizations of Post Keynesian theory. The current book is intended to fill this lacuna. However, though seeking to illuminate the intellectually consistent structure that girds Post Keynesian economics, the book is not intended as a textbook.— at least of the type found in the mainstream, where textbooks represent canonical statements. At this stage of the Post Keynesian program it is too early for such a statement, and in addition, the epistemological foundations of Post Keynesianism discourage the formation of such overwhelming unanimity even amongst Post Keynesians.

Since its inception in the 1930s, Keynesian economics has been subject to interpretation, and fragmentation into different schools of Keynesianism. One such school is Post Keynesian economics, the origins of which are principally associated with an eclectic group of economists located in Cambridge, England. Amongst this group were such luminaries as Nicholas Kaldor, Joan Robinson, and Richard Kahn. Another important figure at Oxford, was the Polish emigre economist, Michael Kalecki; in the United States, the founding contributors to the Post Keynesian tradition in macroeconomics include Paul Davidson, Sidney Weintraub, and Hyman Minsky.²

During the 1950s economists began to try and gird the economics of Keynes with neo-classical micro-foundations, and in particular they focused on the implications of disequilibrium in one market for supply and demand in other markets.¹ This project ultimately developed into what became termed the “disequilibrium approach” to macroeconomics, the fullest expression of which is found in Barro and Grossman (1976) and Malinvaud (1977). The ultimate conclusions derived from this approach were that (i) Keynesian economics was a form of disequilibrium economics, and (ii) Keynes had failed in his claim to have provided a theoretically cogent explanation of equilibrium involuntary unemployment except for the special case where nominal wages were downwardly rigid. For mainstream neo-Keynesians these conclusions led to a re-casting of Keynesian economics in terms of price rigidities, and in terms of the speed with which prices adjusted so as to yield full-employment equilibrium (Tobin, 1975). In effect, this re-casting amounted to a tacit rediscovery of a position that had been identified by Modigliani (1944) and Patinkin (1948) almost thirty years earlier. However, in the 1970s this disequilibrium—rigid prices interpretation of The General Theory was itself subjected to challenge.

Mainstream classical macroeconomics challenges Keynes’ claim to have demonstrated the possibility of equilibrium involuntary unemployment in a perfectly competitive economy with flexible prices and nominal wages. This challenge is predicated on the Pigou (1943) effect, according to which decreases in the general price level increase the real value of nominally denominated assets, thereby giving rise to a positive wealth effect on spending. It is also supported by the Keynes effect (1936), whereby decreases in the general price level increase the real money supply and lower interest rates. As a result nominal wage reduction, through its impact on product prices, can increase aggregate demand and restore full employment.

Expectations about the future are critical in economics, and they have long been central to the Post Keynesian construction of economics. We have already seen evidence of this in Chapter 5 which dealt with the Keynesian theory of aggregate supply. It is only by an appeal to belief in a future that we can begin to explain why agents engage in activities such as saving and investment, why they are willing to make loans, and why they are willing to accept intrinsically worthless money in exchange for goods and services. The future would therefore be critical even if it were known with complete certitude, but the fact that it is known only with uncertainty, if it is known at all, makes its representation and effects even more important.

Thus far, the focus of inquiry has been on the effect of price level adjustment on aggregate demand and supply, and on the ability of price and nominal wage adjustment to ensure full employment equilibrium. During the course of this inquiry the financial sector has been restricted to the background, and quantities of financial assets and liabilities have been taken as given. It is now time to turn to an investigation of the financial sector, and examine how the money supply and other financial magnitudes are determined. Later, in Chapter 9, this examination of the financial sector will be joined with our earlier examination of the operation of goods markets to provide a full Post Keynesian model of the determination of the level aggregate economic activity.

The theory of endogenous money represents the central concern of Post Keynesian monetary theory. This endogeneity of money has major significance for the process governing the evolution of aggregate nominal demand, and is vital for understanding the process of inflation. However, the focus on the money supply has naturally concentrated attention on the the banking sector, yet banks represent only one amongst many financial intermediaries, and financial intermediaries are themselves only one source of finance. This suggests that an understanding of the interaction between financial markets and goods markets requires the inclusion of wider forms of finance than just bank credit. Such an approach harks back to the monetary theory of the Radcliffe Committee (see Rowan, 1961), and it also appears to be implicit in Wray’s (1992) linking of endogenous money with Minsky’s (1977, 1982) theory of financial instability.

The previous eight chapters have examined the foundational components of Post Keynesian macroeconomic analysis. This examination covered a range of issues including the nature of demand equilibrium (Chapter 3), the inability of generalized nominal wage and price level adjustment to necessarily secure full employment (Chapters 4 and 5), the theory of aggregate supply based on producers’ expectations of aggregate demand (Chapter 5), the problem of expectations in an uncertain world (Chapter 6), and the endogenous nature of money and finance (Chapters 7 and 8). The current chapter serves to unify these elements of analysis in a coherent macroeconomic model that describes the determination of short period equilibrium.¹

Within Post Keynesian economics, the standing of the Phillips curve has tended to be somewhat ambiguous. In part, this ambiguity reflects the uncertain standing of the Phillips curve in the profession at large, and in part it reflects the fact that Post Keynesians have been eclectic in theorizing about inflation. In particular, whereas the mainstream of professional economists has come to see inflation as exclusively caused by excessive money growth, Post Keynesians also emphasize the significance of labor market conflict over the distribution of income. These two approaches to the theory of inflation represent lineal developments of earlier (1950s) interpretations of inflation in terms of “demand-pull” and “cost-push” factors: thus, the new classical money growth approach may be identified as a particular expression of the demand-pull perspective, while the Post Keynesian distributional conflict approach can be identified with the cost-push perspective.

The importance of debt and credit have been evident throughout much of this book. Chapter 4 showed how the presence of inside debt potentially undermined the ability of price level reductions to increase aggregate demand. The importance of credit was also evident in the discussion of the money supply in Chapter 7, and it reappeared as an important element in the theory of endogenous finance that was developed in Chapter 8. Thus far, the treatment of credit has been restricted to a static context, and this has meant that the aggregate demand effects of debt have been restricted to its deflationary “stock” effects. However, issuance of new debt can have expansionary “flow” effects on aggregate demand. This chapter combines these stock-flow aggregate demand effects of debt within the context of a model of the business cycle.

At the outset of this book it was noted that the charge of “incoherence” is widely used to diminish and dismiss Post Keynesian economics. The previous twelve chapters have demonstrated the falsity of this charge, and shown that Post Keynesian macroeconomics represents a distinctive body of thought that rests on reasoned and logically consistent foundations. An appropriate closure calls for rising above specific details, and focusing on the profound theoretical and policy differences that flow from the Post Keynesian vision of macroeconomics as compared with the competing visions offered by new classical, neo-Keynesian, and new Keynesian macroeconomics.