Keynesian Splenetics: From Social Philosophy to Macroeconomics
vol. 6, no, 4, pp. 471-492
Roger W. Garrison
Underlying the analytical framework of Keynes's General Theory
is a comparison of capitalism and socialism in terms of the risks and consequent
rates of interest, rates of investment and capital accumulation, and levels
of employment and output. Keynes's social philosophy and corresponding
vision of macroeconomic reality biases his comparison in favor of socialism,
or, more precisely, in favor of "a comprehensive socialization of investment."
Recognizing the significant influence of Keynes's early social philosophy
on his subsequent macroeconomics—which is firmly established by
Allan Melzer's "different" interpretation of Keynes—refocuses criticism
of Keynes's analytics, provides a basis for assessing other interpretations
of the General Theory, and helps account for the absence of reconciliation
among the modern recastings of Keynesian macroeconomics.
In the fall of 1986,
sixteen economists gathered in San Francisco to discuss a book-length manuscript
prepared by Allan H. Meltzer. Its five substantive chapters, nearly complete
at the time if not completely understood by its earliest readers, represented
more than two decades of grappling with Keynes's vision of the world and
with the analytical framework on which Keynes hung his ideas. In comparison
to most of the conference participants, which included Milton Friedman,
David Laidler, Axel Leijonhufvud, Donald Moggridge, and Leland Yeager [PHOTO],
I was a newcomer to the business of interpreting Keynes. But I had been
following the development of Meltzer's argument since the publication of
"Keynes's General Theory: A Different Perspective" in 1981.(1)
And this early paper had become the core chapter in Meltzer's extended
treatment of Keynes's vision and analytics.
If my reading of Meltzer
is correct, then Keynes's Monetary Theory: A Different Interpretation
(Cambridge: Cambridge University Press, 1988) is doubly mistitled. Too
narrowly focused and substantially understated, Meltzer's title is at odds
with his overarching theme: Unlike all the other books and articles offering
"different" interpretations of Keynes, this one shows that Keynes's macroeconomics,
very broadly conceived, is simply an extension of his social philosophy.
Possibly because of the title, reviewers of Meltzer's book have limited
their own focus to Keynes's theory of money or to the age-old policy debate
on rules versus discretion.(2) This review
article provides an opportunity to assess, in the broadest possible context,
the difference that Meltzer has made. Framed by Keynes's social philosophy,
Meltzer's book presents a view of Keynes that is both refreshing (in approach)
and disquieting (in substance). And the apparent ease with which Meltzer
arrives at his interpretation causes the reader to wonder how so many other
interpreters could have missed so much for so long.
Meltzer's scholarship invites
a stocktaking. A half century and counting after the publication of the
General Theory,(3) interpreting Keynes
remains a growth industry—and with no clear industry leader. What accounts
for the enduring scope for interpretation—and misinterpretation—of Keynes?
What obstacles are there to getting Keynes straight? And what are the standards
by which a given interpretation can be judged or alternative interpretations
compared? A brief digression on the different interpretations will increase
our appreciation for Meltzer's insights. The most satisfying answers to
these and related questions are ones that stem from Keynes's social philosophy.
Keynes in the Hands of His Interpreters
The General Theory is filled with engaging but cryptic prose.
While its lack of clarity was seen by some early critics as a clear symptom
of error and confusion, it was seen by others as a hallmark of genius.(4)
It was that special combination of "engaging but cryptic"—coupled with
Keynes's long established status as a man of letters and of political affairs—that
gave birth to the enterprise of interpreting Keynes. What did he actually
say? What could he possibly mean? Interpreters soon discovered that plausible
answers to one of these questions were difficult to square with answers
to the other. The gap between actual statements made and (alleged, supposed,
or divined) meaning intended was substantial—and remained so until Meltzer's
melding of Keynes's macroeconomics and social philosophy.
Most of Keynes's interpreters
start on the "meaning" side of the interpretation gap and try to bridge
toward actual statements in the General Theory. Anatol Murad's 1962
book is immodestly entitled What Keynes Means.(5)
Other interpreters dwell on what Keynes must have had in the back of his
mind or hint about how he would have changed his mind had he lived a few
more years—long enough to see the inflationary bias in his policy prescriptions.(6)
The range of possible meanings that characterizes this approach has been
effectively constrained by the implicit assumption that Keynes's intended
message is internally consistent, insightful, and relevant. Whether or
not such an assumption is warranted, most modern readings of the General
Theory take the form of a conjectured vision of the macroeconomy, largely
if not wholly of the recaster's own making, followed by a search through
Keynes's writings for passages that provide hints about the vision. Judged
by this standard of exegetical research, Meltzer's is truly a different
Differences among interpretations
are attributable in large part to different judgments of the interpreters
about which chapter(s) of the General Theory or which assumption(s)
are key to getting Keynes's central message (pp. 282 and passim).
For instance, so-called Keynesian Hydraulics draws inspiration from Chapter
3, "The Principle of Effective Demand" and Chapter 10 "The Marginal Propensity
to Consume and the Multiplier." These chapters, which emphasize the determinacy—given
the level of investment—of the other macroeconomic magnitudes, underlie
the conventional textbook Keynesianism of the 1960s. Keynesian Kaleidics,
which features the radical subjectivism of G. L. S. Shackle and Ludwig
M. Lachmann, draws heavily on Chapter 12, "The State of Long-Term Expectations."
This chapter, along with the 1937 summing-up article(7)
in which Keynes emphasizes the uncertainties inherent in a market economy,
establish the fundamental indeterminacy of investment and hence of the
other macroeconomic magnitudes. The same uncertainty that discourages investment
encourages the hoarding of money, which accounts for the emphasis by Paul
Davidson and other Post Keynesians on Chapter 17, "Essential Properties
of Interest and Money" (p. 285). Meltzer deals with Shackle and Davidson
under the headings "Irrational Expectations" (pp. 280-85) and "Gross Substitution
of Finance" (pp. 285-91).
The New Keynesians of recent
years find their General Theory roots not in some specific chapter
but in the assumption of fixed or sticky prices and wage rates, an assumption
widely believed (though not by Meltzer) to underlie the first eighteen
chapters of the book. New Keynesians reject New Classical theories that
assume perfect price and wage flexibility, thereby reversing the free-market
conclusions and policy implications that would otherwise flow from New
Classical models, A major concern of the New Keynesians is the status of
the claim that prices and wage rates are fixed or sticky downward. Prior
to their own theorizing, the notion of fixity or stickiness, on which so
much of Keynesianism is thought to rest, had been brought into macroeconomics
by Keynes's interpreters (if not by Keynes himself) as an ad hoc
assumption. What is new about New Keynesianism is its supply of "sophisticated
reasons" for stickiness, which save the theory from ad hocery. Theories
about pricing behavior have important implications about the pattern of
price and wage adjustments that might follow, say, an economywide increase
in the demand for output. And the adjustment pattern determines, in turn,
how the impact of the increased demand is divided between increases in
prices and wages and increases in output and employment.(8)
Recognizing that unemployment
follows trivially from the assumption that the wage rate is stuck above
its market-clearing level, Don Patinkin imputes great significance to Chapter
19, "Changes in Money-Wages," where Keynes explicitly relaxed the assumption
of price and wage-rate stickiness but went on to argue that the general
thrust of his theory was unaffected: So long as downward adjustments in
the wage rate are accompanied by downward adjustments in prices, unemployment
would persist. Although inspired in part by the perceived Swedish flavor
of that same Chapter 19, Axel Leijonhufvud interpolates between Keynes's
earlier book, A Treatise on Money (1930), and the General Theory,
producing a smorgasboard of meanings. Z-theory, so named by Leijonhufvud,
gives play to quantity adjustments in the spirit of the General Theory
but rejects the liquidity-preference theory of interest, which Keynes saw
as a critical innovation, setting his second look at macroeconomic relationships
apart from his first.(9) Leijonhufvud's
interpretation gets the highest marks for internal consistency, insightfulness,
and relevance, but he has difficulty in convincingly bridging from this
interpretation to actual passages in either of the two books. Meltzer deals
with Patinkin and Leijonhufvud under the headings of "Elasticity pessimism"
(pp. 270-286) and "Coordination failures" (pp. 266-270).
Chapters 3, 10, 12, and
19 of the General Theory all have some claim on our attention. These
and most of the other chapters sandwiched between Keynes's throat-clearing
remarks in Chapter 1 and his excursions into social philosophy in Chapter
24, contain important clues about macroeconomic relationships as envisioned
by Keynes. Significantly, the one chapter most heavily discounted if not
entirely overlooked by modern macroeconomists is the final one, Chapter
24, "Concluding Notes on the Social Philosophy toward which the General
Theory might lead." This common oversight is attributable, one suspects,
partly to its status as "Notes," partly to the shift in focus from macroeconomics
to social philosophy, and partly to the change in tone. If Chapters 2 through
23 read like papers presented in a series of seminars, Chapter 24 reads
more like a transcription of lively conversation at the cocktail party
marking the end of the series.
Standing at the open bar,
Keynes lets down his guard and tells the reader what he has in mind for
our future. He looks forward to a more equitable and less arbitrary world,
achievable, in his judgment, within one or two generations. This imagined
world is one in which capital yields no return apart from compensation
for supervising it and bearing the associated risks. Interest, which "rewards
no genuine sacrifice," would be nil. Its elimination would mean "the euthanasia
of the rentier, and consequently, the euthanasia of the cumulative oppressive
power of the capitalist to exploit the scarcity-value of capital." Once
the "high stakes" of the capitalist system are eliminated, "the State will
have to exercise a guiding influence." In Keynes's reflective judgment,
"a somewhat comprehensive socialization of investment will prove the only
means of securing an approximation to full employment."(10)
The unbuttoned Keynes of
Chapter 24 makes no appearance at all in modern textbooks and is largely
ignored by Keynes's interpreters. Alvin Hansen, in his influential Guide
to Keynes, suggests that Keynes was just "flying his kite" in the final
chapter (quoted by Meltzer, p. 182). Dismissing Chapter 24 in such a cavalier
fashion might be justified if it weren't for the fact that the views expressed
there, as Meltzer shows, serve to reaffirm fundamental beliefs long held
by Keynes. His views on social philosophy remained largely unchanged from
the early years, when he wrote "Am I a Liberal?" (1925), "The End of Laissez
Faire" (1926), and "The economic Possibilities of Our Grandchildren" (1930).
The kite that Keynes flew at the end of the General Theory, together
with his subsequent article on "My Early Beliefs" (1938), signals a reaffirmation
of those beliefs.(11) His macroeconomics
of the mid-1930s in not to be interpreted as something at odds with his
long-embraced social philosophy. Here Meltzer is simply heeding Joseph
Schumpeter's insight that vision precedes theory.
Meltzer's rendition of Keynes
is not drawn from Chapter 24 in the same way that Keynesian Hydraulics
is drawn from Chapter 3 and 10 and Keynesian Kaleidics from Chapter 12.
Rather, in reading the first 23 chapters, Meltzer couples Keynes's final
chapter with his "early beliefs" to fashion a kind of social-philosophy
sieve. This sieve allows much to fall through—the imposing and relaxing
of heuristic assumptions about price and wage-rate fixity, the interplay
of demand elasticities that characterize the real and monetary sectors
of the economy, and the hint about short-run countercyclical policy—while
trapping only the nuggets of wisdom about the root nature of capitalism
and the implied directions for reform.
This technique pays off
for Meltzer in a way that belies his book's modest title. His interpretation
is in one sense less and in another sense more than the others. It is less
than the others because once the sieve has sorted things out, Meltzer simply
takes Keynes at his word. He begins on the What-did-Keynes-actually-say?
side of the interpretation gap, And the sieve itself, he discovers, has
reduced if not eliminated the gap. Getting to the What-could-he-possibly-mean?
side requires little or no input from the interpreter. Meltzer, operating
under the assumption that Keynes meant what he said, refrains from imposing
the constraint that what he meant must be internally consistent, insightful,
and relevant. However, Meltzer's Keynes amounts to more of an interpretation
than the others (as argued in the subsequent section) because it actually
encompasses important aspects of most of the chapter-specific renditions
Meltzer shares with the
Keynesian fundamentalists a certain insistence that we take Keynes literally
but differs from them by having a workable technique for determining what
is fundamental. That is, while the fundamentalist pore over the General
Theory, Meltzer pours the General Theory through the social-philosophy
sieve. For the student of Keynesian economics who is not well grounded
in Keynes's social philosophy, a nearly equivalent operating procedure
would be: The more Keynes sounds like he is venting his spleen, the more
fundamental are his thoughts and the more literal his pronouncements are
to be taken. Hence the title of the present essay, which attempts to capture
substance and spirit of the central message that Meltzer draws from Keynes's
Keynes as Comparative Systems Analyst
As chapter follows chapter, Keynes's focus shifts—usually without warning—from
one level of abstraction to another, from pure theory to empirical observation,
and from concern about workaday policy to prospects for fundamental reform.
But underlying it all in a lopsided exercise in comparative economic systems.
Keynes is continually comparing capitalism-as-it-is against the standard
of socialism-as-it-has-never-been. Judging the current system to be both
unstable and unjust, he holds out hopes—and is even optimistic about the
prospects—for making the transition to something better.
Meltzer's Keynes argues
from his belief that in a society with ideal economic institutions the
rate of interest would be zero to the conclusion that in our society, with
its less-than-ideal economic institutions, the rate of employment is too
low (pp. 123-135). A chain of arguments involving risk, interest, investment,
capital, output, and labor is tailored to fit each of the two sets of economic
institutions and to demonstrate the superiority of the imagined society
over the actual one.
In the imagined system of
socialism-as-it-has-never-been, risks would be minimized, the rate of interest
would be nil, and all investment opportunities would be fully exploited.
Capital (whose rental price in equilibrium is the rate of interest) would
cease to be scarce, output would be at its maximum, and the labor force
would be fully employed. In our current system of capitalism-as-it-is,
risks are unnecessarily high, the rate of interest is correspondingly high
(read: not zero), and investment is limited to those undertakings whose
expected yield exceeds the interest rate. Capital, then, is kept artificially
scarce, output is less than its maximum, and the level of employment is
below its potential. Meltzer demonstrates, in effect, that Keynes's ultimate
verdict on capitalism, as well as his proposals for reform, are based squarely
on this comparative-systems exercise. (In correspondence, Meltzer has indicated
that, for him, the comparison is between actual and ideal conditions rather
than between capitalist and socialist systems. I do not believe, however,
that my preference for the terms capitalist and socialist does injustice
either to Meltzer or to Keynes.)
The theory offered up by
Keynes traces the perceived chain of causation from greater-than-zero interest
to less-that-full employment. If this is the essence of the General
Theory (and I believe that it is), then the decades of difficulties
in so identifying it become understandable. First, exercises in comparative
economic systems can have relevance only if the systems being compared
are in fact comparable. Actual or possible systems can be compared with
one another; ideal or imagined systems can be compared with one another.
But a hybrid comparison—between one actual and one ideal system—is so biased
from the outset in favor of the ideal as to hardly be recognizable by modern
scholars. Second, the one-way causal connections (from interest to employment),
so important to Keynes's comparative-systems story, often get lost in the
telling. His use of the conventional analytics of supply and demand—in
which the interaction of the market for labor and the market for loanable
funds implies two-way causality—belies his central theme. This particular
obstacle to getting Keynes straight was compounded by Keynes himself when
he endorsed John R. Hicks's early interpretation of the General Theory,
for Hicks's set of simultaneous equations explicitly show the interaction
of the market forces that determine both labor income and the interest
rate.(12) And third, the arguments are
presented backwards. The logical and causal chain runs from the rate of
interest to the rate of employment, yet Keynes deals with the market for
labor first (in Chapter 2) and only much later (starting with Chapter 13)
with the rate of interest. Here Meltzer's interpretation is actually bolstered
by one aspect of the General Theory's obscurity. In his early chapter
on the problem of less-than-full employment, Keynes attempts to downplay
the significance of market forces operating within the labor market itself.
In so doing he finds it necessary to anticipate a later argument (involving
the rate of interest) by referring cryptically to "certain other forces,"
or "a different set of forces."(13)
To enumerate these difficulties
is not to cast doubts on Meltzer's interpretation. After all, Meltzer's
Keynes firmly believed that the ideal system he had in mind was in fact
a possible system. His failure to explain in any detail just how this ideal
system would work is consistent with socialist thought in general, which
has always focused on the perceived failings of the actual system rather
than on the allegedly superior workings of the imagined one. Keynesian
economics as an exercise in comparative systems, then is not to be dismissed
out of hand. In carrying out the exercise, Keynes often resorted to the
framework of mutual determination because that was British economics of
the period. And he addressed the issue of employment first because that
was his and his readers' most pressing concern.
Now that Meltzer has overcome
the difficulties of interpretation and identified Keynes's underlying chain
of argument, we are in a position to ask some critical questions. How well
does this chain hold up? How strong is each of its links? And how essential
is each link to the Keynesian vision and to the various interpretations
of Keynes? Meltzer provides good clues and a summary judgment but stops
short of a full critical analysis.
Keynes as Socialist
Unique to Meltzer's interpretation is the particular significance he
attaches to Keynes's treatment of risk (pp. 128-130 and passim).
The focus here is on the riskiness of lending over and above the riskiness,
if any, of the projects undertaken by borrowers. In a market economy, saving
must wend its way to investment through financial markets. And while the
saver-lender and the borrower-entrepreneur share their investment's yield,
there is a compounding of risk. Equivalently, the so-called lender's risk
rides piggy-back on the project risk born by the borrower. The borrower
forms a risky expectation about the net yield of his or her investment
project; the lender forms a risky expectation about the borrower's ability
to form relevant expectations. Inherent in private financial and capital
markets, then, is a component of risk that would be completely absent if
the borrower and the lender were the same agent—completely absent, that
is, if there were a comprehensive socialization of investment. Keynes seemed
to believe that this component of risk was large and unstable. In the Keynesian
vision, this socially unnecessary lender's risk accounts for most if not
all of the market rate of interest. And worse, it is subject to unanticipated
change as lenders, overcome by the "fetish of liquidity," hoard rather
than lend their money in order to avoid the risk. Accordingly, the elimination
of lender's risk through the social direction of investment would effectively
minimize if not eliminate altogether the necessity of paying—and the privilege
of receiving—interest income.
The first two links in Keynes's
chain of argument, establishing the comparative risks and the corresponding
interest rates that characterize capitalism and socialism, are the most
crucial and the least plausible. Keynes seems to believe that risks can
be eliminated through social reform with no effect on the quality of investment
decisions. He sometimes argues as if his ideal government can somehow control
the total volume of investment, minimizing risk, while private enterprise
continues to control the direction of investment, maximizing allocational
efficiency. On the page immediately following his call for a comprehensive
socialization of investment, Keynes sees "no reason to suppose that the
existing system seriously misemploys the factors of production which are
in use .... It is in determining the volume, not the direction, of actual
employment that the existing system has broken down."(14)
Just what specific social reforms would eliminate risk so as to correct
for volume but would leave direction unaffected are never spelled out in
enough detail to permit a critical evaluation.
Further, to argue that the
elimination of lenders' risk—or of all risks, for that matter—translates
into the elimination of the interest rate is to totally misunderstand the
nature and significance of interest. Whatever complications there may be
in the form of a risk premium, an inflation premium, and a liquidity premium,
the rate of interest reflects some underlying intertemporal terms of trade.
Goods or purchasing power available only at some future date trade at a
discount relative to goods available now. The general notion that sooner
is preferred to later is as fundamental to economic reasoning as the notion
that more is preferred to less. The systematic discounting of the future
and the corresponding positive rate of interest was understood by some
classical economists, as particularly evidenced in Nassau senior's abstinence
theory of interest; by the Swedish economists, as exposited at length in
Gustav Cassel's Nature and Necessity of Interest; and by the Austrian
economists, some of whom attributed interest solely to the time preferences
of market participants. Even in Marshall's Principles, the notion
of "waiting" figures importantly in the discussion of interest. Independent
of monetary considerations, the value of time implies a positive rate of
interest. Keynes gained little ground in his attempt to denigrate this
broadly shared understanding of the economics of interest. His question-begging
perplexity about Marshall's views was based on the failure of Marshall
(as perceived by Keynes) to recognize that interest is largely a monetary
phenomenon particularly characteristic of a decentralized financial sector.(15)
Once Keynes has established—at
least to his own satisfaction—that in an economy with a private investment
sector, there are substantial risks which are subject to change and that
the sole effect of socializing that investment sector is to eliminate those
risks and with them the interest rate, his propositions about the level
of investment, the size of the capital stock, and the rates of output and
employment follow almost trivially. Investment, capital, output, and employment
are necessarily greater in Keynes's imagined world than the corresponding
magnitudes in the world-as-we-know-it, where lenders take risks and borrowers
pay interest. Indeed, in Keynes's utopia investment is exhaustive, capital
in not scarce, output is maximal, and employment is full.
Less important to Keynes
was the fact that the macroeconomic magnitudes in the world-as-we-know-it
are collectively subject to variation. The performance of capitalism is
not always as bad as it is sometimes. The prospects for ironing out the
ups and downs have long been the primary focus of Keynesian Hydraulics.
The key issues here are the relative strengths of the government-spending
multiplier as compared to the tax-cut multiplier, and the relative merits
of fiscal policy in general as compared to monetary policy as a means of
nudging capitalism-as-it-is in the direction of full employment. Though
not Keynes's fundamental concern, he recognized that intervention, in the
form of monetary and fiscal policy, by making for marginal improvements
in economic performance, may hasten the day that society can afford the
more fundamental transition to something better. Some makeshift patching
up of the current system may even be necessary to prevent serious backsliding
and to keep hope alive.
Keynes's exercises in comparative
economic systems can serve as the basis for the claim that he offered a
theory of employment (as suggested by the title of his book) rather than
a theory of unemployment. That is, he theorized that the equilibrium level
of employment in the world as we know it is less on average and involves
a greater variability than in his imagined world. So-called involuntary
unemployment—a term that has engendered much controversy—is simply the
difference between the two equilibrium levels of employment. It is a comparative-systems
employment differential made up of two components. The secular component
derives from the "less on average" aspect of the comparison: the cyclical
component derives from the "greater variability" aspect of the comparison.
Meltzer (p. 126) argues that the secular component is Keynes's major concern.
The General Theory is not predominantly about business cycles.
Although Meltzer seems unperplexed
to find little in Keynes's book about business cycles and counter-cyclical
policy, he is perplexed to find so little about foreign trade and
trade policy. The neglect of the foreign sector in the General Theory,
Meltzer claims, is "inexplicable" (p. 311). But his general approach to
explaining Keynes seems uniquely capable of putting the issues of foreign
trade and trade policy in their proper perspective. Taking a comparative-systems
point of view, we can say that throughout has academic career Keynes was
in matters of trade consistent. That is, he was consistently against intervention,
or consistently in favor of it, depending upon what alternative mechanisms
there were for macroeconomic manipulation. He applauded the Mercantilists
for manipulating trade flows, recognizing that there was nothing else for
them to manipulate. For later periods when fiscal and monetary policy institutions
had become sufficiently developed, he recommended these as the more appropriate
tools of intervention. Policies affecting trade flows pit country against
country, but fiscal and monetary policies can lift all countries together
toward higher levels of prosperity. However, if most countries are lacking
in enlightened leadership, the fiscal and monetary policies of enlightened
countries—and certainly their reforms aimed at eliminating the interest
rate—will have to be accompanied by protectionist policies to prevent trade
flows from thwarting the uplifting effects of such policies and reforms.(16)
The lessons of the General
Theory, whether in terms of policy in the narrow sense or of fundamental
reform, apply either (1) to all countries collectively and without protectionist
measures or (2) to each country separately but with protectionist measures.
This implicit all-and-without and each-but-with rule for application allowed
Keynes to unbundle the issues and compare existing with imagined societies
without addressing at each turn the issues of foreign trade.
Keynes and the Keynesians
Keynesian Splenetics stands or falls with the validity of Keynes's
comparative-systems analysis and hence the relevance of the employment
differential. By discounting Chapter 24 and related material scattered
over earlier chapters, virtually all prior interpretations of Keynes have
implicitly rendered the judgment of "invalid and irrelevant." Keynes's
lamentable use of the term "involuntary unemployment," however, has allowed
interpreters to conceive of the comparative-systems employment differential
as unemployment in the more conventional sense. Unemployment means
that workers are off their supply curve—either temporarily or permanently.
The quantity of labor demanded falls short of the quantity supplied. Accordingly,
full employment means that level of employment that puts workers on their
supply curve. Full-employment output and full-employment income are defined,
in this recasting of Keynes, as the levels of output and income consistent
with a fully employed labor force working with a given stock of capital.
Keynes's comparison of capitalism
and socialism is thus replaced with an analysis of capitalism that allows
for the possibility of an unemployment equilibrium. The problem of unemployment,
whether conceived in equilibrium or disequilibrium terms, must stem from
sluggishness or from perversities of one sort or another in the market
process where labor supply is played off against labor demand. The notions
of non-scarce capital, exhaustive investment, and zero interest play no
part at all in either the dynamics of disequilibrium or the possibility
of unemployment equilibrium.
Here, the gulf between Keynes
and the Keynesians, the interpretation gap, is virtually unbridgeable.
Keynes compared capitalism and socialism in terms of a perceived unidirectional
causation—from risk to interest to investment to capital to output and
employment. His unemployment-equilibrium interpreters depict the capitalist
system with simultaneous equations, which imply multidirectional causality.
Typically, this fundamental difference between Keynes and his interpreters
is not explicit acknowledged, but hints of it are unavoidable as the interpreters
try to make sense out of Keynes's theory of interest and his notion of
involuntary unemployment as an equilibrium phenomenon. Keynes's arguments
reflecting the belief that zero interest and non-scarce capital are the
relevant standards for judging the actual performance of a labor market
in a capitalist system have to be transformed into arguments offered by
interpreters that, under capitalism, an excess supply of labor is consistent
with macroeconomic disequilibrium.
The unidirectional argument
from interest to employment is most easily seen in Keynes's view—not held
consistently throughout the General Theory—that the rate of interest
is determined by monetary factors alone.(17)
Hoarding money as a way of avoiding the adverse changes in the rate of
interest that are characteristic of a capitalist system accounts for both
the existence of the interest rate and its unduly high level. Keynes seeks
to keep the interest rate free of any significant non-monetary influences,
such as underlying time preferences and resource constraints, in order
to keep his analytics consistent with his imagined world, in which the
elimination of risk—and hence the elimination of the desire to hold money
as a means of avoiding risks—leads directly to a zero rate of interest.
Here Meltzer fails to make full use of his social-philosophy sieve: Hicks-style
simultaneous determination of interest and income falls through the sieve;
the purely monetary theory of interest remains. But Meltzer (p. 149) simply
remarks that Keynes "may have been confused on this point."
The second symptom of an
unbridgeable gap between Keynes and his followers is their treatment of
the notion of unemployment. Divorced from Keynes's comparative-systems
analysis, the "equilibrium level of involuntary unemployment" is a phrase
at war with itself. Under a wide variety of assumptions, the root notion
that the labor market fails to clear is either clearly false for trivially
true. So long as an excess supply of labor puts some downward pressure
on the wage rate, the notion is clearly false. The market process through
which labor supply and labor demand are brought into balance is still working;
equilibrium is yet to be attained. If it is specified that the wage rate
is above its market-clearing level and cannot adjust downward, then the
labor market's failure to clear and the corresponding unemployment follow
trivially. It is unobjectionable, of course, to argue that labor markets—as
well as most other markets—do not clear instantly and that the market process
through which they eventually do clear may involve a substantial amount
of unemployment. But striking a balance in this way between a clear falsehood
and a trivial truth produces a commonplace, as Meltzer (pp. 255-56) notes,
that predates Keynes's earliest contributions to macroeconomic theory.
Too many interpreters follow
Keynes in his obscurity rather than in his comparative-systems analysis
and leave as an unsolved mystery why reductions in expenditures on output
and hence reductions in labor demand should result in involuntary unemployment
rather than in a reduced wage rate. Why doesn't the wage rate adjust to
existing supply and demand conditions? (I remember Milton Friedman raising
this question repeatedly at the 1986 conference.) Keynes's Chapter 19,
to which some interpreters attach so much importance, suggests that a reduced
demand for labor does cause the wage rate to adjust downward, but that
it causes prices to adjust downward as well, such that the real
wage rate remains unchanged. Real-wage stickiness follows from wages and
prices that are either separately sticky or jointly variable. Nominal stickiness
may not be crucial to the argument, but then real stickiness is. So why
doesn't the real wage rate adjust to existing supply and demand conditions"
For most interpretations of Keynes, the answer to this question and hence
the cause of so-called involuntary unemployment remains obscure. The mystery
was identifies early on by Frank Knight: "To explain unemployment, Mr.
Keynes first assumes (a) unemployment, and (b) such a price situation,
and (c) such a mode of operation of the price mechanism, that growth in
employment is blocked. This blocking is the fundamental mystery."(18)
To prevent this enduring
mystery from blocking the development of Keynesian economics, most modern
interpreters have adopted the pre-Keynesian commonplace notion of unemployment.
Changes in market conditions may involve a substantial excess of labor
supply over labor demand during the process of adjusting to a new equilibrium.
Though not itself true to the General Theory, this reconstruction
serves two purposes. First, it saves Keynes from himself: It saves him
from his belief that a society with zero interest and non-scarce capital
is an achievable goal and a relevant standard for judging the performance
of capitalist economies. Second, it serves as a basis for dealing with
those of Keynes's insights that are believed to be worth developing—insights
about the precarious circumstances in which business firms form long-term
expectations and about the interconnectedness of the loanable-funds market
and the labor market. These issues will be discussed below in connection
with the separate views of Shackle and Leijonhufvud.
Reconstructions of the General
Theory that treat unemployment as a disequilibrium phenomenon necessarily
involve a shift of emphasis from the secular component of unemployment
to the cyclical component. In fact, cyclical unemployment and involuntary
unemployment have come to mean the same thing. Since the secular component
of involuntary unemployment, which Meltzer argues is the more important
of the two, is squarely based on Keynes's comparative-systems analysis,
its appearance in modern reconstructions would require that the supply
of and demand for labor reflect current market conditions, but at the same
time a wage rate that somehow reflects the market conditions in Keynes's
imagined world. Unemployment, then would persist until the wage rate is
brought down from its other-worldly level or until our actual society is
transformed into Keynes's imagined one. To my knowledge, such a hybrid
construction involving a mysterious mix of comparative-systems and market-process
analysis has not yet occurred to Keynes's interpreters. Instead, the focus
has shifted to the cyclical unemployment, where, in a capitalist system,
downward shifts in the demand for labor can produce unemployment so long
as the wage rate continues to reflect the pre-existing market conditions.
The significance of the
difference between the comparative-systems Keynes and the dynamics-of-disequilibrium
Keynesians is becoming increasingly evident with the development of New
Keynesianism, which differs from New Classicism only in its rejection of
the assumption of instantaneous market clearing. New Keynesian John Taylor
put the matter straight in his treatment of the concept of involuntary
unemployment: "In retrospect, Keynes would have added clarity to his discussion
by unbundling his theory [of deficient aggregate demand] and his definition
of involuntary unemployment."(19) In other
words, (1) why aggregate demand and hence the demand for labor are lower
than they might otherwise be, and (2) why that relatively low demand manifests
itself as unemployment rather than as a correspondingly low wage rate,
are separable questions. Meltzer focuses on the first issue, about which
Keynes had a unique perspective; the New Keynesians focus on the second
issue, about which Keynes had no special insights to contribute. We—and
Meltzer—can easily accept Taylor's retrospective judgment here, but not
without wondering if clarity on this point wouldn't have cost Keynes much
of his influence.
Shackle's and Leijonhufvud's Keynes Reconsidered
Two particular modern interpreters are worthy of a reconsideration:
Shackle, whose Keynesian Kaleidics focuses on the uncertain business environment
in which long-term expectations are formed, and Leijonhufvud, who tries
to make Keynes out as a developer of macroeconomic disequilibrium theory
in the tradition of the Swedish school.(20)
Although Meltzer is critical of these two interpreters—overly so in my
judgment—they actually come as close to Meltzer's own interpretation as
their market-process, disequilibrium theorizing permits.
Shackle has a kinship to
Meltzer in seeing uncertainty as the root cause of macroeconomic problems.
Shackle's Keynes argues from the pervasive uncertainty in a market economy
to the unemployment that may accompany unexpected changes in market conditions.
Shackle grounds this interpretation in Keynes's belief that long-run expectations
have little basis in objective reality. But the expectations held by the
business community are not so much irrational as arational. Further,
and still following Keynes, a given state of expectations can for a time
be upheld as a matter of convention. Expectations are contagious and thus
self-reinforcing. According to this construction, the economy can prosper
so long as the collectively held expectations hold up—even though the expectations
themselves have long ceased to have, if ever they had, any solid grounding.
But doubts can creep in.
Some businesspeople in a reflective mood may perceive the precarious nature
of things. And doubts are contagious, too. One state of expectations can
be suddenly superseded by another, more pessimistic state. Asset markets
as well as labor markets would then be in turmoil until the pattern of
prices and wage rates is brought into line with the new state of expectations.
Shackle's kaleidoscope, whose changing patterns of cut glass reflect the
changing patterns of prices and wage rates, captures Keynes's view of a
market economy No one pattern can be designated as the correct one or as
representing underlying realities more accurately than any of the others.
And if shaken by doubts that have overcome the business community, the
new pattern of prices and wage rates is not predictable in its particulars
from even the fullest knowledge of the old.
Investors in the pre-capitalist
era, when markets for the means of production were thin or nonexistent,
can be compared to investors in the modern capitalist era, which is characterized
by well-organized capital markets. Staying in business or continuing with
an investment project was a matter of long-term commitment in the earlier
era and of short-term confidence in the modern era. In the spirit of Shackle's
Keynes, we can say that businesspeople, once wedded to their businesses
by custom, are able to break loose from them as capital markets develop.
Then in the absence of any commitment or direction, they follow one another
over the nearest cliff—losing their grounding altogether. But like the
coyote in the Saturday morning cartoons, they can walk on air so long as
nobody looks down. When one looks down, though, they all look down, and
down they go. With a comprehensive socialization of investment, the businesspeople,
if effect, are individually rewedded to their respective businesses and
hence collectively rewedded to the underlying economic realities. This
vision of the market economy by Shackle's Keynes is wholly consistent with
Leijonhufvud's kinship to
Meltzer lies in his portrayal of the connection between the loanable-funds
market and the labor market. Meltzer, interpreting Keynes in a comparative-systems
framework, would say that the failure of the loan market to clear at a
zero rate of interest causes the labor market to clear at a low level of
employment; Leijonhufvud, interpreting Keynes in a disequilibrium framework,
would say that the failure of the loan market to clear at an interest rate
that reflects the underlying economic realities can cause the labor market
not to clear at all. The loan market and the labor market are "cross-wired,"
to use Leijonhufvud's own imagery, such that a change in the conditions
in one market has its greatest impact on the other.(22)
For illustration, suppose
the economy is functioning at its full-employment level, meaning that the
wage rate clears the labor market and that labor supply and labor demand
accurately reflect underlying economic realities. Now suppose that the
rate of interest rises because of speculation not grounded in the fundamentals.
A higher interest rate means a lower level of investment, which means a
reduction in labor demand. The old wage rate is now too high. According
to Leijonhufved's Keynes, however, it is the interest rate and the corresponding
demand for labor—and not the wage rate—that are inconsistent with underlying
economic realities. Keynes's assumption that the wage rate will not fall
becomes a recommendation that it not be allowed to fall.(23)
It is the interest rate—and more fundamentally, the uncertainties that
gave rise the destabilizing speculation—that needs attention.
Identifying the interest
rate as the source of the problem does not silence criticism in the spirit
of Friedman. Wouldn't a fall in the wage rate be a solution to the problem
even if an excessive wage rate is not—in some ultimate or general-equilibrium
sense—the source of the problem? A reduced wage rate would alleviate the
immediate problem of unemployment and may well constitute the first phase
of a market process that moves both labor and asset markets toward equilibrium
more broadly conceived. Meltzer's Keynes might respond that the prospect
of falling wages and falling prices, which would eventually bring the real
wage rate in line with labor-market conditions that had been distorted
by speculation in asset markets, simply adds to the uncertainties that
give rise to destabilizing speculation in the first place.
The interpretations of Shackle
and Leijonhufvud, allowing for the differences in analytical frameworks,
are largely consistent with Meltzer's treatment of the cyclical component
of involuntary unemployment. But rather than acknowledge the similarities
and draw strength from them Meltzer simply criticizes Shackle for reading
irrational expectations into Keynes and criticizes Leijohhufvud for misreading
Keynes as a Swedish-style disequilibrium theorist.
Keynes, Meltzer, and Meltzer's Keynes in Perspective
It is probably fair to say that if Meltzer undersells his own interpretation
of the General Theory, he oversells Keynes. In his introductory
chapter Meltzer (12) claims to share in many of Keynes's social views but
to reject Keynes's perception of government. In his concluding chapter
Meltzer offers the summary assessment that "Keynes was an economist, one
of the greatest" (p. 302). He then briefly discusses seven problems in
the General Theory, which he categorizes—somewhat artificially—as
flaws in Keynes's analytical framework (1 through 3) and flaws in Keynes's
vision of the world (4 through 7). Thus, Keynes (1) fails to explain unemployment,
(2) is cavalier in his treatment of expectations (positing elastic or inelastic
expectations as suits his immediate purpose), and (3) neglects the effect
of inflation on money demand. He (4) omits considerations of international
trade, (5) seems unconcerned generally about the consequences of inflation,
(6) makes the questionable judgment that the state can reduce interest
to zero, and (7) is too willing to sacrifice freedom (p. 311).
At this point, let me simply
note the incongruity in claiming that Keynes was a great economist and
then listing as one of his analytical flaws a failure to explain unemployment.
In accordance with most any interpretation except Meltzer's, the failure
of the General Theory to explain unemployment would be catastrophic.
Only in the comparative-systems context of Keynesian Splenetics, which
most Keynesians have overlooked and the rest have rejected, is the failure
to explain unemployment—in the sense of an excess supply of labor—inconsequential
to the general thrust of the theory. But the general thrust of Keynesian
Splenetics hinges critically on the ideas of zero interest and non-scarce
capital, which involve such a serious flaw of vision as to be rejected
out of had under most all interpretations.
Meltzer claims in his early
article, again in his response to critics, and still again in his book,
not to be offering anything more than a "different" interpretation of Keynes—to
be added, presumably, to the many existing ones. He emphasizes that no
single one is the correct interpretation. Yet by demonstrating the
importance of what I have dubbed Keynesian Splenetics, Meltzer penetrates
to the core of Keynes's most firmly held beliefs, puts other interpretations
of Keynes in clear perspective, and accounts for the decades of difficulties
in getting Keynes straight. In the judgment of this reviewer, Allan Meltzer's
insights and scholarship will contribute importantly to the writing of
the final chapter of the Keynesian episode.
1. Allan H. Meltzer, "Keynes's General
Theory: A Different Perspective," Journal of Economic Literature,
vol. 19, no. 1 (March), 1981, pp. 34-64 and idem, "Interpreting
Keynes," Journal of Economic Literature, vol. 21, no. 1 (March),
1983, pp. 66-78.
2. See, for examples, Lorie Tarshis,
Review of Keynes's Monetary Theory: A Different Interpretation,
of Economic Literature, vol. 28, no. 3 (September), 1990, pp. 1203-04,
and Marcello de Cecco, "Keynes Revived, a Review Essay," Journal of
Monetary Economics, vol. 26, 1990, pp. 179-90. In contrast, see Joseph
T. Salerno, "The Development of Keynes's Economics: From Marshall to Millennialism,"
of Austrian Economics, vol. 6, no. 1, 1992, pp. 3-64, in which Salerno
credits Schumpeter and Meltzer for seeing Keynes's analytics as a reflection
of his early vision and then offers his own account of both the continuity
and the discontinuity in the development of Keynes's thinking.
3. John Maynard Keynes, The General
Theory of Employment, Interest, and Money (London: Macmillan, 1936).
4. The sharpest contrast in this respect
is that between Frank Knight, "Unemployment: And Mr. Keynes's Revolution
in Economic Theory," The Canadian Journal of Economics and Political
Science, vol. 3 (February), 1937, pp. 102-123, and Paul A. Samuelson,
"The General Theory," in Robert Lekachman, ed., Keynes' General
Theory: Report of Three Decades (New York: St. Martin's Press, 1964),
5. Anatol Murad, What Keynes Means:
A Critical Clarification of the Economic Theories of John Maynard Keynes
(New York: Bookman Associates, 1962).
6. After presenting his own rendition
of Keynesian macroeconomics, Robert Clower makes the unqualified claim
that "Keynes either had [Clower's rendition] in the back of his mind, or
most of the General Theory is theoretical nonsense." Clower, "The
Keynesian Counter-Revolution: A Theoretical Appraisal" in idem,
ed., Monetary Theory (Middlesex: Penguin Books, 1969), p. 284.
7. John Maynard Keynes, "The General
Theory of Employment," Quarterly Journal of Economics, vol. 51 (February),
1937, pp. 209-223.
8. Meltzer (pp. 255-266) deals with
the rigid-wage angle on the General Theory, but New Keynesianism
se is too new to have been included. This strand of thought is sometimes
dated to a paper published the same year as Meltzer's book: Laurence Ball,
N. Gregory Mankiw, and David Romer, "The New Keynesian Economics and the
Output-Inflation Trade-off," Brookings Papers on Economic Activity I
(1988), pp. 1-65. With arguments anchored in the pre-Keynesian equation
of exchange (MV=PQ), the New Keynesians concern themselves with the question
of the effect of changes in spending (Money multiplied by its Velocity
of circulation) on inflation and output (as measured by the Prices of goods
and the Quantities of goods bought and sold). Because of its attention
to changes in MV and the consequent changes in P and Q, new Keynesianism
might be better described as New Monetarism. (That this new and important
school of macroeconomic thought is seriously mislabeled was pointed out
to me by Leland Yeager.)
9. Z-theory is spelled out in Axel
Leijonhufvud, "The Wicksell Connection: Variations on a Theme," in idem,
and Coordination: Essays in Macroeconomic Theory (Oxford: Oxford University
Press, 1981), pp. 131-202.
10. Keynes, General Theory,
11. The three pre-General Theory
articles are included in Keynes, Essays in Persuasion (New York:
W. W. Norton, 1963), pp. 323-338, 312-322, and 358-373; the post-General
Theory article in included in Keynes, The Collected Writings of
John Maynard Keynes, vol. 10, ed. Donald Moggridge (London: Macmillan,
1972), pp. 433-450.
12. John R. Hicks, "Mr. Keynes and
the 'Classics': A Suggested Interpretation," Econometrica, vol.
5 (April), 1937, pp. 147-19. Meltzer (pp. 129-123) argues, in effect, that
Keynes's reservations about Hicks's interpretation are more significant
than generally recognized.
13. Keynes, General Theory,
pp. 13, 14, and passim.
14. Ibid., p. 379.
15. Ibid., p. 189. In correspondence,
however, Meltzer has reminded me that the zero rate of interest is a common
feature of classical economics. According to David Ricardo and J. S. Mill,
the economic forces that pit labor against capital will eventually eliminate
all interest income.
16. This role for protectionist policies
is most explicit in Keynes, "National Self-Sufficiency," Yale Review,
vol. 22 (June), 1933, pp. 755-769.
17. "The current rate of interest
depends ... not on the strength of the desire to hold wealth but on the
strengths of the desires to hold it in liquid and in illiquid forms respectively,
coupled with the amount of the supply of wealth in one form relative to
the supply of it in the other." Keynes, General Theory, p. 213.
Meltzer's interpretation of this passage is what caused one reviewer to
part company with him. See Tarshis, 1203-4.
18. Knight, "Unemployment," p. 102.
19. John B. Taylor, "Involuntary Unemployment,"
in John Eatwell, Murray Milgate, and Peter Newman, eds., The New Palgrave
Dictionary of Economics, vol. 2 (London: Macmillan, 1987), p. 1000.
20. G. L. S. Shackle, Keynesian
Kaleidics (Edinburgh: Edinburgh Press, 1974); Axel Leijonhufvud, On
Keynesian Economics and the Economics of Keynes (Oxford: Oxford University
Press, 1968); and especially idem, "The Wicksell Connection," in
his Information and Coordination (n. 9 above).
21. Keynes himself argued in terms
of the institution of marriage: "The spectacle of modern investment markets
has sometimes moved me towards the conclusion that to make the purchase
of an investment permanent and indissoluble like marriage, except by reason
of death or other grave cause, might be a useful remedy for our contemporary
evils." Keynes, General Theory, p. 160.
22. Leijonhufvud, "The Wicksell Connection,"
23. "It is more expedient to aim at
a rigid money-wage policy than at a flexible policy responding in easy
stages to changes in the amount of unemployment." Keynes, General Theory,