High Interest, Low Demand, and Keynes: Rejoinder to Hill and Felix
Roger W. Garrison
Both Greg Hill(1) and David Felix(2) call attention to the liquidity-preference theory of interest in their discussions of Keynes's General Theory, Meltzer's interpretation, and my review article. Both draw from Keynes's Chapter 13, "The General Theory of the Rate of Interest," which argues that interest is "the reward for parting with liquidity," (3) or "the compensation received for parting with liquidity for a specified period of time, that is, for not hoarding." (4) Interestingly, this critical aspect of Keynes's analytical framework is highlighted by the two commentators for radically different reasons. Hill restates the liquidity-preference theory and defends it on his way to arguing that the market has no mechanism to govern the rate of investment--and that government should step in and fill the void or, at least, lead the way; Felix points to a single sentence that captures the essence of the liquidity-preference theory and offers it as conclusive evidence that Keynes's views on interest-rate determination are "nonsensical" and that "his pure theory is the purest piffle." Both commentators hint that I have misread or not read Keynes.
High Interest
Keynes's liquidity-preference theory of interest, which was the focus
of the earliest critical analysis, follows almost trivially from his idiosyncratic
way of framing the issue. Individuals earn incomes, which permit them to
buy goods and interest-earning assets and to hold money. Keynes formulates
his theory by imposing a particular sequence on the income-earner's decision
process:
Low Demand
Both Hill and Felix point to another aspect of Keynes's theory, namely,
the supposed waning of spending propensities as wealth increases, as critical
to interpreting his message. As people earn higher incomes and accumulate
wealth, their spending does not increase proportionally. The increasing
gap between spending and earning works as a drag on the economy. Each year
investment spending needs to rise in order to turn the increased savings
into more income but is likely to fall in anticipation of a still further
weakening of consumption demand. According to Hill, "Keynes reasoned that
a redistribution of wealth would increase the propensity to spend and,
therefore, the inducement to invest"(14)
This aspect of Keynesian theory is offered as evidence that "it is the
economic analysis which produces the social vision and not the other way
around." Felix characterizes the notion of spending waning with wealth
as an "unproven ... proposition"(15) and
argues elsewhere that the supposed relationship between spending propensities
and wealth levels was no more than an assumption and that modern empirical
research reveals a lack of supporting evidence.(16)
The general notion that
the economy is beset by demand deficiencies--whether or not these deficiencies
are believed to increase proportionally or only absolutely with income--has
given scope to alternative interpretations of Keynes's central message.
Is the widespread unemployment of labor and of other resources ultimately
attributable to the mispricing of these factors of production--and to a
corresponding mispricing in product markets? Or does the deficiency persist
even when the economy is in equilibrium (in the sense of market clearing)
in both factor and product markets? Keynes's willingness to state the problem
by comparing the business of pyramid building in Ancient Egypt to the business
of railway construction in modern England suggests that his theory did
not hinge on the difference between equilibrium and disequilibrium. "Two
pyramids, two masses for the dead, are twice as good as one; but not so
two railways from London to York." (17)
They are twice as good not because pyramid markets clear while railway
markets do not but because two--or twenty--can be ordered up from on high
independent of any waning of consumption propensities. The ultimate solution
to the problem of demand deficiencies, then, is not to be found in policies
that encourage wage and price flexibility or even in monetary and fiscal
policies that add to total demand. The ultimate solution, in Keynes's final
reckoning, is reform in the direction of a command economy. This is the
general thrust of Keynesian Splenetics.
Hill finesses the critical
question about the nature of demand deficiency. Whether the spending gap
is conceived as a disequilibrium or an equilibrium phenomenon, Hill sees
a vital role for government in leading the business community back to full
employment. During a slump, an individual firm that expands its own operations
would be doing more good for society than would be reflected in its own
profits. But, expecting modest profits at best and fearing losses in the
event that no general economic expansion develops, each individual firm
is unlikely to expand. The role for government, then, according to Hill,
is one of converting some of the largest firms to public ownership and
allowing those firms' decisions to be based on the benefits to society
as a whole. Alternatively, the government could orchestrate the expansion
of privately owned firms through some sort of indicative planning. Envisioning
such roles for government entails a dramatic departure from the fiscal
and monetary policies associated with the Keynesian Hydraulics of modern
textbooks, but Keynes himself provides clear supporting text: "I expect
to see the State, which is in a position to calculate the marginal efficiency
of capital-goods on long views and on the basis of general social advantage,
taking an ever greater responsibility for directly organizing investment
... .(18) There is not much distance between
Hill's (and Keynes's) idea of government as bellwether or sheepdog and
Keynes's hint in Chapter 24 of a comprehensive socialization of investment.
Instincts and Visions
Finally, let me comment on Keynes's wisdom, as judged by Felix, in
seeing the darker side of the socialist development. Felix quotes from
the first paragraph of a letter to F. A. Hayek in which Keynes praises
Hayek's Road to Serfdom: "morally and philosophically I find myself
in agreement with virtually the whole of it; and not only in agreement
with it, but in a deeply moved agreement."(19)
A critical difference between Keynes's and Hayek's thinking, however, is
revealed in the two final paragraphs: "Moderate planning will be safe if
those carrying it out are rightly orientated in their own minds and hearts
to the moral issue ... . Dangerous acts can be done safely in a community
which thinks and feels rightly, which would be the way to hell if they
were executed by those who think and feel wrongly." (20)
In sharp contrast to Hayek, Keynes was an elitist. He believed that the
agencies of government would--or should--be populated by an elite who take
the long view, who act with a eye toward social advantage, and who respect
the rights and liberties of those over whom they have power. Hayek hoped
for institutions that would uphold the rule of law--that would protect
people's rights and liberties no matter which particular individuals populate
the agencies of government. Felix uses this letter to Hayek to suggest
that Keynes was "true in instinct and realistically in equilibrium with
economics and politics"; I see the letter as clear evidence of the difference
between Keynes and Hayek in terms of their contrasting visions of the macroeconomy
and of the potential for government to compensate for the market's perceived
shortcomings.
I do not intend to suggest,
as Hill hints that I may, that having a pre-analytic vision about economic
relationships is, in and of itself, a corrupting influence on the analytics.
I do suggest, following Meltzer and Schumpeter, that a difference in vision,
e.g., as between Keynes and Hayek, is more fundamental than differences
in analytics. According to Schumpeter, "analytic effort is of necessity
preceded by a preanalytic cognitive act [which he calls a vision] that
supplies the raw material for the analytic effort." (21)
Schumpeter cites Keynes as the most telling example of intellectual development
illustrating his point. He argues that the Keynesian "vision, as yet analytically
unarmed," was clearly present in Keynes's 1919 book The Economic Consequences
of the Peace.(22) In my judgment, Meltzer's
book contributes importantly toward substantiating Schumpeter's methodological
views.
Can Keynes's General
Theory be seen as a collection of mutually reinforcing and jointly
supportable propositions about the functioning of a market system and about
the implied policy prescriptions and needed reform? After more than a half-century
of debate, it is difficult to answer this question in the affirmative.
There are too many loose arguments, too many inconsistencies, and too much
scope for interpretation. There is some textual evidence to weigh in favor
of each of the many competing interpretations. But Meltzer has come the
closest, in my judgment, to producing the proverbial smoking gun--in the
form of Keynes's social philosophy. His interpretation, which maximizes
the fit between Keynes's macroeconomic theories and his early beliefs,
gets high marks as a plausible interpretation having a substantial basis
in the text. Assessing the economy's performance under actual as compared
to ideal circumstances, as Meltzer does, or comparing capitalism-as-it-is
with socialism-as-it-has-never-been, as I do, captures much of both the
substance and the spirit of Keynes's book. My own interpretation differs
from Meltzer's largely in its being less complimentary to Keynes. I can
readily accept Hill's summary of my review article, according to which
I have added a critical dimension to Meltzer's analysis by arguing that
Keynes's vision is so utopian as to weaken his case against allowing markets
to work.(23) But this difference aside,
I find Meltzer's interpretation more plausible and truer to Keynes than
any of those that have gained wider acceptance.
Notes:
*Roger W. Garrison, Department of Economics, Auburn University, Auburn, AL 36849, telephone (205) 844-2920, telefax (205) 844-4016, wishes to thank Thomas J. McQuade and Leland B. Yeager for their helpful comments.
1.. Greg Hill, "Misreading Keynes: Reply to Garrison," Critical Review, vol.8, no. 3 (Summer 1994), 441-46.
2. David Felix, "Interpreting Keynesian Instinct and Keynesian Theory: Reply to Garrison," Critical Review, vol.8, no. 3 (Summer 1994), 447-49.
3. Quoted by Felix from John Maynard Keynes, The General Theory of Employment, Interest, and Money (London: Macmillan, 1936), 167.
4. Reported by Hill with citation to Keynes, General Theory 166-67.
5. Keynes, General Theory, 166.
6. Dennis H. Robertson et al., "Alternative Theories of the Rate of Interest," Economic Journal, 42 (September 1937), 431.
8. I leave aside the question of whether a market price (of liquidity, credit, labor, or goods and services) is usefully thought of as a reward. Is the price of a movie ticket the theater owner's reward for allowing a patron to watch a movie? Hayek argues, in effect, against conceiving the wage rate as the reward for parting with leisure. "Reward" implies a meritorious act, which parting with leisure (or liquidity) does not necessarily entail. His arguments apply with greater force, in my judgment, to the interest rate. See Friedrich A. Hayek, The Constitution of Liberty (Chicago: University of Chicago Press, 1960), Chapter 6.
9. Keynes, General Theory, 167, n. 1.
10. Roger W. Garrison, "Keynesian Splenetics: From Social Philosophy to Macroeconomics," Critical Review 6, no. 4 (Fall 1993), 483.
11. Robertson, "Alternative Theories," 433.
13. Keynes's General Theory contains several passages in which a zero marginal efficiency of capital in equilibrium (which implies a zero rate of interest, too) is taken to be an attainable goal: "a properly run community ... ought to be able to bring down the marginal efficiency of capital in equilibrium approximately to zero within a single generation" (220). "If I am right in supposing it to be comparatively easy to make capital-goods so abundant that the marginal efficiency of capital is zero, this may be the most sensible way of gradually getting rid of many of the objectionable features of capitalism" (221). And: "only experience can show ... how far it is safe to stimulate the average propensity to consume, without forgoing our aim of depriving capital of its scarcity-value within one or two generations" (377).
16. David Felix, "Consuming Our Way to Greater Well-Being: Theory and History," Critical Review 3, nos. 2-4 (Summer-Fall 1989) 589-99.
17. Keynes, General Theory, 131.
19. Quoted by Felix from John Maynard Keynes, Collected Writings (London: Macmillan, 1971-1983), 27:385-88.
20. John Maynard Keynes, Collected Writings (London: Macmillan, 1971-1983), 27:385-88.
21. Joseph A. Schumpeter, History of Economic Analysis (New York: Oxford University Press, 1954) 41.