Macroeconomics from a Pre-Keynesian Perspective

October 21, 2010

by Mario Rizzo  

The principal component-idea of macroeconomics – aggregate demand and aggregate supply – trades on the analogy with the Marshallian individual market demand and supply analysis. For many students this makes the idea of macro-aggregation seem quite uncontroversial, almost “natural.”  

My “complaint” will not be about aggregation in general. We are always aggregating and disaggregating when the occasion warrants it. My problem is with a particular form of aggregation. Is it useful? Has it led us to an analysis of the right questions? Does it obscure important interrelations?  

Consider, for example, my post below on Say’s Law of Markets. One reason many economists are today unable to understand the claim that “general gluts” are impossible is because their first instinct is to think in macroeconomic terms.  

Imagine a world without macroeconomics in the Keynesian sense. What is aggregate supply? There are no producers of goods-in-general. There are just producers of specific goods aimed at specific customers. (Of course, some guy can run around adding this up in terms of market prices or whatever.)  There are no demanders-in-general. There are just demanders of specific goods to be purchased from specific producers.  

And when the Keynesian speaks of aggregate demand falling short of what would generate full employment, this does not mean that every market is characterized by deficient demand. (I am abstracting from what “full employment” might coherently mean.)  

So the humble pre-Keynesian economist looks around and sees many specific markets out of equilibrium. The first thing that occurs to such an economist is: Why are there so many errors? Normally, so many producers do not make large errors in deciding what to produce and what to sell. Normally, large numbers of workers do not find themselves making mistakes about where the demand for their services lies.  

Normally, the production decisions of particular firms are more or less coordinated with the buying decisions of other agents – both at a point in time and across time.  

The pre-Keynesian economist is thus naturally driven to find the breakdown in the normal coordination mechanism. This was in fact described by terms like disproportionality or maladjustment of production. 

Consider how a pre-Keynesian, Frank W. Taussig, analyzed a depression in the 1927 edition of his Principles of Economics (vol. ii, 60-61).  

“Some of the phenomena connected with crises, and especially the course of events during a period of depression, have been ascribed to overproduction. During times of depression, it would seem, more is produced than can be readily sold or than can be sold at a profit: is there not general overproduction?
These phenomena, however, result from the breakdown of the machinery of exchange. They are not due to permanent or deep-seated difficulties of finding an extensible or profitable market. They are due to the fact that confidence has been shaken, credit disturbed, the usual course of production and sale subjected to shock…. They are little related to those supposed limitations of demand and those possibilities of permanent overinvestment, which are urged by the persons who maintain that there is danger of general overproduction…. These things correct themselves in time. The mechanism of exchange is restored to its normal working, and the maladjustment in production is set right.”  

Obviously, the last point about things setting themselves right in time brings up additional issues. But the remedy for depressions is not my point. My point is that the pre-Keynesian “macroeconomic” thinking, relying as it did on Say’s Law, points to an entirely different set of causes of depression: disproportionality in the production structure relative to the preferences of economic agents.  

Thus, the Mises-Hayek theory of depressions – while it has its own unique features – is thoroughly in the classical tradition of business-cycle analysis. It finds the cause of depressions in the disproportionality (discoordination) between the preferences of consumer-savers and investors.  

For further enlightenment I recommend Steven Kates, Say’s Law and the Keynesian Revolution: How Macroeconomic Theory Lost its Way, Chapter 5 (Edward Elgar, 1998). The above quotation from Taussig is taken from Kates’s book.

32 Responses to “Macroeconomics from a Pre-Keynesian Perspective”

  1. Greg Ransom Says:

    And there is every reason to believe this is just how the Marshall economists at Cambridge came up with “Keynesian” economics — it’s Marshallian economics of individual choices and individual markets extended and applied to the whole of “supply” and “demand” for the whole of the economy.

    [It’s best to avoid the word “aggregates” here – which doesn’t clarify things or make the distinctions which matter here, as you yourself hint at in your post. Groping for alternative language almost always helps when you are trying to make distinctions about essentially contested explanatory rivals using common language — a lesson from Larry White, a philosopher of science, argument, and explanation.]

    And it’s essentially all the economics that Keynes ever studied or understood — if we take Hayek’s word for it.


  2. Mario has framed the issue very well, and captured the essence of “classical” thinking on the issues. Depressions are coordination problems.

    Greg raises an important issue. Which microeconomics? Cambridge was no longer classical by the younger Keynes’ day, and Marshall was more careful than some of his students. Reasoning in terms of the representative individual may be the source of macro thinking. But I wouldn’t blame Marshall.

  3. Ed Dolan Says:

    I’ve been spending part of the day reading contributions from both sides in the debate over whether our current level of unemployment is structural, or a matter of inadequate demand. It strikes me that the writers on the structuralist side are very much aware that there is no aggregate demand for labor, just demand for particular classes of labor, or even for the labor of each individual worker. After reading several items on both sides, I am convinced that all unemployment, all the time, is structural, that is, reflects some degree of skills mismatch. If I and another candidate interview for a job today, and she is hired and I am not, so that I remain unemployed at least until tomorrow’s next interview, doesn’t that mean her skill set was a better fit to the employer’s needs? Somehow labor market economists seem more comfortable with disaggregation of that kind than the economists who write about fiscal stimulus and QE and such topics.

  4. pcle Says:

    Yes, its become obvious that Keynes General Theory was a detour to a dead end.

    Modern neoclassical economics has investigated the rich potential of sectoral shocks as the driver of fluctuations. The original real business cycle model of Long and Plosser (1983) was of this type. (The inferior model of Prescott got more attention initially, but that line has foundered in the long term). The recent work of Gabaix and Carvalho (2010) follows in the micro-shocks cause macro volatility tradition.


  5. pcle brings up an important, alternative body of analysis.

    Real business cycle theories are very old. The new RBC theories have great technical virtuosity, but do not, as far as I can tell, overcome the problems of the older theories. I do agree with pcle that Plosser had the better story.

    I find the productivity stories in modern RBC unpersuasive. Peter Temin wrote a masterful review essay on RBC in the Setpember 2008 JEL.

    Hayek and other Austrian theorists integrated monetary and real factors. The monetary shocks cause the real, sectoral shocks. Hayek attended so much to the real side, that Schumpeter judged his theory “real.”

    The SOURCE of the sectoral shock is the big issue. It is central. Thanks to pcle for raising it.

  6. Troy Camplin Says:

    IN a strange way, aggregates manage to hide the very problem — which is why it is that such large numbers of people make exactly the same mistakes at exactly the same time. On the other hand, perhaps it is not so strange. One cannot describe mass actions without dealing with the individuals involved, each making their own decisions. Aggregate supply and aggregate demand erases human beings from the picture, and looks at the economy as a collective. Thus it misses what really drives a real economy. Collectivist economics fails yet again.

  7. Some Links Says:

    […] Mario Rizzo, over at ThinkMarkets, writes eloquently on the state of modern macroeconomics. […]


  8. Now, given persistent emphasis on the problem of low aggregate demand by New Keynesians, at least in the non-academic sphere, why do you think they are so opposed to de-aggregating demand and searching for what causes this fall in aggregate (monetary) demand?

  9. Troy Camplin Says:

    Do Keynesians even take into consideration the Yule-Simpson’s paradox of aggregates?

    http://pareonline.net/pdf/v15n15.pdf

    Talk about the potential for leading to wrong conclusions!

  10. George Selgin Says:

    I’m sorry to be going against the grain on this forum, but I emphatically believe general gluts _are_ possible, Say’s Law notwithstanding, so long as by “general” one means “pertaining to goods in general” and not “pertaining to both goods and money.”

    Nor do you have to be a Keynesian to think so. You just have to believe that there can be a (temporary) shortage of real money balances. Don’t think that any classical economist worth his salt would believe it? Then I suggest you read chapter VIII of Poulett Scrope’s excellent 1833 _Principles of Political Economy_, which concludes a discussion of say’s law with a section, “General Glut impossible, except through a Scarcity of Money.”

    More generally, I worry that he call for ditching macro “in the Keynesian sense” risks becoming in practice a call for ditching both good and bad macroeconomics, and giving flesh and blood to Keynes’s straw man view of “Classical” economics.

    As for me, I’m planning to stick to speaking in terms of aggregate demand, and aggregate supply, and (yes) even general gluts. I see no basis in recent events for jettisoning any of these concepts, and I hope people will reconsider the frankly naive claim that, just because they are unfit for telling the whole story of economic fluctuations, then they cannot be useful for telling any part of it. (Hell: I bet anyone on this list that I can explain more of the Great depression using only those concepts than anyone can explain while consistently refraining from using them.)

  11. Mario Rizzo Says:

    George,

    The question of the general glut is whether in the ordinary course pf events the economy could through its productive decisions — especially capital accumulation — fail to produce enough purchasing power to buy it all, assuming that the specific things produced are in accord with individual commodity demands. It is not in the first instance a point about the demand for money. To see this, note that Tugwell/Hobson and others claimed that overproduction/underconsumption was the *cause* of Great Depression. They believed that there was something inherent in the capitalist system such that the power to demand commodities could not keep up with increasing production. All this is clear from J.S. Mill in “Some Unsettled Questions.”


  12. George repeated his comments at Coordination Problem, and I responded there. I suggest those interested go there for my full response. Two main points:

    (1) Historically the general-glut controversy was about a long-run deficiency in demand. The long and short of the debate often got confused.

    (2) The classical/Austrian analysis is a theory of disproportionality in production. A “general” deficiency of demand is a consequence of the coordination problem. A flood of money may address the general aspect of the problem, but may also interfere with the needed repricing.

  13. Mario Rizzo Says:

    I agree with Jerry.

  14. Lee Kelly Says:

    In my opinion, a general glut is impossible, because Say’s law is true. But a shortage of money can create something superficially similar to a general glut. Not much else need be said.

  15. Pietro M. Says:

    It looks like in the last two or three decades there has been a shift between a view of crises as caused by a dearth of savings and excessive investment in saving-thirsty production processes, as in Mises and Hayek, and crises caused by a dearth of money, as in old monetarism.

    These are two different views of the causes and consequences of boom/bust cycles. Maybe they are complementary, maybe one is better than the other on some aspects, but they are two completely different theories.

    The fact that, whatever the BoJ or the Fed have done to pump the money supply, has failed makes me prefer the standard view. Structural problems are usually, albeit not always, more important than money shortages.

  16. George Selgin Says:

    Concerning naive underconsumption and pverproduction theories (which I agree are nonsense, but which I also think have not been so important since the 30s), the best work I am aware of is Evan Durbin’s _Purchasing Power and Trade Depression: A Critique of Under-consumption theories.” Although Durbing was on the wrong side of the calculation debate, his arguments here are truly excellent. Mario, you may already know them. But if not, you’re in for a real treat!

  17. Current Says:

    Pietro M,

    I think that these things are very closely connected. Let’s take monetary equilibrium theory that embraces ABCT and secondary recessions and add to it Higgs. I think if you look at all three things become much clearer.

    Let’s say that at any time we live in a particular regime of monetary policy. That may be inflation targeting, a gold standard, a “labour standard” as Hicks described ISLM Keynesianism or something else. What will cause the largest upsets is not a business cycle, or a secondary depression but rather a situation of Higgsian regime uncertainty. A situation where one regime has ended, or is looking very shaky, but another hasn’t yet been established.

    The problem that we currently face is that the existing regime of institutions is being replaced. As Jerry has said the Dodd-Frank act effectively makes the big banks into GSEs. Under this situation it’s doubtful if any amount of money can satisfy the demand for money.

    Something that I think people sometimes forget is that if monetary equilibrium type policies are to work even reasonably well then the monetary authority must swear itself to follow them in the future. If the future purchasing power of money is very uncertain then it won’t work. Investors will hold low-risk and liquid assets.

  18. Bill Stepp Says:

    George,

    Evan Durbin sounds like an interesting fellow even if he was confused about some issues. Maybe there’s a HOPE article about him waiting to be penned.

  19. Ed Dolan Says:

    Pietro M hits the nail on the head about regime uncertainty. Right now we have three big uncertainties. (1) Will the Fed try QE2? The FOMC is clearly not unanimous. (2) What effect will QE2 have? There is unusually diverse opinion in the economics profession about the transmission mechanism for this type of operation. (3) Is QE2 part of an inflation targeting regime, or something apart from it? If inflation targeting, an IT regime that includes rebasing, or not?

  20. Current Says:

    Well, I said that not Pietro M, but he hinted at it.

  21. Bill Says:

    I SUPPORT YOU!

  22. Ed Dolan Says:

    Sorry, Current. I now see the bit I was looking at was addressed to, not written by P.


  23. How different is Bernanke’s case for QE2 from underconsumption theories decried by Taussig? Production is not generating enough purchasing power to consume the output produced, so the Fed must create additional purchasing power.

    Taussig noted the real cause of depressions is “a beakdown of the machinery of exchange.” Bernanke’s own research backs up Taussig’s analysis. In the present context, that would imply fixing the banks. But Bernanke, allied with Geithner, won’t do that. So he is not addressing the problem. Instead, he inflates.

  24. Ed Dolan Says:

    Jerry, I guess I’ll have to brush up my Taussig before daring to answer that one.

    Here is something interesting, though: The old meaning of the word “inflation” had long gone out of use, to be replaced by the modern meaning inflation=rate of price increase. Now suddenly people have noticed that an increase in money doesn’t necessarily bring an increase in the price level, so the old meaning is creeping back in, as in your last sentence.


  25. Ed,

    Yes. And, on my part, deliberately so.

    The prices in CPI or PCE are a subset of all prices. Many years ago, Alchian and Klein argued there was no theoretical basis for constructing a price index that excluded asset prices.

    If it were ever in doubt, the housing boom and bust demonstrated how powerful the effects of expansive monetary policy can be, and hardly be picked up in these indices.

    Revisions show the Fed was above its inflation target even by these narrow measures. Revisions in price data are just another reason to question inflation targeting.

  26. Current Says:

    Ed,

    That old confusion has been rearing it’s head on mises.org for some time. That’s why I now talk about price inflation and money creation and risk sounding 80 years out of date.

  27. Ed Dolan Says:

    Current–Yes, best to be clear and say “price inflation” but it is hard to break linguistic habits. I still ask my wife “Do you want to tape the tennis match?” even though our VCR has been in the landfill many years now.

    Jerry–I recently had occasion to go back over the record of Bernanke’s obstinant resistance to consideration of asset prices when calibrating monetary policy. Here is what I found:

    “Bernanke has long been skeptical that monetary policy causes bubbles or can help mitigate them. In 2002 he said flatly “Even putting aside the great difficulty of identifying bubbles in asset prices, monetary policy cannot be directed finely enough to guide asset prices without risking severe collateral damage to the economy.” As recently as 2008, he was repeating that mantra almost word-for-word.

    Recently, he has shown just a smidgen of flexibility on the issue. In a January speech this year, he said “However, if adequate reforms are not made, or if they are made but prove insufficient to prevent dangerous buildups of financial risks, we must remain open to using monetary policy as a supplementary tool for addressing those risks [asset bubbles]–proceeding cautiously and always keeping in mind the inherent difficulties of that approach.” Even more recently, he has called for more research on the issue of monetary policy and asset bubbles.”

    I guess it will take one more big asset bubble to convert him.

  28. Greg Hill Says:

    It’s important to distinguish between the short- and long-run in thinking about Say’s Law (as a couple of commentators have pointed out). Leaving aside the long-run “under-consumption” theories, it seems clear that, in the short-run, incomes paid out to the factors of production won’t be sufficient to purchase output (at the prices expected when production was undertaken) if income recipients decide to save a larger portion of their incomes than the proportion of output that firms devote to the production of investment goods. This is the way Keynes puts it in the Treatise on Money, which G.L.S. Shackle glosses as a disequilibrium between ex ante saving and ex ante investment.

    Alternatively, one could say, as Keynes does in The General Theory, that unemployment arises because “because people want the moon; ― men cannot be employed when the object of desire (i.e., money) is something which cannot be produced and the demand for which cannot be readily choked off.” Why would people want to hold money rather than goods, bonds, or stocks? Because they lack confidence in their judgments about the future.

    Is Keynes’s explanation of slumps (in The General Theory) really so much different than the account offered by Taussig when he says that slumps “are due to the fact that confidence has been shaken, credit disturbed, the usual course of production and sale subjected to shock”?

    Mario concludes by saying that “the Mises-Hayek theory of depressions – while it has its own unique features – is thoroughly in the classical tradition of business-cycle analysis. It finds the cause of depressions in the disproportionality (discoordination) between the preferences of consumer-savers and investors.”

    This proposition is not inconsistent with what Keynes says in the Treatise on Money, if we simply add the proviso that slumps occur when ex ante saving exceeds ex ante investment (which results in sales at lower than expected prices) and booms occur when ex ante investment exceeds ex ante saving (which results in sales at greater than expected prices).

  29. Current Says:

    Greg,

    I agree with you that there are some similarities. Somewhere in the “General Theory” Keynes suggests that the underlying cause of crises is that the marginal efficiency of capital doesn’t necessarily follow the interest rate. In some ways this is a version of ABCT in miniature.

    In my view the Keynesian way of approaching the problem which you outline is still not correct though. The issue isn’t savings per se, it’s demand for money which is something different.

  30. Greg Hill Says:

    Current,

    I want to pick up on your thought about the relationship between the interest rate and the marginal efficiency of capital (MEC). The MEC is the discount rate that equates the PV of net proceeds from an investment to its capital cost.

    The MEC, in turn, is based on the firm’s own estimate of the project’s costs and revenues. If the MEC is less than the (risk-adjusted) rate of interest, then the project isn’t “profitable” and won’t be undertaken. Given the uncertainty surrounding future costs and revenues, it’s easy to see the importance of “confidence,” aka “animal spirits.”

    Two quick points: 1) if the public has a strong desire to hold money, interest rates on long-term bonds will be relatively high, which sets a higher bar for the MEC to reach before investments are undertaken; and 2) when resources are idle, the “social” MEC will exceed the firm’s MEC because the hiring of idle factors of production will increase the MEC for other firms’ investments.

    When the “social” MEC differs from the private MEC, it’s not reasonable to expect the market to deliver the optimal level of aggregate investment, for the same reason that firms won’t invest in the optimal level of pollution control if they don’t bear the full cost of their polluting activities.

    One further point: if households increase their rate of saving to rebuild their balance sheets, the demand for consumer goods will fall. But, you may ask, won’t the additional flow of saving push interest rates down, thereby making investment more attractive?

    Not likely. First, the flow of saving won’t increase if reduced expenditure reduces income (the paradox of thrift). And second, the flow of saving is small compared to the stock of outstanding financial assets, which means that the bullishness or bearishness of wealth holders has a much bigger impact on long-term interest rates than changes in the flow of saving.

  31. Current Says:

    Greg,

    This is an interesting and difficult debate. The problem is that many groups hold quite similar views about the outcomes involved, but different views about the mechanisms behind them and different views about the right theoretical perspective to put onto the problem.

    My view is that you have been miseducated by post-Keynesians, but I would think that😉

    > I want to pick up on your thought about the relationship between the
    > interest rate and the marginal efficiency of capital (MEC). The MEC
    > is the discount rate that equates the PV of net proceeds from an
    > investment to its capital cost.
    >
    > The MEC, in turn, is based on the firm’s own estimate of the
    > project’s costs and revenues. If the MEC is less than the
    > (risk-adjusted) rate of interest, then the project isn’t
    > “profitable” and won’t be undertaken. Given the uncertainty
    > surrounding future costs and revenues, it’s easy to see the
    > importance of “confidence,” aka “animal spirits.”

    I certainly agree that confidence is very important for financial markets, no schools of economics really denies that. However, it’s important to understand that Keynesians go much further with this theory.

    They believe that there are certain times when confidence is objectively “too low” or “too high”. The believe that there are policies that will necessarily instill confidence in the market, or remove it.

    In a sense the “marginal efficiency of capital” stands in the centre of Mises argument against Socialism in his book of that name. Mises points out that each particular entrepreneur faces his own particular set of trade-offs. He or she is the one who can make those trade-offs by thinking ahead and using the tools of experience, appraisal and accountancy. Those of us who are looking in on the process can see what affects it and maybe improve policies relating to those effects. But, we cannot do more than that. We can’t really say if confidence is too high or too low.

    Keynes confuses himself with his assumption that capital assets remain the same in the period concerned. By doing that he eliminates the possiblity that a crises can come from the structure of capital. So, the only possibility remaining is that it can come from confidence in the value of that existing structure of capital, which is where his MEC theory comes from.

    I don’t think that the points that Keynes and the post-Keynesians make are necessarily clearly wrong. But, I think that we can only know if it is right or wrong onces we have reasonable monetary institutions and the possibility of ABCT being triggered is removed.

    I think that the Keynesian theory is somewhat incoherent. If we want to get to a capital theory which gives up a self-sustaining “big blob of K” then to do so some radical assumptions must be made. That includes assumptions about confidence.

    > Two quick points: 1) if the public has a strong desire to hold
    > money, interest rates on long-term bonds will be relatively high,
    > which sets a higher bar for the MEC to reach before investments are
    > undertaken;

    Remember that we live in a world of fractional reserve banking. I have some savings bonds that I normally role over. Let’s suppose that instead of buying another 1 year bond I decide to turn one of them worth £9000 into money and put it in a current account. All that means is that instead of lending a bond provider £9000 I lend a bank £9000 on-demand. The question then becomes: “how much lending does my £9000 loan” facilitate? The answer is that in the bond case the bond-issuer only have one day per year where they could concievably have to pay me back, and I have to give notice well before. But, in the current account case I could do it at any time. As a result the bank must hold a precautionary reserveof outside money against my balance. So, the £9000 in the current account provides a lower amount of investment to the £9000 bond.

    The difference here really depends on whether the change in demand for money is permanent or not. If it’s permanent and thought to be permanent then the banks have no problem, they are being loaned money at low rates which puts a big smile on their faces. But, if the change is thought to be very short-term then things are different. In that case the banks must provision for the situation to end, and when it ends there will be a large rise in V, and a consequently an increased need to hold reserves. This is the situation that reduces funds available for investment.

    > and 2) when resources are idle, the “social” MEC will
    > exceed the firm’s MEC because the hiring of idle factors of
    > production will increase the MEC for other firms’ investments.
    >
    > When the “social” MEC differs from the private MEC, it’s not
    > reasonable to expect the market to deliver the optimal level of
    > aggregate investment, for the same reason that firms won’t invest in
    > the optimal level of pollution control if they don’t bear the full
    > cost of their polluting activities.

    I like it when people I’m arguing with put scare quotations around their own terms🙂

    As you say, if business X contracts its activities because of fears about the future then it has a knock-on effect on other businesses. They may well use that as a signal that their capital isn’t worth as much as they thought it was. I don’t think that there is such a thing as a “social MEC”. Let’s suppose your an entrepreneur and you have under-invested. That means that if you can get $100 then you can invest it in your business and get more back, and more than the interest rate. You know how to do this but nobody else can. Return on investment is all about entrepreneurship and context. We cannot know what any sort of overall MEC is, though we can concieve of it.

    However, we can look at variables that affect it, and we can look at it “topologically”. That is, we can say that a reduction in expenditure by business X will affect businesses Y and Z which trade with X negatives if it occurs ceteris paribus along with no other changes. But, what we must recognise is that if we say that “X reduces expenditure” without supposing any other change then what we are talking about is a rise in demand for money.

    Consider the equation MV=PT or M=kPT. What that equation tells us, and Walras’ matrices tell us the same thing, is that a reduction in expenditure on one good without a corresponding rise of it on another good means that V decreases or alternatively that k increase. And k is demand for money. Account falsification comes in here too because we can say that in a situation with surprise deflation profits will be understated in nominal terms by normal accounting methods.

    The essence of all of Keynes and Kahn’s multipliers is that an increase in expenditure in one place causes a fall in demand for money elsewhere, and vice-versa, so they are a form of Wicksell’s cumulative rot argument. Certainly that’s true, but I disagree with they way they put the problem.

    > One further point: if households increase their rate of saving to
    > rebuild their balance sheets, the demand for consumer goods will
    > fall. But, you may ask, won’t the additional flow of saving push
    > interest rates down, thereby making investment more attractive?
    >
    > Not likely. First, the flow of saving won’t increase if reduced
    > expenditure reduces income (the paradox of thrift).

    That’s not really the paradox of thrift. The paradox of thrift is the theory that saving is an anti-social activity that decreases economic output. Some hold that this applies always, others that it applies in recessions.

    Everyone however, agrees that if incomes fall then the flow of savings may fall with them. That’s not the pertinent question though, Keynes thought that if any individual decided to increase his or her rate of saving then that caused incomes to fall, whether they do or not is the important question.

    This is where in my view Keynesians start to get into a muddle. Let’s suppose that I have £1. I can spend that pound on consumer goods. Or, I can save it. If I save it in a bond then a borrower receives £1 which he or she can use on investment goods. We suppose that when a consumer goods producer recieves that £1 they are more confident about their future, or that when a capital goods producer recieves that £1 they are more confident about their future. If we take this view then the question becomes entirely about time. You are supposing that the knock-on effects will occur more quickly through the consumer goods route than through the investment route. Again, this is really an argument about demand for money in disguise. Keynes is supposing that investors have a high demand for money and so giving it to them is a bad policy in recessions. This is basically what he says in Chapter 12 of the “General Theory”.

    The problem though is that we are assuming something asymmetrical here. Granted, savings are small compared to capital stock. But also, expenditure on consumer goods is small too. What you are supposing is that if a business receives £X in extra sales then they will see that as justifying their investment decisions, and will consequently assume that their capital is worth more, and that extra production may be desirable. But, you are supposing that when an investment firm recieves £X in extra bond purchases that it doesn’t see this as a sign that access to funds will be cheaper in the future and that investment in lower return businesses (or more roundabout production paths if you prefer) is likely to be profitable. I don’t think this is true, all businesses are forward-looking and speculative, not just ones that are generally thought of as speculative like banks and finance houses.

    > And second, the
    > flow of saving is small compared to the stock of outstanding
    > financial assets, which means that the bullishness or bearishness of
    > wealth holders has a much bigger impact on long-term interest rates
    > than changes in the flow of saving.

    Certainly, investment decisions have a lot to do with confidence, as we agreed earlier. If investors aren’t confident then they may hoard money, or banks may hoard base, as they are doing now. However, I think this has much more to do with rational decision making than Keynesians suppose. Given the current climate of regime uncertainty I discussed above investing is genuinely difficult.


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