The Post Keynesians

1. The Post Keynesians Intermediate Macroeconomics ECON-305 Spring 2013 Professor Dalton Boise State University

2. OriginsandDevelopment

3. The Founders • John Maynard Keynes (1883-1946) • The General Theory of Employment, Interest, and Money (1936) • Post-Keynesians argue that his views have been bastardized as they have been incorporated into orthodox economics

4. The Founders Michal Kalecki (1899-1970) Selected Essays on the Dynamics of the Capitalist Economy, 1933-1970 (1971) Came to many of the “Keynesian” conclusions by a slightly different route, stated more boldly and without compromise

5. The Founders PieroSraffa (1898-1983) Production of Commodities by Means of Commodities (1960) Revival of Classical economics and the importance of distributional issues to the demand and supply of goods “Neo-Ricardians”

6. SchoolorTradition?

7. Fundamentalists Emphasis Fundamental Uncertainty Endogenous Money Liquidity Preference Financial Instability Maintain many neoclassical claims Strategic mistake to attempt to integrate strands of Post-Keynesianism Davidson and Minsky

8. Sraffians Emphasis Relative Prices Techniques of Production Interdependence of multi-sector production While criticizing Marxian labor theory of value, attempts to preserve a labor theory of value Little concern with historical time Sraffa and Marx

9. Kaleckians Emphasis Role and Realization of Profits Microeconomics, especially product pricing and firm behavior Kalecki, Marx, Kaldor, Robinson

10. Paul Davidson Money and the Real World (1978) Post Keynesian Macroeconomic Theory (1994) Financial Markets, Money and the Real World (2003) Major American proponent and an advocate of “fundamentalism”

11. Fundamentalist PK The Keynesian View Rejection of (1) axiom of gross substitution, (2) axiom of reals, and (3) axiom of ergodic economic world. In the real world, (1) money matters – is non-neutral- in both short and long runs; (2) economy moves from irrevocable past into uncertain future; (3) forward contracts are institution to organize time-consuming production; (4) unemployment is common feature of laissez-faire, monetary market economies

12. Methodology Shared Themes Economy as dynamic historical process Uncertainty central to economic life Distribution of income/wealth central to understanding of economy Human choice is real Institutions (money and power structures) shape economy Goals of policy extend beyond efficiency and growth Divergent Models Post-Keynesian models of particular behavior don’t necessarily fit well together (or at all)

13. Presuppositions of Post-KeynesianMacroeconomics

14. Rationality Orthodoxy – Substantive Rationality Agents possess quasi-unlimited knowledge and hyper-ability to optimize PK – Procedural Rationality Agent rationality is bounded – limits to ability to acquire and process information; insufficient information often leads to postponing decisions Agents “satisfice;” rules of thumb are rational responses to uncertainty and complexity

15. Analytical Focus Orthodoxy – Scarcity & Exchange Scarcity is central fact that governs behavior; relationships are viewed within a framework of exchange PK – Production & Growth Primary focus on need to create necessary resources to contribute to wealth through organizing production

16. Analytical Focus “What is emphasized among post-Keynesian economists is the degree to which these resources are utilized. In this sense, the economy usually operates within the boundaries of the production possibility frontier, which is itself quite flexible. As a result, there are always opportunities for a free lunch. …Economists therefore should not focus on the allocation of scarce resources; rather they should concentrate on going beyond scarcity, when, and if ever, scarcity arises. - Lavoie, Introduction, p. 10-11

17. Essential Characteristics The Principle of Effective Demand Production adjusts to demand for goods Investment not tied to intertemporal consumption decisions by households Long-run is not constrained by supply (2) Dynamic Historical Time Time and decisions (to some extent) are irreversible Path-dependency (long-run is result of short-run) Dynamic models need to explain changes in the productive structure

18. Auxiliary Features (1) Inefficacy of Flexible Prices Strong income effects make flexible prices counter-productive (2) Monetary Production Economy Contracts are in money; debts and assets impose financial constraints; endogenous money means investment can preceed saving (3) Fundamental Uncertainty Future inherently unknowable; liquidity preference as consequence (4) Relevant microeconomics Choice often lexiographic; For firms, diminishing returns don’t exist (5) Theoretical pluralism Reality can take different forms; different theories are a necessary consequence

19. Monetary Theory Endogenous Money Supply of money determined by the demand for bank credit and the public’s preferences. Creation of loans and hence deposits is ex nihilo – without previous reserves - all that is needed is a credible borrower. Banks obtain cash and required reserves from the central bank as a consequence of loan-creation.

20. Monetary Theory All money (reserves, currency, deposits) is endogenous and demand-determined!

21. Monetary Theory All interest rates are tied to the “benchmark rate” that is administered by the central bank. The rate chosen by the central bank is described by a reaction function, specifying the policy goals the central bank has. e.g., raise interest rates when the inflation is rising, unemployment falling, capacity utilization is high.

22. Monetary Theory At any given point in time, the supply of money is perfectly elastic at the benchmark rate. The demand for money is determined by the loan rate of interest, the growth rate of output, the growth rate of prices and the rate of investment. i R St2 St1 St0 D High-powered Money

23. Financial Instability Hypothesis Focus on “capital development of economy” rather than “allocation of resources” Capital development is accompanied by exchanges of present money for future money “Present money” pays for resources into production of investment output; “Future money” is the profits accruing to capital-asset owning firms Control over capital stock is financed by liabilities

24. Financial Instability Hypothesis Liability Structures: the balance sheet of firms determine a time-series of payment commitments and time-series of conjectured cash receipts Money flows are from depositors to banks to firms, and then from firms to banks to depositors Flow of money to firms is response to expected future profits; Flow of money from firms is result of realized profits Consumers, governments and international agents also have liability structures

25. Financial Instability Hypothesis The key determinant of system behavior is the level of profits FIH incorporates the Kaleckian view of profits – structure of AD determines profits Simplest model, the aggregate level of profits equals the aggregate level of investment each period (P/Y = I/Y). FIH is a theory of the impact of debt on system behavior.

26. Financial Instability Hypothesis Banks are innovative profit-seekers Seek to innovate new profitable assets they acquire and liabilities they market Three distinct income-debt relations for economic agents Hedge-financing Speculative -financing Ponzi-financing

27. Financial Instability Hypothesis Hedge finance: agents which can fulfill all of their payment obligations from cash flows Speculative finance: agents which can fulfill their payment obligations from their income account, even though cash flow can not repay principle on contractual debt (such units must “roll over” debt)

28. Financial Instability Hypothesis Ponzi finance: cash flows are not sufficient to fulfill either repayment of principle or interest due on outstanding debt; such agents must either sell assets or increase borrowing Borrowing or selling assets lowers the equity of these agents

29. Financial Instability Hypothesis First Theorem “The economy has financing regimes under which it is stable, and financing regimes under which it is unstable.” If hedge-financing dominates, the economy is an equilibrium-seeking and containing system. The greater the weight of speculative and Ponzi financing, the greater the likelihood the economy is a deviation-amplifying system. Source: Hyman Minsky, “The Financial Instability Hypothesis”, Handbook of Radical Political Economy, 1993.

30. Financial Instability Hypothesis Second Theorem “Over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.” If an unstable economy occurs during a period of inflation, an attempt to reduce inflation via monetary constraint will push speculative units into Ponzi units and Ponzi units will see their asset values collapse. Source: Hyman Minsky, “The Financial Instability Hypothesis”, Handbook of Radical Political Economy, 1993.

31. FIH: The Central Question Why does speculative and Ponzi financing become more prevalent in times of prolonged prosperity?

32. Aggregate Demand Theory Keynes’ General Theory Kaleckian alternative Aggregate Supply Function Relationship of firms’ expected sales receipts to level of employment hired Aggregate Demand Function Relationship of households’ expected purchases to level of employment Interaction produces Macreconomic equilibrium

33. Aggregate Supply and Demand • Keynes viewed Say’s Law as requiring a coincidence between the Z and D functions Source: Paul Davidson, “Reviving Keynes’ Revolution,” Why Economists Disagree, p. 70.

34. Keynes and Say’s Law Whether Keynes accurately portrayed Say’s Law has been a subject of a prolonged and ongoing debate. Recall that Leijonhufvud argues that what Say had in mind was a “constraint on reasoning,” and that therefore Say’s Law is really a relationship between plans and not the fruition of plans. Davidson and Post-Keynesians accept Keynes’ portrayal.

35. Aggregate Supply and Demand • Keynes argued that involuntary unemployment is due to a lack of effective demand (Given D at D’, equilibrium sales are E and employment is N1 rather than full employment Nf ‘ Source: Paul Davidson, “Reviving Keynes’ Revolution,” Why Economists Disagree, p. 70.

36. Aggregate Demand Theory The primary determinant of the level of effective demand is investment, which does not require saving. Rather investment only depends upon the willingness to borrow (tied to expected sales) and the willingness to lend (tied to expected sales). Thus the importance of consumer demand in molding the expectations of firms and banks to enter into loan contracts to finance investment.

37. Normative Criteria and Policy Espousal • Success at full employment and fair distribution of income rather than success at allocating resources • Government Management • Price and income policies can do good • Socialist to corporate liberalism