Archive for the 'W. S. Jevons' Category

The Rises and Falls of Keynesianism and Monetarism

The following is extracted from a paper on the history of macroeconomics that I’m now writing. I don’t know yet where or when it will be published and there may or may not be further installments, but I would be interested in any comments or suggestions that readers might have. Regular readers, if there are any, will probably recognize some familiar themes that I’ve been writing about in a number of my posts over the past several months. So despite the diminished frequency of my posting, I haven’t been entirely idle.

Recognizing the cognitive dissonance between the vision of the optimal equilibrium of a competitive market economy described by Marshallian economic theory and the massive unemployment of the Great Depression, Keynes offered an alternative, and, in his view, more general, theory, the optimal neoclassical equilibrium being a special case.[1] The explanatory barrier that Keynes struggled, not quite successfully, to overcome in the dire circumstances of the 1930s, was why market-price adjustments do not have the equilibrating tendencies attributed to them by Marshallian theory. The power of Keynes’s analysis, enhanced by his rhetorical gifts, enabled him to persuade much of the economics profession, especially many of the most gifted younger economists at the time, that he was right. But his argument, failing to expose the key weakness in the neoclassical orthodoxy, was incomplete.

The full title of Keynes’s book, The General Theory of Employment, Interest and Money identifies the key elements of his revision of neoclassical theory. First, contrary to a simplistic application of Marshallian theory, the mass unemployment of the Great Depression would not be substantially reduced by cutting wages to “clear” the labor market. The reason, according to Keynes, is that the levels of output and unemployment depend not on money wages, but on planned total spending (aggregate demand). Mass unemployment is the result of too little spending not excessive wages. Reducing wages would simply cause a corresponding decline in total spending, without increasing output or employment.

If wage cuts do not increase output and employment, the ensuing high unemployment, Keynes argued, is involuntary, not the outcome of optimizing choices made by workers and employers. Ever since, the notion that unemployment can be involuntary has remained a contested issue between Keynesians and neoclassicists, a contest requiring resolution in favor of one or the other theory or some reconciliation of the two.

Besides rejecting the neoclassical theory of employment, Keynes also famously disputed the neoclassical theory of interest by arguing that the rate of interest is not, as in the neoclassical theory, a reward for saving, but a reward for sacrificing liquidity. In Keynes’s view, rather than equilibrate savings and investment, interest equilibrates the demand to hold the money issued by the monetary authority with the amount issued by the monetary authority. Under the neoclassical theory, it is the price level that adjusts to equilibrate the demand for money with the quantity issued.

Had Keynes been more attuned to the Walrasian paradigm, he might have recast his argument that cutting wages would not eliminate unemployment by noting the inapplicability of a Marshallian supply-demand analysis of the labor market (accounting for over 50 percent of national income), because wage cuts would shift demand and supply curves in almost every other input and output market, grossly violating the ceteris-paribus assumption underlying Marshallian supply-demand paradigm. When every change in the wage shifts supply and demand curves in all markets for good and services, which in turn causes the labor-demand and labor-supply curves to shift, a supply-demand analysis of aggregate unemployment becomes a futile exercise.

Keynes’s work had two immediate effects on economics and economists. First, it immediately opened up a new field of research – macroeconomics – based on his theory that total output and employment are determined by aggregate demand. Representing only one element of Keynes’s argument, the simplified Keynesian model, on which macroeconomic theory was founded, seemed disconnected from either the Marshallian or Walrasian versions of neoclassical theory.

Second, the apparent disconnect between the simple Keynesian macro-model and neoclassical theory provoked an ongoing debate about the extent to which Keynesian theory could be deduced, or even reconciled, with the premises of neoclassical theory. Initial steps toward a reconciliation were provided when a model incorporating the quantity of money and the interest rate into the Keynesian analysis was introduced, soon becoming the canonical macroeconomic model of undergraduate and graduate textbooks.

Critics of Keynesian theory, usually those opposed to its support for deficit spending as a tool of aggregate demand management, its supposed inflationary bias, and its encouragement or toleration of government intervention in the free-market economy, tried to debunk Keynesianism by pointing out its inconsistencies with the neoclassical doctrine of a self-regulating market economy. But proponents of Keynesian precepts were also trying to reconcile Keynesian analysis with neoclassical theory. Future Nobel Prize winners like J. R. Hicks, J. E. Meade, Paul Samuelson, Franco Modigliani, James Tobin, and Lawrence Klein all derived various Keynesian propositions from neoclassical assumptions, usually by resorting to the un-Keynesian assumption of rigid or sticky prices and wages.

What both Keynesian and neoclassical economists failed to see is that, notwithstanding the optimality of an economy with equilibrium market prices, in either the Walrasian or the Marshallian versions, cannot explain either how that set of equilibrium prices is, or can be, found, or how it results automatically from the routine operation of free markets.

The assumption made implicitly by both Keynesians and neoclassicals was that, in an ideal perfectly competitive free-market economy, prices would adjust, if not instantaneously, at least eventually, to their equilibrium, market-clearing, levels so that the economy would achieve an equilibrium state. Not all Keynesians, of course, agreed that a perfectly competitive economy would reach that outcome, even in the long-run. But, according to neoclassical theory, equilibrium is the state toward which a competitive economy is drawn.

Keynesian policy could therefore be rationalized as an instrument for reversing departures from equilibrium and ensuring that such departures are relatively small and transitory. Notwithstanding Keynes’s explicit argument that wage cuts cannot eliminate involuntary unemployment, the sticky-prices-and-wages story was too convenient not to be adopted as a rationalization of Keynesian policy while also reconciling that policy with the neoclassical orthodoxy associated with the postwar ascendancy of the Walrasian paradigm.

The Walrasian ascendancy in neoclassical theory was the culmination of a silent revolution beginning in the late 1920s when the work of Walras and his successors was taken up by a younger generation of mathematically trained economists. The revolution proceeded along many fronts, of which the most important was proving the existence of a solution of the system of equations describing a general equilibrium for a competitive economy — a proof that Walras himself had not provided. The sophisticated mathematics used to describe the relevant general-equilibrium models and derive mathematically rigorous proofs encouraged the process of rapid development, adoption and application of mathematical techniques by subsequent generations of economists.

Despite the early success of the Walrasian paradigm, Kenneth Arrow, perhaps the most important Walrasian theorist of the second half of the twentieth century, drew attention to the explanatory gap within the paradigm: how the adjustment of disequilibrium prices is possible in a model of perfect competition in which every transactor takes market price as given. The Walrasian theory shows that a competitive equilibrium ensuring the consistency of agents’ plans to buy and sell results from an equilibrium set of prices for all goods and services. But the theory is silent about how those equilibrium prices are found and communicated to the agents of the model, the Walrasian tâtonnement process being an empirically empty heuristic artifact.

In fact, the explanatory gap identified by Arrow was even wider than he had suggested or realized, for another aspect of the Walrasian revolution of the late 1920s and 1930s was the extension of the equilibrium concept from a single-period equilibrium to an intertemporal equilibrium. Although earlier works by Irving Fisher and Frank Knight laid a foundation for this extension, the explicit articulation of intertemporal-equilibrium analysis was the nearly simultaneous contribution of three young economists, two Swedes (Myrdal and Lindahl) and an Austrian (Hayek) whose significance, despite being partially incorporated into the canonical Arrow-Debreu-McKenzie version of the Walrasian model, remains insufficiently recognized.

These three economists transformed the concept of equilibrium from an unchanging static economic system at rest to a dynamic system changing from period to period. While Walras and Marshall had conceived of a single-period equilibrium with no tendency to change barring an exogenous change in underlying conditions, Myrdal, Lindahl and Hayek conceived of an equilibrium unfolding through time, defined by the mutual consistency of the optimal plans of disparate agents to buy and sell in the present and in the future.

In formulating optimal plans that extend through time, agents consider both the current prices at which they can buy and sell, and the prices at which they will (or expect to) be able to buy and sell in the future. Although it may sometimes be possible to buy or sell forward at a currently quoted price for future delivery, agents planning to buy and sell goods or services rely, for the most part, on their expectations of future prices. Those expectations, of course, need not always turn out to have been accurate.

The dynamic equilibrium described by Myrdal, Lindahl and Hayek is a contingent event in which all agents have correctly anticipated the future prices on which they have based their plans. In the event that some, if not all, agents have incorrectly anticipated future prices, those agents whose plans were based on incorrect expectations may have to revise their plans or be unable to execute them. But unless all agents share the same expectations of future prices, their expectations cannot all be correct, and some of those plans may not be realized.

The impossibility of an intertemporal equilibrium of optimal plans if agents do not share the same expectations of future prices implies that the adjustment of perfectly flexible market prices is not sufficient an optimal equilibrium to be achieved. I shall have more to say about this point below, but for now I want to note that the growing interest in the quiet Walrasian revolution in neoclassical theory that occurred almost simultaneously with the Keynesian revolution made it inevitable that Keynesian models would be recast in explicitly Walrasian terms.

What emerged from the Walrasian reformulation of Keynesian analysis was the neoclassical synthesis that became the textbook version of macroeconomics in the 1960s and 1970s. But the seemingly anomalous conjunction of both inflation and unemployment during the 1970s led to a reconsideration and widespread rejection of the Keynesian proposition that output and employment are directly related to aggregate demand.

Indeed, supporters of the Monetarist views of Milton Friedman argued that the high inflation and unemployment of the 1970s amounted to an empirical refutation of the Keynesian system. But Friedman’s political conservatism, free-market ideology, and his acerbic criticism of Keynesian policies obscured the extent to which his largely atheoretical monetary thinking was influenced by Keynesian and Marshallian concepts that rendered his version of Monetarism an unattractive alternative for younger monetary theorists, schooled in the Walrasian version of neoclassicism, who were seeking a clear theoretical contrast with the Keynesian macro model.

The brief Monetarist ascendancy following 1970s inflation conveniently collapsed in the early 1980s, after Friedman’s Monetarist policy advice for controlling the quantity of money proved unworkable, when central banks, foolishly trying to implement the advice, prolonged a needlessly deep recession while central banks consistently overshot their monetary targets, thereby provoking a long series of embarrassing warnings from Friedman about the imminent return of double-digit inflation.


[1] Hayek, both a friend and a foe of Keynes, would chide Keynes decades after Keynes’s death for calling his theory a general theory when, in Hayek’s view, it was a special theory relevant only in periods of substantially less than full employment when increasing aggregate demand could increase total output. But in making this criticism, Hayek, himself, implicitly assumed that which he had himself admitted in his theory of intertemporal equilibrium that there is no automatic equilibration mechanism that ensures that general equilibrium obtains.

In Defense of Stigler

I recently discussed Paul Romer’s criticism of Robert Lucas for shifting from the Feynman integrity that, in Romer’s view, characterized Lucas’s early work, to the Stigler conviction that Romer believes has characterized Lucas’s later work. I wanted to make a criticism of Lucas different from Romer’s, so I only suggested in passing that that the Stigler conviction criticized by Romer didn’t seem that terrible to me, and I compared Stigler conviction to Galileo’s defense of Copernican heliocentrism. Now, having reread the essay, “The Nature and Role of Originality in Scientific Progress,” from which Romer quoted, I find, as I suspected, that Romer has inaccurately conveyed the message that Stigler meant to convey in his essay.

In accusing Lucas of forsaking the path of Feynman integrity and chosing instead the path of Stigler conviction, making it seem as if Stigler had provided justification for pursuing an ideological agenda, as Romer believes Lucas and other freshwater economists have done, Romer provides no information about the context of Stigler’s essay. Much of Stigler’s early writing in economics was about the history of economics, and Stigler’s paper on originality is one of those; in fact, it was subsequently republished as the lead essay in Stigler’s 1965 volume Essays in the History of Economics. What concerns Stigler in the essay are a few closely related questions: 1) what characteristic of originality makes it highly valued in science in general and in economics in particular? 2) Given that originality is so highly valued, how do economists earn a reputation for originality? 3) Is the quest for originality actually conducive to scientific progress?

Here is Stigler’s answer to the first question provided at the end of the introductory section under the heading “The Meaning of Originality.”

Scientific originality in its important role should be measured against the knowledge of a man’s contemporaries. If he opens their eyes to new ideas or to new perspectives on old ideas, he is an original economist in the scientifically important sense. . . . Smith, Ricardo, Jevons, Walras, Marshall, Keynes – they all changed the beliefs of economists and thus changed economics.

It is conceivable for an economist to be ignored by contemporaries and yet exert considerable influence on later generations, but this is a most improbable event. He must have been extraordinarily out of tune with (in advance of?) his times, and rarely do first-class minds throw themselves away on the visionary. Perhaps Cournot is an example of a man whose work skipped a half a century, but normally such men become famous only by reflecting the later fame of the rediscovered doctrines.

Originality then in its scientifically important role, is a matter of subtle unaccustomedness – neither excessive radicalism nor statement of the previous unformulated consensus.

The extended passage quoted by Romer appears a few paragraphs later in the second section of the paper under the heading “The Techniques of Persuasion.” Having already established that scientific originality must be both somehow surprising yet also capable of being understood by other economists, Stigler wants to know how an original economist can get the attention of his peers for his new idea. Doing so is not easy, because

New ideas are even harder to sell than new products. Inertia and the many unharmonious voices of those who would change our ways combine against the balanced and temperate statement of the merits of one’s ” original ” views. One must put on the best face possible, and much is possible. Wares must be shouted — the human mind is not a divining rod that quivers over truth.

It is this analogy between the selling of new ideas and selling of new products that leads Stigler in his drollery to suggest that with two highly unusual exceptions – Smith and Marshall – all economists have had to resort to “the techniques of the huckster.”

What are those techniques? And who used them? Although Stigler asserted that all but two famous economists used such techniques, he mentioned only two by name, and helpfully provided the specific evidence of their resort to huckster-like self-promotional techniques. Whom did Stigler single out for attention? William Stanley Jevons and Eugen von Bohm-Bawerk.

So what was the hucksterism committed by Jevons? Get ready to be shocked:

Writing a Theory of Political Economy, he devoted the first 197 pages of a book of 267 pages to his ideas on utility!

OMG! Shocking; just shocking. How could he have stooped so low as that? But Bohm-Bawerk was even worse.

Not content with writing two volumes, and dozens of articles, in presenting and defending his capital theory, he added a third volume (to the third edition of his Positive Theorie des Kapitals) devoted exclusively to refuting, at least to his own satisfaction, every criticism that had arisen during the preceding decades.

What a sordid character that loathsome Austrian aristocrat must have been! Publishing a third volume devoted entirely to responding to criticisms of the first two. The idea!

Well, actually, they weren’t as bad as you might have thought. Let’s read Stigler’s next paragraph.

Although the new economic theories are introduced by the technique of the huckster, I should add that they are not the work of mere hucksters. The sincerity of Jevons, for example, is printed on every page. Indeed I do not believe that any important economist has ever deliberately contrived ideas in which he did not believe in order to achieve prominence: men of the requisite intellectual power and morality can get bigger prizes elsewhere. Instead, the successful inventor is a one-sided man. He is utterly persuaded of the significance and correctness of his ideas and he subordinates all other truths because they seem to him less important than the general acceptance of his truth. He is more a warrior against ignorance than a scholar among ideas.

I believe that Romer misunderstood what Stigler mean to say here. Romer seems to interpret this passage to mean that if a theorist is utterly convinced that he is right, he somehow can be justified in “subordinat[ing] all other truths” in cutting corners, avoiding contrary arguments or suppressing contradictory evidence that might undercut his theory – the sorts of practices ruled out by Feynman integrity, which is precisely what Romer was accusing Lucas of having done in a paper on growth theory. But to me it is clear from the context that what Stigler meant by “subordinating all other truths” was not any lack of Feynman integrity, but the single-minded focus on a specific contribution to the exclusion of all others. That was why Stigler drew attention to the exorbitant share of Jevons’s book entitled Principles of Political Economy devoted to the theory of marginal utility or the publication by Bohm-Bawerk of an entire volume devoted to responding to criticisms of his two earlier volumes on the theory of capital and interest. He neither implied nor meant to suggest that either Jevons or Bohm-Bawerk committed any breach of scientific propriety, much less Feynman integrity.

If there were any doubt about the correctness of this interpretation of what Stigler meant, it would be dispelled by the third section of Stigler’s paper under the heading: “The Case of Mill.”

John Stuart Mill is a striking example with which to illustrate the foregoing remarks. He is now considered a mediocre economist of unusual literary power; a fluent, flabby echo of Ricardo. This judgement is well-nigh universal: I do not believe that Mill has had a fervent admirer in the twentieth century. I attribute this low reputation to the fact that Mill had the perspective and balance, but not the full powers, of Smith and Marshall. He avoided all the tactics of easy success. He wrote with extraordinary balance, and his own ideas-considering their importance-received unbelievably little emphasis. The bland prose moved sedately over a corpus of knowledge organized with due regard to structure and significance, and hardly at all with regard to parentage. . . .

Yet however one judges Mill, it cannot be denied that he was original. In terms of identifiable theories, he was one of the most original economists in the history of the science.

Stigler went on to list and document the following original contributions of Mill in the area of value theory, ignoring Mill’s contributions to trade theory, “because I cannot be confident of the priorities.”

1 Non-competing Groups

2 Joint Products

3 Alternative Costs

4 The Economics of the Firm

5 Supply and Demand

6 Say’s Law

Stigler concludes his discussion with this assessment of Mill

This is a very respectable list of contributions. But it is also a peculiar list: any one of the contributions could be made independently of all the others. Mill was not trying to build a new system but only to add improvements here and there to the Ricardian system. The fairest of economists, as Schumpeter has properly characterized Mill, unselfishly dedicated his abilities to the advancement of the science. And, yet, Mill’s magisterial quality and conciliatory tone may have served less well than sharp and opinionated controversy in inciting his contemporaries to make advances.

Finally, just to confirm the lack of ideological motivation in Stigler’s discussion, let me quote Stigler’s characteristically ironic and playful conclusion.

These reflections on the nature and role of originality, however, have no utilitarian purpose, or even a propagandistic purpose. If I have a prejudice, it is that we commonly exaggerate the merits of originality in economics–that we are unjust in conferring immortality upon the authors of absurd theories while we forget the fine, if not particularly original, work of others. But I do not propose that we do something about it.


About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner

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