Challenging Hegemony: On varieties of Keynesianism Marc Lavoie

Target paper 2 Robertson’s hare Click View then Header and Footer to change this text

Duncan Foley’s Keynes «Levels of output, employment and income will vary in response to shocks to aggregate demand». «…The resulting configuration of the economy [is] an equilibrium, even when there is substantial involuntary unemployment». Click View then Header and Footer to change this text

Involuntary unemployment cannot be proven to exist « Economic theorists, on the other hand, had difficulty in coming to terms with Keynes’ characterization of economies with substantial unemployment as equilibria » (Foley 2014, p. 8) Indeed…. « The concept of involuntary unemployment can find no room in the theoretical discourse » (De Vroey 2004). According to De Vroey, within the confines of neoclassical theory, especially the neo-Walrasian branch, one cannot demonstrate the existence of involuntary unemployment. Click View then Header and Footer to change this text

Why then stick to neoclassical theory? Because of « the failure of alternative paradigms, based on a more heterodox reading of the General Theory » And because of « the impressive resilience of the neoclassical apparatus and its capacity to tackle issues that were earlier thought to be beyond its grasp » (De Vroey 2004 again) Click View then Header and Footer to change this text

Walrasian or heterodox? The radical perspective on Keynes is reduced to one page (four paragraphs) out of 13 on the topic. Duncan Foley’s perspective on varieties of Keynesianism is more Walrasian than heterodox. He distinguishes two interpretations of Keynes: –the Bastard Keynesians, with sticky money wages or sticky real wages, which also includes several New Keynesian models; –and the more fancy New Keynesian models based on a lack of coordination, with uncorrected externalities (New Keynesians of the third kind, in classifications that were popular in the 1990s). –But what about the New Consensus models of the 2000s, where wages are fully flexible while prices are not? Click View then Header and Footer to change this text

Walrasian perspectives The benchmark is the neo-Walrasian model with complete markets and perfect information. The GT is reinterpreted as a big coordination problem, associated with incomplete or asymetric information, liquidity- constrained decisions, externalities, and so on, where the lack of fully flexible wages and prices are not necessarily at stake. The «reflexivity» of markets, à la Soros, is described as an externality (in financial markets or when workers negotiate their salaries relative to those of other trade unions). This all leads to the possibility of multiple equilibria Click View then Header and Footer to change this text

Complexity economics, alias Post- Walrasian economics « The difference between Walrasian and Post Walrasian macroeconomics can be demonstrated in their alternative formal specification of aggregate production functions….In Post Walrasian work, the aggregate production function must be modelled differently to allow direct consideration of alternative levels of output due to non-market coordination failures and multiple equilibria. The production function must allow the same amount of capital and labour to be associated with different levels of output. It must allow for shifts in aggregate output due to demand spillover effects, externalities, coordination failure, or whateve. » (Colander 1998). y = f (K, L, C) Click View then Header and Footer to change this text

Aggregate demand or aggregate supply? Colander (2001, p. 375), reminding us that he is a ‘Post Keynesian fellow traveler’, has claimed that post-Keynesians were doing a poor job at marketing their ideas. His advice at the time was that: « put bluntly, in today’s environment you can’t market the term “effective demand” – you can market the term “effective supply”». What does that mean? According to Colander (2001, p. 380), «expectations of demand become self-fulfilling», so the supply decisions of firms are the key. Colander’s other suggestion has already been noted: add an extra component to the standard production function – a coordination component – which will affect expectations. Click View then Header and Footer to change this text

The Great Recession caused by a lack of coordination (but between who and who?) Imagine what post-Keynesian economics would look like if post-Keynesians would have followed Colander’s advice of The recession of 2001 and the Great Recession of 2008 would both be explained by: – self-fulfilling expectations – a lack of coordination – negative shocks on effective supply Click View then Header and Footer to change this text

The New Consensus: supply-led In the New Consensus (Real business cycles with some New Keynesian content, DSGE model), a lower real rate of interest speeds up the economy, as in the Old Keynesian model. But the mechanism is different: it does not act through the investment demand function. It acts through the supply of labour. Click View then Header and Footer to change this text

The New Consensus: supply-led II «A cut in interest rates makes consumption today relatively more attractive than consumption tomorrow. Hence, households will try to shift some of their lifetime consumption towards the current period…. This increase in consumption leads to excess demand. As firms try to hire new workers to satisfy this demand, nominal wages increase. As prices are (partly) sticky thanks to the Calvo pricing, this additional consumption demand leads to an increase in real wages and a compression of profits. Higher real wages in turn lead the households to offer more labour (substituting leisure for work) which in turn leads to a new (higher employment) temporary equilibrium in the labour market.» (Dullien, 2009) Click View then Header and Footer to change this text

The liquidity trap Foley (p. 14) briefly discusses Keynes’s liquidity trap. His interpretation is similar to that of Krugman, but it is not Keynes’s. In Krugman and Romer, and the New Consensus, the liquidity trap is the zero-lower bound, due to the fact that the nominal short-term rate of interest cannot fall any lower than zero, whereas a negative nominal short-term rate would be needed to achieve full employment. This is no different from Patinkin (1948). In Keynes (1936), the nominal long-term rate of interest does not fall any lower despite huge quantitative easing, because bond prices are so high that investors fear that future capital losses on long-term securities will wipe out their current interest income. This is Keynes’s liquidity trap, associated with his ‘squares law’. Click View then Header and Footer to change this text

Sticky wages vs sticky interest rates In the ‘good old’ Keynesian model, sticky wages stop the Pigou effect or the real balance effect from operating and achieving full employment. In the New Consensus model, full employment is achieved through the reaction function of the central bank; it is not automatic. Keynesian results are recovered when nominal interest rates become rigid, at the zero-lower bound. So interest rates now provide the rigidity that was provided by wages in the old Keynesian model and by prices in the New Keynesian New Consensus model. Click View then Header and Footer to change this text

Romer’s Newest Consensus, with NAIRU Click View then Header and Footer to change this text

Foley and the post-Keynesians I What is present –Knightian radical uncertainty, fear of econometrics (?) –Rigid markups, rigid real wages –Investment determines output and employment –Deficit-financed fiscal policy tool Click View then Header and Footer to change this text

Rigid markups « Since rigid markups are just as much anathema to orthodox economic thinking as rigid money wages, post-Keynesian economics has had litte purchase on the high-theory struggles over ‘micro-foundations’ for macroeconomics» (p. 16) Is that the only reason? Click View then Header and Footer to change this text

Increasing returns: Lower real wages lead to lower employment (Nell 1978) L D effective LSLS L L fe L1L1 y (w/p) fe (w/p) 1 w/p a 1 /ya 2 /y

Foley and the post-Keynesians II What is missing –Sophisticated financial markets –Lack of link between short-term and long-term rates –Interplay of central bank/financial institutions and the supply of bank reserves –Social coordination failures Is this really a fair assessment? Click View then Header and Footer to change this text

The various PK strands: 5-way typology Fundamentalist or Financial Keynesians: –Money, finance, liquidity preference, uncertainty, methodology –Davidson, Minsky, Kregel, Chick, Dow, Fontana Kaleckians: –Pricing, growth, cycles, employment, income distribution –Sawyer, Bhaduri, Dutt, Blecker, Fazzari, L. Taylor Sraffians: –Relative prices, technical choice, input-output models, capital theory –Garegnani, Kurz, Pasinetti, Steedman Institutionalists: –Institutions (firms, banks, central bank), pricing, behavioural economics – Fred Lee, Peter Earl, Galbraith 2x, MMT (Wray) Kaldorians: –Growth, money, international trade, productivity growth –Godley, Thirlwall, McCombie, Palley, Setterfield –Some authors go across the strands: Arestis, Nell…. UNAM 2014

Impact of the financial crisis The Great Recession will certainly have an impact on the course of macroeconomics. The clearest sign of this is the widespread admission that the loose integration of finance into macroeconomic models was a serious mistake (Eichenbaum 2010), and the ensuing surge of work aiming to fill this gap. At this juncture, it is, however, still difficult to gauge whether a mere integration of the financial sector within the existing framework will suffice, or whether the Great Recession will trigger a more radical reorientation of macroeconomics. –(De Vroey and Malgrange 2011) Click View then Header and Footer to change this text

A response to Foley’s target 2 paper? The Godley stock-flow consistent (SFC) approach Perhaps a more appropriate name would have been: –Post-Keynesian stock-flow consistent approach –Real stock-flow monetary model –Financial stock-flow coherent approach –Sectoral stock-flow coherent approach UMKC March 2014

A feature of SFC The Holy Grail of economics is the ability to integrate the real economy with the financial economy. The purpose is « to show how the whole system fits together and cast banks in a realistic role » (Godley 1996). UMKC March 2014

A critique of G&L by L. Taylor In his review of Godley and Lavoie (2007), Lance Taylor (2008: 643-4) wonders whether the stock-flow consistent approach will ever be able to handle the complexity and the innovations that now characterize the financial system and the recent subprime financial crisis. G&L assumed a single financial sector. One needs at least two financial sectors, perhaps made up of banks and non-banks, or commercial banks and investment banks, or banks and shadow banks (SPV, SIE), with securitization, asset-backed commercial paper, mortgage- backed securities, etc. Click View then Header and Footer to change this text

SFC MODELING ISN’T ALWAYS EASY! UMKC March 2014

Click View then Header and Footer to change this text Poszar et al. 2012

Eatwell, Mouakil and Taylor (2008) Click View then Header and Footer to change this text HouseholdsFirmsBanksSPV Central Bank ∑ Inventories + IN Homes+ p h.h h + K h Cash + HPM b − HPM0 Repos − R + R0 Deposits+ D h − D 0 Loans − L f + L 0 Mortgages − M h + M 0 MBS + p s.s- p s.s 0 Net worth− NW h − NW f − NW b − NW g 0−K h − IN ∑000000

By way of conclusion How about combining SFC with agent-based modeling (without optimization)? Are the emerging properties of ABM simply the counterpart of some straightforward macroeconomic models? (e.g., Seppecher (2012) found that more flexible wages lead to reduced employment relative to more rigid wages, but this is because more flexible wages lead to lower real wages in the downturn and hence reduced aggregate demand). Click View then Header and Footer to change this text