Challenging%20Hegemony:%20On%20varieties%20of%20Keynesianism

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Challenging Hegemony On varieties of Keynesianism

• Marc Lavoie

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Target paper 2

• Robertsons hare

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Duncan Foleys 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.

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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.

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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)

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Walrasian or heterodox?

• The radical perspective on Keynes is reduced to
  one page (four paragraphs) out of 13 on the
  topic.
• Duncan Foleys 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?

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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

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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)

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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 todays environment you cant
  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.
• Colanders other suggestion has already been
  noted add an extra component to the standard
  production function a coordination component
  which will affect expectations.

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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
  Colanders advice of 1998.
• 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

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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.

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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)

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The liquidity trap

• Foley (p. 14) briefly discusses Keyness
  liquidity trap.
• His interpretation is similar to that of Krugman,
  but it is not Keyness.
• 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 Keyness
  liquidity trap, associated with his squares law.

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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.

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Romers Newest Consensus, with NAIRU
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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

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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?

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Increasing returns Lower real wages lead to
lower employment (Nell 1978)
w/p
LS
y
(w/p)fe
LDeffective
(w/p)1
L
L1
Lfe
a1/y
a2/y
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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?

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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.

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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)

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A response to Foleys 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

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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).

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A critique of GL 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.
• GL 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.

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SFC modeling isnt always easy!
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Poszar et al. 2012
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Eatwell, Mouakil and Taylor (2008)
  Households Firms Banks SPV Central Bank ?
Inventories   IN       IN
Homes ph.hh         Kh
Cash     HPMb   - HPM 0
Repos     - R   R 0
Deposits Dh   - D     0
Loans   - Lf L     0
Mortgages - Mh     M   0
MBS     ps.s - ps.s   0
Net worth - NWh - NWf - NWb - NWg 0 -Kh - IN
? 0 0 0 0 0 0
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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).