Research Topics

Evolution and Contemporary Relevance

This paper traces the evolution of John Maynard Keynes’s theory of the business cycle from his early writings in 1913 to his policy prescriptions for the control of fluctuations in the early 1940s. The paper identifies six different “theories” of business fluctuations. With different theoretical frameworks in a 30-year span, the driver of fluctuations—namely cyclical changes in expectations about future returns—remained substantially the same. The banking system also played a pivotal role throughout the different versions, by financing and influencing the behavior of return expectations. There are four major changes in the evolution of Keynes’s business cycle theories: a) the saving–investment framework to understand changes in economic fluctuations; b) the capabilities of the banking system to moderate the business cycle; c) the effectiveness of monetary policy to fine tune the business cycle through the control of the short-term interest rate or credit conditions; and d) the role of a comprehensive fiscal policy and investment policy to attenuate fluctuations. Finally, some conclusions are drawn about the present relevance of the policy mix Keynes promoted for ensuring macroeconomic stability.

Divergent trends, as observed, between growth in the financial and real sectors of the global economy entail the need for further research, especially on the motivations behind investment decisions. Investments in market economies are generally guided by call-put option pricing models—which rely on an ergodic notion of probability that conforms to a normal distribution function. This paper considers critiques of the above models, which include Keynes’s Treatise on Probability (1921) and the General Theory (1936), as well as follow-ups in the post-Keynesian approaches and others dealing with “fundamental uncertainty.” The methodological issues, as can be pointed out, are relevant in the context of policy issues and social institutions, including those subscribed to by the ruling state. As it has been held in variants of institutional economics subscribed to by John Commons, Thorstein Veblen, Geoffrey Hodgeson, and John Kenneth Galbraith, social institutions remain important in their capacity as agencies that influence individual behavior with their “informational-cognitive” functions in society. By shaping business concerns and strategies, social institutions have a major impact on investment decisions in a capitalist system. The role of such institutions in investment decisions via policy making is generally neglected in strategies based on mainstream economics, which continue to rely on optimization of stock market returns based on imprecise estimations of probability.

This paper provides a theoretical explanation of the accumulation process, which accounts for the developments in the financial markets over the recent past. Specifically, our approach is focused on the presence of correlations between physical and financial investment, and how the latter could affect the former. In order to achieve this objective, two assets are considered: equities and bonds. This choice permits us to account for two extreme alternative possibilities: taking risk in the short run with unknown profits, or undertaking a commitment to the long run with known yields. This proposal also accounts for the influence of the cost of external finance and the impact of financial uncertainty, as proxied by the interest rate in the former case and the exchange rate in the latter case; thereby utilizing the Keynesian notion of conventions in the determination of investment. The model thus formulated is subsequently estimated by applying the difference GMM and the system GMM in a panel of 14 OECD countries from 1970 to 2010.

This paper provides a brief exposition of financial markets in Post Keynesian economics. Inspired by John Maynard Keynes’s path-breaking insights into the role of liquidity and finance in “monetary production economies,” Post Keynesian economics offers a refreshing alternative to mainstream (mis)conceptions in this area. We highlight the importance of liquidity—as provided by the financial system—to the proper functioning of real world economies under fundamental uncertainty, contrasting starkly with the fictitious modeling world of neo-Walrasian exchange economies. The mainstream vision of well-behaved financial markets, channeling saving flows from savers to investors while anchored by fundamentals, complements a notion of money as an arbitrary numéraire and mere convenience, facilitating exchange but otherwise “neutral.” From a Post Keynesian perspective, money and finance are nonneutral but condition and shape real economic performance. It takes public policy to anchor asset prices and secure financial stability, with the central bank as the key public policy tool.

 

The Queen of England famously asked her economic advisers why none of them had seen “it” (the global financial crisis) coming. Obviously, the answer is complex, but it must include reference to the evolution of macroeconomic theory over the postwar period—from the “Age of Keynes,” through the Friedmanian era and the return of Neoclassical economics in a particularly extreme form, and, finally, on to the New Monetary Consensus, with a new version of fine-tuning. The story cannot leave out the parallel developments in finance theory—with its efficient markets hypothesis—and in approaches to regulation and supervision of financial institutions.

This paper critically examines these developments and returns to the earlier Keynesian tradition to see what was left out of postwar macro. For example, the synthesis version of Keynes never incorporated true uncertainty or “unknowledge,” and thus deviated substantially from Keynes’s treatment of expectations in chapters 12 and 17 of the General Theory. It essentially reduced Keynes to sticky wages and prices, with nonneutral money only in the case of fooling. The stagflation of the 1970s ended the great debate between “Keynesians” and “Monetarists” in favor of Milton Friedman’s rules, and set the stage for the rise of a succession of increasingly silly theories rooted in pre-Keynesian thought. As Lord Robert Skidelsky (Keynes’s biographer) argues, “Rarely in history can such powerful minds have devoted themselves to such strange ideas.” By returning to Keynes, this paper attempts to provide a new direction forward.

This paper advances three fundamental propositions regarding money:

(1) As R. W. Clower (1965) famously put it, money buys goods and goods buy money, but goods do not buy goods.

(2) Money is always debt; it cannot be a commodity from the first proposition because, if it were, that would mean that a particular good is buying goods.

(3) Default on debt is possible.

These three propositions are used to build a theory of money that is linked to common themes in the heterodox literature on money. The approach taken here is integrated with Hyman Minsky’s (1986) work (which relies heavily on the work of his dissertation adviser, Joseph Schumpeter [1934]); the endogenous money approach of Basil Moore; the French-Italian circuit approach; Paul Davidson’s (1978) interpretation of John Maynard Keynes, which relies on uncertainty; Wynne Godley’s approach, which relies on accounting identities; the “K” distribution theory of Keynes, Michal Kalecki, Nicholas Kaldor, and Kenneth Boulding; the sociological approach of Ingham; and the chartalist, or state money, approach (A. M. Innes, G. F. Knapp, and Charles Goodhart). Hence, this paper takes a somewhat different route to develop the more typical heterodox conclusions about money.