General Theory, chapters one and two
I am repeatedly struck by Keynes’s skill as a literary stylist. Usually this praise is denied the General Theory but I consider the book his Finnegans Wake; the most difficult passages are often the most charming but of course they are not for everyone.
I see three main themes in the book as a whole:
1. Income effects are more important than substitution effects.
2. Expectations matter.
3. The private and social returns to liquidity are very different.
#1
(as applied to macro) and #3 were most original in his time. The book
as a whole circles around these themes and repeats them in varying
combinations, not always coherently or consistently. You could also
add the claims that 4. monetary factors render a "natural rate of
interest" problematic and 5. labor markets are special. Chapter two is
essentially about #1 and #5.
Keynes did go beyond the classics,
even if he did often caricature them. (Keynes is brilliant as a
historian of thought when praising but almost always wrong when
criticizing.) Since Keynes never gives us a truly coherent model —
not even verbally — it is easy to pick holes in the GT.
Keynes had so many exciting new ideas that he never decided what his
main point was or exactly under which conditions it would hold.
Much
of chapter two is devoted to establishing the proposition that workers
cannot in any direct way choose a lower real wage. For Keynes nominal
wage flexibility doesn’t solve the
main problem. If nominal wages fall across the board in an economy,
prices will fall and real wages will remain high. Unemployment will
continue while the economy enters a downward spiral. I’ve already
discussed that point here but to sum up my view Keynes is presenting a special case not a general case.
p.9 puts forward a version of the doctrine of money illusion.
p.15
defines involuntary unemployment, namely if the economy can be inflated
into a higher level of employment. This pragmatic definition reflects
that Keynes was never sure why workers minded inflation, and a cut in
the real wage, less than they minded a cut in the nominal wage. But
that is one of his behavioral postulates and it has survived into macro
to this day.
The "neo-Keynesian" models are not so loyal to Keynes. Keynes held sticky nominal wages to be a policy prescription, but not necessarily a good description of the world.
Chapters
one and two are stunning, as they announce that we are now living on a
different economic terrain. But we’ve yet to see whether the main
arguments are truly sound.
On Thursday we’ll be doing chapters
three and four — be ready! And I encourage other bloggers to follow
along and offer their own commentaries.