Keynes’s *General Theory*, chapter eleven

This chapter is a wild ride, often verging on incoherence but sometimes falling into brilliance.  In any case it is hard to follow.

The first page or two of this chapter presages Tobin's "q theory" and the notion that differential rates of return determine additions to the capital stock (or lack thereof).  The theory of irreversible investment, and the corresponding notion of option value, has made q theory obsolete although not in a way which damaged Keynesian theory.  Quite the contrary.

The end of section i notes that the rate of interest, as used to evaluate capitalized streams of future income, has to come in part from outside the market for capital goods themselves.  This whole section will make more sense once you've read the notorious chapter 17.  Maybe the claims are true as stated in this chapter (all relations are those of general equilibrium in the final analysis), but what Keynes actually meant here is not so obviously true.  He is hinting at the notion that a liquidity trap can halt new investment and that the rate of return on money can "rule the roost."  When and whether this can be true is a central question for contemporary macro and we will return to it.

Parts of section ii hint at the later "reswitching" debates in capital theory and in this section Keynes is drawing upon Irving Fisher's notes on the problem.  He's again getting at the claim that a purely "real" (non-monetary), partial equilibrium theory of interest won't carry much explanatory power.  I don't think he is wielding the right weapon here.

Section iii pokes a hole in the Fisher Effect.  Keynes points out that if expectations of inflation induce a higher nominal interest rate, why don't those same expectations cause prices to go up now?  This adjustment, by the way, would eliminate the nominal premium on the rate of interest.  This simple yet powerful point doesn't get the attention it ought to.  Storage costs for goods and services may eliminate this paradox but perhaps not completely.  It is striking how few economists have thought this problem through.

The chapter ends with a blizzard of arguments about the importance of expectations.

Whew!  Overall this chapter supports my view that Keynes was obsessed with capital theory and had deep ideas on the topic.  But in terms of understanding the overall argument of the GT, if you can follow chapter 17 (ha), you needn't worry too much about all the difficult arguments and passages here.


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