The growing evidence of Keynes s methodology advantage and its consequences within the four macro-markets framework*

Transcription

1 N Th growing vidnc of Kyns s mthodology advantag and its consquncs within th four macro-markts framwork* Angl Asnsio CEPN, Univrsité Paris 13 CNRS This vrsion: Jun 2008 Abstract Rcnt dvlopmnts in conomtrics and conomic thory attst th growing vidnc of strong uncrtainty. Th papr argus that ths dvlopmnts both qustion sriously th mthodological foundations of th mainstram macroconomics and support Kyns s powrful concpts and thory. It mphasizs how rplacing risk with strong uncrtainty suffics to transform th standard four-macro-markts systm into a shifting dmand-drivn systm, with th rsult that pric rigidity is not to b considrd th caus of th ffctiv dmand ladrship (although, as Kyns pointd out, som rigidity is rquird to giv us som stability in a montary conomy). As it is not basd on a rstrictiv dfinition of uncrtainty, Kyns s thory is mor ralistic than th mainstram. It is also mor gnral, for th quilibrium lvl of mploymnt dpnds on th viws about th futur, instad of having a uniqu natural anchor. JEL classification: E00, E12, E13, B22 Kywords: Gnral quilibrium, Uncrtainty, Post-Kynsian Résumé Ls dévloppmnts récnts d l économétri t d la théori économiqu témoignnt d l évidnc croissant d l incrtitud fondamntal. L papir montr qu cs dévloppmnts qustionnnt sériusmnt ls fondmnts méthodologiqus d la macroéconomi dominant t corrobornt ls concpts t la théori d Kyns. Il montr qu rmplacr l risqu par l incrtitud fondamntal suffit à transformr l systèm habitul à quatr macro-marchés n un systèm gouvrné par la dmand, d sort qu la rigidité ds prix n st pas la caus du rôl dominant d la dmand (bin qu, comm Kyns l a souligné, il faut un crtain rigidité pour qu un économi monétair soit stabl). N étant pas basé sur un définition rstrictiv d l incrtitud, la théori d Kyns s avèr ainsi plus réalist. Ell st aussi plus général, car l nivau d équilibr d l mploi n a pas d ancrag naturl uniqu ; il dépnd ds vus concrnant l futur * Papr prsntd at Mthodology aftr Kyns, 11th SCEME sminar in conomic mthodology, joint with th Post Kynsian Economics Study Group and th Scottish Institut for Rsarch in Economics, Stirling Univrsity, U.K., 20 Spt

2 "I accus th classical conomic thory of bing itslf on of ths prtty, polit tchniqus which tris to dal with th prsnt by abstracting from th fact that w know vry littl about th futur." Kyns, 1937, Th Gnral Thory of Employmnt, QJE, 51, p Introduction Th mainstram macroconomics has bn built from th 18 th cntury on th postulat that th conomic systm obys a natural ordr. Th modrn translation of such a blif is to b found in applid conomtrics. Tim-sris conomtrics indd aims at finding a data gnrating procss (DGP) in conomic sris, which rquirs th sris to xhibit som rgularity. Hnc, applid conomtrics usually starts by making th sris stationary (diffrntiating if ndd). Th postulat that som natural ordr prdtrmins th futur of th conomic systm and, thrfor, maks th futur prdictabl, is th vry rason why optimization, spcially intrtmporal optimization, has bn promotd in mainstram s micro and macroconomics. Ths ar th mthodological foundations of th modrn mainstram s macroconomic modl, th so calld DSGE1. In such a concptual framwork, uncrtainty is considrd an piphnomnon, a 'whit nois' around th natural and, thrfor, prdictabl trajctory. Now, whil conomtrics has bn a powrful instrumnt of th mainstram domination, it is bcoming a major sourc of its wakning, for thr is mor and mor vidnc that th DGP of th priod t- n to t is nvr nsurd to hold in th subsqunt priods. This is clarly attstd in th xploding litratur on tim varying rlations, shifting / switching rgims and structural chang, with havy mthodological consquncs (Hndry 2002, Kurmann, 2005, Hinich, Fostr & Wild 2006), spcially as concrns th prdictiv capacity of agnts. Accordingly, Phlps (2007) could claim that if an conomy posssss dynamism, so that frsh uncrtaintis incssantly flow from its innovativ activitis and its structur is vrchanging, th concpt of rational-xpctations quilibrium dos not apply and a modl of such an conomy that imposs this concpt cannot rprsnt at all wll th mchanism of such an conomy s fluctuation. Kyns prcisly concivd a gnral thory of quilibrium without postulating any 'natural' position or trajctory. In th absnc of any anchor for xpctations, dcisions hav to b mad according to th subjctiv flings about what th futur will b, which implis that th collctiv outcom of such dcisions continuously dpnds on th changing viws about th futur. Consquntly, in a comptitiv systm, Kyns's thory dlivrs a diffrnt quilibrium for vry stat of th 'viws concrning th futur', whil 1 S Bnassy (2007) for a stylizd vrsion. 2

3 th mainstram s nw synthsis only rckons th Parto-optimal quilibrium as a rsult of optimal intrtmporal choics2. This is why Th Gnral Thory is basically mor gnral than th mainstram s thory3. According to Kyns, th influnc of th changing viws about th futur is th ultimat critrion of diffrntiation of Th Gnral Thory vis-à-vis th orthodox thory: "Or, prhaps, w might mak our lin of division btwn th thory of stationary quilibrium and th thory of shifting quilibrium maning by th lattr th thory of a systm in which changing viws about th futur ar capabl of influncing th prsnt situation. [ ] W can considr what distribution of rsourcs btwn diffrnt uss will b consistnt with quilibrium undr th influnc of normal conomic motivs in a world in which our viws concrning th futur ar fixd and rliabl in all rspcts; with a furthr division, prhaps, btwn an conomy which is unchanging and on subjct to chang, but whr all things ar forsn from th bginning. Or w can pass from this simplifid propadutic to th problms of th ral world in which our prvious xpctations ar liabl to disappointmnt and xpctations concrning th futur affct what w do to-day." (Kyns, Th Gnral Thory, p ) Kynsian uncrtainty dos not man that agnts do not try to prdict th valu of such and such dcisiv variabl, but th maning and usfulnss of forward looking xpctations is much wakr than th on usually supposd in th mainstram approach. Kynsian rational xpctations admit that popl mak us of all availabl information of cours, but whatvr th kind of probabilistic tools thy us, tru uncrtainty maks it possibl for xpctations to rval vntually systmatically wrong; th past vnts nvr giv nough information about what th futur will b (non rgodicity4). That is th rason why Kyns thought that dcisions actually "also dpnd on th confidnc with which w mak this forcast on how highly w rat th liklihood of our bst forcast turning out quit wrong" (Kyns, 1936, p. 148). Intrstingly, non-kynsian thorists admit largr dfinitions of uncrtainty mor and mor, with th rsult that adaptiv larning and xpctations no mor look irrational nowadays (Sargnt 1999, Farmr, 2002, Evans & Ramy 2006, Prston 2006, Hansn 2007). Exprimntal conomics also attsts that, whn th nvironmnt changs continually, including th bhavior of othr invstors, th larning procss may nvr rach a stationary point (Sundr, 2007). Epstin & Wang (1994) showd in a gnral quilibrium modl of asst pric dtrmination that uncrtainty may lad to quilibria that ar indtrminat, that is, thr may xist a continuum of quilibria for givn 2 Actually, gnral quilibrium thorists hav pointd out for a long tim that gross substitution of xcss dmand functions must b postulatd to nsur th comptitiv quilibrium stability. 3 S Davidson (1996, p 494) for a discussion. 4 Ergodicity is dfind as th dynamic stability of a stochastic procss; s Vrclli (1991, pp. 40, 154) and Davidson (2002, pp.39-69). 3

4 fundamntals. That lavs th dtrmination of a particular quilibrium pric procss to "animal spirits" and sizabl volatility may rsult. 5 Thr ar also dynamic modls basd on th Rational Blifs Equilibrium thory (RBE; s Kurz 1994, Kurz & Motols 2001, Wu & Guo, 2003), a thory of nonstationary (thrfor nonrgodic) systms, whr popl xpctations chang according to thir (rational) changing blifs or thory about th conomic systm functioning. This approach unqustionably improvs th rol of uncrtainty by allowing for non rgodicity, but it assums howvr that agnts always ar confidnt about thir xpctations in spit of th fact that thir thory is likly to chang in th futur. This is an unfortunat assumption which disposssss uncrtainty of its vnom, for, as Knight pointd out from 1921, th dgr of confidnc is a ky concpt of dcision thory in uncrtain contxts. Th point is formally attstd in th modrn dcision thory undr uncrtainty in gnral (s Chataunuf, Eichbrgr & Grant 2007 for xampl), as wll as in various spcific filds. In thir job sarch modl, Nishimura & Ozaki (2004) showd that, whil an incras in risk ("man prsrving sprad of th wag distribution th workr thinks sh facs") incrass th rsrvation wag, an incras in Knigthian uncrtainty ("a dcras in hr confidnc about th wag distribution") rducs th rsrvation wag. Although thir analysis is not about financial dcisions, th intuitiv rason strongly rcalls Kyns's argumnts on liquidity prfrnc and inducmnt to invst: whn uncrtainty incrass, popl aim at rducing it by accpting a job and cancl a futur sarch (that is by prfrring a crtain amount of mony today, rathr than an uncrtain amount tomorrow). Th authors also showd in a rcnt papr on invstmnt (Nishimura & Ozaki 2007), that an incras in Knightian uncrtainty maks th uncrtainty-avrs dcision-makr mor likly to postpon invstmnt to avoid facing uncrtainty, in a way similar to Kyns viws about th ffcts of a stat of confidnc dcras on th marginal fficincy of capital. In th sam vin, Goms (2007) found that an uncrtainty avrs agnt savs mor than a risk avrsion agnt and this gap incrass with th dgr of uncrtainty avrsion. By rfuting th mainstram s rstrictiv dfinition of uncrtainty and considring th dcisiv rol to th stat of th confidnc, Kyns rvolutionizd macroconomics, providing it with nw concpts such as th liquidity prfrnc or th marginal fficincy of capital, and nw rsults such as th non nutrality of mony and th failur of comptitiv forcs to rmov unmploymnt. Th papr mphasizs th transmutation of th standard four macro-markts articulation that Kynsian uncrtainty implis in th comptitiv quilibrium analysis. Sction 2 shows first how th Kynsian ky concpts wr adaptd to th mainstram s rgodic vision of th world, and why, onc amputatd of thir ssntial attributs, thy wr unabl to chang th quilibrium proprtis in th long run. Sction 3 prsnts th basic gnral quilibrium conditions and th rlatd macro-markts articulation, first within th mainstram s approach, and thn focusing on how Kynsian uncrtainty transforms that articulation into a (shifting) dmand-drivn 5 Ths rsults wr obtaind with Knight's dfinition of uncrtainty, which rmains narrowr than th on adoptd by Kyns and, thrfor, dos not fully captur Kyns s viw. S Davidson (1996). 4

5 quilibrium with radically diffrnt proprtis. Th discussion is firstly conductd for a givn lvl of wags, but th sction also addrsss th issu of th wags quilibrium lvl. It is argud that, though som stickinss is rquird for any quilibrium with Kynsian unmploymnt to xist, wags downward rigidity is not to b takn as an unsaf obstacl to full mploymnt at all, for flxibl wags would not rmov unmploymnt in gnral, and could vn worsn th situation. Wag rigidity instad turns out to b th ndognous stabilizing rspons of institutional forcs aimd at stopping th cumulativ dprssion procss which could rsult from flxibl wags. Sction 4 concluds. 2. Uncrtainty in th mainstram: impovrishd concpts and thory As Th Gnral Thory shd so much troubl within th classical way of thinking, orthodox conomists subsquntly providd a (dgnratd) rational for th Kynsian ky concpt basd on thir rstrictiv dfinition of uncrtainty. For xampl, whn Kyns put forward th spculativ motiv of th dmand for mony, h thought about consquncs of uncrtainty and liquidity prfrnc. Empirical vidnc against th singl transaction-mony thory thn calld for a thortical rspons of th mainstram conomics. But th rspons only consistd in justifying th spculativ dmand for mony in trms of som optimal portfolio trad-off btwn intrst and risk6, not uncrtainty. Anothr crucial xampl is givn by th marginal fficincy of capital, which maning was cautiously distinguishd by Kyns from th marginal productivity of capital prcisly bcaus of uncrtainty. But Kyns's thory of th inducmnt to invst, which provd to b bttr than th traditional function of th intrst rat, was translatd in trms of 'Tobin's Q' dviations from th quilibrium valu (that is 1) within a stationary modl7. Yt, Kyns' Q clarly dpartd from th rgodic vision of th world (Kyns, 1936, ch. 11, s. 2, and ch. 21, s. 1). Th damag xtndd to th thory of conomic policy. Insofar as th rgodic axiom was maintaind, and comptitiv forcs wr supposd to driv th systm to th "natural" anchor at last in th long run, macroconomic policis could at bst provid a stabilisation dvic whn nominal rigiditis dlay th adjustmnt procss. In such a contxt, automatic montary and fiscal ruls can b formulatd, sinc thy aim mrly to offst dviations from th targt (th 'natural' valu). But, in nonrgodic rgims, ruls of this typ do not mak sns; firstly, bcaus thr is no natural targt, and, scondly, bcaus macroconomic policy nvr is nsurd to rach any targt, though it may b succssful somtims (S Asnsio 2006, 2007, 2008 for furthr discussion). Consquntly, contrary to th viw xprssd by Kydland and Prscott (1977), who conclud that discrtionary policy should b abandond, macroconomic policy can not 6 S Tobin (1958). 7 S Brainard & Tobin (1968, p 105). 5

6 b but discrtionary in uncrtain contxts, insofar as authoritis can not sriously commit thmslvs to such and such objctivs, though thy can xprss intntions8. Onc amputatd of thir ssntial attributs Kyns s innovativ concpts turnd out inoffnsiv as rgard th long run proprtis of comptitiv markts. In today s mainstram, th only way to prsrv som influnc to th dmand sid is through nominal rigiditis, which only allows for tmporary ffcts. Of cours, th mainstram also can xplain prsistnt markt failurs and unmploymnt. Gnral comptitiv quilibrium thorists hav shown that imprfct comptition and incomplt markts may caus dysfunctions. But such dysfunctions stm from structural dfcts, not from insufficint dmand, at last in th long run. Solutions thrfor hold in rinforcing comptition and crating mor markts, not in stimulating th dmand for goods, xcpt whn it is possibl to tak advantag of som nominal stickinss so as to spd up th rlativ prics adjustmnt by mans of som tmporary incras in th pric of goods. Th rason is basically that th aggrgat dmand can not constrain th aggrgat supply onc th rlativ prics adjustmnt is compltd: ithr, markts clar through th rlativ prics adjustmnt, or, if markt imprfctions prvnt th optimal outcom at th collctiv lvl, th distortd rlativ prics and th involvd individual optimal dcisions mak th distortd aggrgat supply and dmand qual, so that it rmains inadquat to stimulat th aggrgat dmand. Assssd at th macroconomic lvl, an insufficint aggrgat dmand in th goods markt, or, quivalntly, an xcss of saving, is not a stabl situation in th mainstram s viw, for it would triggr a dcras in th rat of intrst which, simultanously, would clar both th markt for goods and th markt for saving (Say s law). As th supply of goods can not b constraind by th dmand, firms may thrfor frly dcid to hir as long as th marginal product of labour xcds th ral factor cost. In th montary vrsion of th thory, th fourth markt, namly th mony markt, also contributs to th support of aggrgat dmand through th ral balanc ffct and th misladingly calld Kyns ffct. Hnc, a dficint aggrgat dmand can not b a caus of unmploymnt. Lt us now considr how uncrtainty intrfrs with th functioning of comptitiv markts. In th fac of uncrtainty, an intrst rat dcras causd by a dprssd aggrgat dmand ( Kyns s ffct), as wll as th ral balanc ffct, may mt various obstacls. First, if th mony supply dcrass along with th dmand for mony (as statd in th ndognous mony litratur), which dpnds on th banking systm bhaviour, th rat of intrst rmains unchangd. But vn if banks do not rduc th mony supply, it may b that th dprssiv forcs harm th stat of th confidnc in such a way that popl incrass th liquid-assts shar in thir portfolio, which would limit or inhibit both th Kyns s and Pigou s ffcts. In addition, th worsning businss 8 Th trm discrtionary is takn as opposd to a commitmnt on som automatic rul. Hnc, our argumnt actually rjoins Batman obsrvation that Kyns rjctd th hydraulic accptation of discrtionary policis, not discrtionary policis in gnral (s th discussion blow). 6

7 climat could dtr invstmnt projcts dspit th (possibl) dcras in th intrst rat. Thus, without considring th possibl dstabilizing forcs that will b considrd in sction 3, it appars at this point of th discussion that stabilizing forcs may fail. Why dosn t th mainstram considr ths obstacls? Th answr is bcaus uncrtainty is not rally considrd, but risk. Thrfor, whn a dprssion ariss, popl do not incras th liquid-assts shar as far as th dprssion is considrd a whit nois. In th sam spirit, a dprssion dos not chang th long run xpctd rturn on capital ithr. Th point is that Say s law only holds undr th rstrictiv condition that th dprssion is considrd a tmporary dviation (a whit nois), which postulats som rgulatory forcs that oprats in th long run so as to anchor th conomy in an imaginary natural position. In th fac of tru uncrtainty, on th othr hand, th spculativ dmand for mony tnds to b too high and th inducmnt to invst too low, which inhibits Say s law vn in comptitiv markts. Such unforsabl shifts in th dmand for mony also hav havy implications on th capacity of montary policy to control th long-trm intrst rat. Whn th montary bas is incrasd through lowr short-trm rats, lowr long-trm bank rats boost th dmand for crdit only if th liquidity prfrnc dos not shift too much. Indd, an incras in liquidity prfrnc owd to unfavourabl xpctations may mak banks abl to sll mor crdit without having to rduc thir intrst rats, for non-bank loans rats in this cas tnd to ris in ordr to compnsat th incrasing liquidity prfrnc. In addition, vn whn authoritis do control th intrst rat ffctivly, th possibility of unforsabl shifts in th marginal fficincy of capital and inducmnt to invst would mak th outcom uncrtain. But, ovrlooking ths possibl obstacls, a psudo- Kynsian thory of conomic policy was dvlopd whr moving th IS and/or LM curv(s) accuratly was rgardd as th lmntary solution to rstor full mploymnt. Th mainstram thn consistntly dvlopd that ida by considring that agnt xpctations could not ignor th futur of such a simpl machin, and inflation targting (say Non Inflationary Stabilizing Policy ) providd th optimal policy rul in stochastically disturbd (though dynamically stabl 9 and thrfor optimizabl) rgims, as stipulatd within th nw standard DSGE modlling. 3. Markts articulation in th mainstram and in Th Gnral Thory According to th discussion abov, it turns out that th mainstram nvr digstd th ssntial aspcts of Th Gnral Thory, that is, th ability to fairly considr th consquncs of tru uncrtainty. Morovr, ths consquncs do not concrn th mony dmand and invstmnt functions only, thy also mak mony non nutral and rmov Say s law by th way. It is vntually th macro-markts articulation which is radically transformd. 9 Th dynamic stability of a stochastic procss is known as rgodicity; s Vrclli (1991, pp. 40, 154) and Davidson (2002, pp.39-69). 7

8 Markts articulation according to th mainstram Th basic mainstram s gnral quilibrium supposs a st of compatibl conditions btwn th aggrgat supply and dmand in vry macro-markt, givn th capital stock and th "markt structurs" (tchnology, prfrncs, dgr of comptition ). Not that th Walras law nsurs that th bonds markt quilibrium conditions hold if th thr rmaining markts conditions hold. If th mony supply is assumd to b xognous (th cas for ndognous mony is discussd blow), th gnral quilibrium conditions thrfor rduc to fiv: th supply and dmand of labour conditions, th supply and dmand for goods conditions, and th mony markt claring condition (Tabl 1 blow). Tabl n 1: Th basic mainstram s modl quilibrium conditions (xognous mony) Labour markt ( N*, w*) ' f N ( N, K ) = N w p = N s w p (1) Dmand: marginal productivity qualization to th ral labour cost (2) Supply: marginal disutility of labour qualization to th xpctd ral wag Goods markt ( Y*, i*) Y = f ( N, K) (3) Supply: production function (constant capital in th short run, diminishing marg. prod.: f N '<0,f N ''>0) Y ( i p& ) Y (4) Aggrgat dmand d = Mony markt ( p*) Bonds markt (, p i) M = L Y, Implicit (5) Markt claring condition; by stting th quantity of mony, th cntral bank controls p and can (tmporarily) impact th dmand for labour and th supply of goods through inflation surpriss: p / p Walras law 8

9 N is th lvl of mploymnt w is th nominal wag p is th xpctd currnt pric indx lvl p& is th xpctd inflation Y is th output lvl K is th stock of capital (constant) i is th nominal rat of intrst M is th quantity of mony Th modl includs fiv ndognous variabls: Y,N,w,p,i which dpnd on th xognous variabls K, M, p and p&. 10 It lnds itslf to an analysis in trms of aggrgat supply and aggrgat dmand: combining quations (4) and (5) (similar to th IS-LM conditions) givs th aggrgat dmand quation Y(p, p&,m), which may b writtn p(y, p&,m); quations (1), (2), and (3) giv th aggrgat supply quation Y(p/p, ). Rsolution yilds Y and p, which prmits to solv for N by (3), thn w by (2), and finally i by (5). Howvr, th output variations do not rally dpnd on currnt pric indx variations, but on th currnt pric indx rror of prdiction. It is through p/p that dmand shocks and unxpctd policis may influnc aggrgat supply and mploymnt in th short run. This is an ssntial fatur of th modrn mainstram thory. Th systm indd bhavs diffrntly dpnding on whthr th xpctd pric indx matchs th ffctiv indx (which is supposd to b tru in th long run 12 ) or not (which may b tru in th short run). In ordr to xplain that, lt us suppos that contracts hav bn ngotiatd at th starting point of th priod on th basis of th xpctd currnt pric indx (p ). Hnc, an unxpctd incras in p will rduc th ral wag and thrfor will incras th dmand of labour (quation 1). Th comptitiv prssur thn incrass w (lss than p) and pushs th workrs to incras th supply of labour, insofar as thy ar xpcting highr ral wags (quation 2). Thus, non xpctd inflationary shocks, which dpnd on th quantity of mony for th momnt (quation 5), influnc th lvl of mploymnt through th prdiction rror (p/p ). 10 Th ndognous dtrmination of p, p& and M ar discussd blow. 9

10 Th mainstram aggrgat markts articulation in th short run a (xognous mony) 1) w(n,p,k) 2) N(p/p,K) 3) Y(p/p,K) 4) i(p/p, p&,k) w(p/p,k) Y*(K,p*/p, p& ) N*(K,p*/p, p& ) w*(k,p*/p, p& ) i*(k,p*/p, p& ) 5) inflation surpriss 5) p*(p, p&,m,k) a) Bracktd numbrs rfr to quations in Tabl 1. Y*, N*, w*, p* and i* ar th quilibrium solutions. figur n 1 In rcnt vrsions of th "nw consnsus", montary policy controls th rat of intrst rathr than th quantity of mony, which is consquntly considrd an ndognous variabl (s Romr, 2000) 11. In that cas, th output lvl (Y) is dtrmind by th sol IS function (quation 4), dpnding on th rat of intrst st by montary authoritis. Thn w can gt N by (3), w by (2), p by (1) and finally M by th function LM (quation 5), which indd is not rquird for dtrmining ral magnituds (figur n 2) 12. Th mainstram aggrgat markts articulation in th short run (ndognous mony) 4) Y*(i, p& ) 3) 2) N*(K, i, p& ) w*(k, i, p&,p ) 1) p(n,k, i, p&,p ) 5) M*(K,i, p&,p ) p*(k,i, p&,p ) figur n 2 11 This assssmnt of ndognous mony diffrs from th Post Kynsian on which is rootd in th crdit natur of mony (s Pally, 2006a). 12 Notic that mploymnt is dtrmind by conditions which involv th goods markt, whras prics ar dtrmind by conditions involving th labour markt. Whil it disappars in th long run (s blow), this proprty will b found in th Kynsian modlling, but with a quit diffrnt maning, as statd blow. 10

11 Although this functioning givs a ladr rol to montary-managd aggrgat dmand, it is fundamntal to rmmbr that it only holds tmporarily; it works conditionally to inflation surpriss that can not b systmatically rproducd ovr th long priod, sinc thy would b xpctd (whn p =p, which is assumd to b tru ovr th long priod as a rsult of rational xpctations in an rgodic stationary rgim, prics do not intrfr with mploymnt and output dtrmination sinc thy do not influnc th ral wag). Assuming thrfor that authoritis do not attmpt (inconsistntly) to gt prmannt xtra output through systmatic inflationary shocks, montary policy can b supposd to announc a targt and rspct it ovr th long priod. As long as th commitmnt is crdibl, popl xpct th announcd targt. As a mattr of simplicity, lt us suppos that montary authoritis aim to stabiliz th pric indx ovr th long priod. Hnc, p& = 0 and, by normalizing th pric indx to 1, w gt p =1. In that cas, th articulation of markts rvals prfctly classical ovr th long priod: th labour markt dtrmins th lvl of nominal wags (quation 2) and mploymnt (quation 1) as functions of th capital stock (givn tchnology, ndowmnt and prfrncs). Thn quation (3) yilds th output lvl (as a function of th capital stock). Th intrst rat follows by (4), so as to adjust th aggrgat dmand to th supply of goods (Say's law). Finally, quation (5) givs th (ndognous) mony quantity which is consistnt with th stationary conditions and prics stability. 13 Th mainstram aggrgat markts articulation ovr th long run a 1) w(n,k) 2) N*(K) 3) Y*(K) 4) Say's law i*(k) w*(k) a) Notic that, sinc p=1 and p& = 0, w and i can b intrprtd as th ral wag and th ral intrst rat. figur n 3 M*(K) Finally, in th long run: a) mploymnt is xclusivly dtrmind in th labour markt, b) output and intrst rat ar dtrmind in th goods markt, conditionally to th labour markt outcoms, and c) mony is ncssary ndognous, for a stationary rgim rquirs a prdictabl pric indx trajctory (rmmbr that p=p must hold), and such a prdictabl trajctory, vn th "zro inflation rat", puts a condition on th quantity of 5) 5) 13 It is of intrst to not that this long run ndognous montary policy implis that, ovr th long priod, th ral rat of intrst is at th "natural" (stationary) lvl, though it may tmporary dviat in th short run (whn p p ), as popularizd in th litratur on 'Taylor's rul'. 11

12 mony, dirctly (authoritis adjust th quantity of mony so as to rach th targt ovr th long priod, and thn th intrst rat adjusts ndognously to th "natural rat" ovr th long priod), or indirctly (authoritis adjust th intrst rat to th "natural lvl" ovr th long priod, and thn th quantity of mony ndognously clars th markt). Rmark Thr can b many pric indx trajctoris ovr th long priod in th thory, dpnding on th inflation targt. Insofar as th nominal intrst rat is th ral rat plus th rat of xpctd inflation (which is th ffctiv rat of inflation ovr th long priod), it follows that th montary rgim, as dfind by th inflation targt, influncs th natural nominal rat of intrst (but not th natural ral rat of intrst). Markts articulation in Th Gnral Thory A crucial fatur of Th Gnral Thory is that, bcaus of th snsitivity of th dmand for mony mntiond in sction 2, th long-trm intrst rat nithr tnds to adjust th dmand for goods to th output lvl nor is undr th dirct control of th cntral bank. Th quilibrium long-trm intrst rat dpnds on th markt conviction about th quilibrium lvl, for any lowr (highr) lvl would incras (dcras) th spculativ dmand for mony as a rsult of pssimistic (optimistic) xpctations about th futur pric of non-montary assts. Th long-trm rat of intrst thrfor is a highly convntional [ ] phnomnon. For its actual valu is largly govrnd by th prvailing viw as to what its valu is xpctd to b. Any lvl of intrst which is accptd with sufficint conviction as likly to b durabl will b durabl; subjct, of cours, in a changing socity to fluctuations for all kinds of rasons round th xpctd normal (Th Gnral Thory, p. 203). According to Kyns s viw on uncrtainty, such a convntional intrst rat has no objctiv or natural anchor and must b considrd an xognous variabl, unlss any spcific contxt is undr xamination. As it is not nsurd that th markts can adjust (or b adjustd by th montary policy) so as to push th aggrgat dmand up high nough, firms may b obligd to adjust thir output and dmand of labour to th lvl of ffctiv dmand. Whn h prsnts th 'principl of ffctiv dmand', Kyns provisionally supposs constant mony wags bcaus it maks it asir to show how th dmand sid dtrmins th quilibrium lvl of mploymnt: [ ] w shall assum that th mony-wag and othr factor costs ar constant pr unit of labour mployd. But this simplification, with which w shall dispns latr, is introducd solly to facilitat th xposition. Th ssntial charactr of th argumnt is prcisly th sam whthr or not mony-wags, tc., ar liabl to chang (Th Gnral Thory, p. 27). Lt us thrfor assum provisionally that th xognous nominal wag is xognous and considr th ffctiv dmand ffcts ovr th markts articulation. Equation (4 k ) in tabl n 2 xhibits both, th rol of th marginal fficincy of capital schdul, which varis with all factors influncing th xpctd rturn on capital (including xpctd 12

13 inflation), and th privilgd influnc of th currnt incom on consumption 14, givn th convntional intrst rat. As firms can not sll mor goods than it is dmandd, th dmand of labour will not b dtrmind by quation (1), but by quation (3), which givs th variation in mploymnt that maks th bttr us of th tchnology givn th lvl of th dmand for goods. Hnc, if Y* is dtrmind by th aggrgat dmand principl (quation 4 k ) and if, givn Y*, N* rsults from th availabl tchnology (quation 3), thn quation (1) no mor is rquird to dtrmin N*. This dos not man that firms can not adjust th marginal productivity of labour to th factor ral cost, but only that it is not through th mploymnt lvl that thy can do it. Equation (1) actually givs th pric indx variation that maks firms abl to rmain on thir dmand curv of labour whn th dmand of labour is dtrmind in accordanc with th dmand of goods 15. If th dmand incrass, it is through inflation that th ral wag variation is mad qual to th marginal productivity dclin. Notic that inflation may b causd by an intrst rat dcras through th impact on th dmand and output lvls, but in contrast to th modrn mainstram macroconomics, this impact dos not rquir inflationary surpriss. As th lvl of labour is dtrmind by firms on th dmand sid, th supply sid quation of th labour markt could b xpctd to dtrmin th quilibrium wag. But as w hav provisionally supposd that th wag is xognously givn, quation (2) is rplacd by th condition (2 k ). Hnc, if aggrgat dmand and mploymnt ar not larg nough, som workrs hav no job at quilibrium, vn if th marginal disutility of labour is smallr than th ral wag; in short, thr is unmploymnt owing to insufficint dmand for goods Th propnsity to consum hypothsis rsults from th vidnc that valuation of futur rvnus is subjct to strong uncrtainty, so that standard optimization dos not work. 15 According to quation (1) in tabl 2, an incras in ffctiv dmand and mploymnt incrass th pric indx lvl as far as f " N < 0 (as in th prvious sction, w only considr th cas for diminishing rturns). This shows that cost pushd inflation and dmand ld inflation may xprss th sam rality. In fact, whatvr apparnt causs it has, inflation always rquirs an incras in dmand, for inflationary ffcts associatd to wags and/or mark-up prssurs dpnd on th way montary authoritis will pass thm on ffctiv dmand. Insofar as highr dmand for transaction mony coms with cost prssurs, inflation dvlops if th banking systm satisfis th additional dmand of mony. But if th cntral bank raiss th short trm intrst rats so as to stabiliz th pric indx, banks will incras th long trm rats, and lss (crdit) mony will vntually b dlivrd. 16 Th radr should not conclud too quickly that this rsults from th assumption that wags ar xognous (as it will b argud blow). 13

14 Tabl n 2: Kynsian shifting quilibrium conditions (ndognous mony, xognous wags) Goods markt ( Y*, p*) Labour markt ( N*, w*) Mony markt ( M*) Y = Y ( Y, i, E) d ' f N ( N, K) = p = w p w ' f ( N, K) N Y = f ( N, K) N = g( Y, K) w is xognous ( Y, p i) M = L k, (4 k ) Effctiv dmand drivs aggrgat supply a). Th marginal fficincy of capital schdul (E, xognous) may shift according to th viws about th futur (including p& ) (1) marginal productivity qualization to th ral labour cost provids a mark-up pric quation b) ('1 st classical postulat' holds) (3) Dmand: short run production function (diminishing marginal product of labour, givn capital stock) (2 k ) Excss of supply ('2 d classical postulat' rjctd), xcpt if aggrgat dmand is high nough. (5 k ) Markt claring condition (xognous intrst rat ndognous mony supply); th dmand L k is subjct to shifts in th stat of confidnc CB imprfctly controls i. Bonds markt Implicit Aggrgat balancd budgts c) a) As it is not ssntial for our purpos, w ovrlook variabls such as public xpnditurs and taxs. b) Comptitiv imprfction such as monopoly powr is not ncssary for a mark-up rlation to appar. 1 α For xampl, with th familiar Cobb-Douglas tchnology: f ( N, K) = AN α K, 0 < α < 1, w gt w 1 wn immdiatly f N ( N, K ) = ' α Y, whr 1 rprsnts a mark-up on th unit labour cost. α c) In th mainstram approach, th aggrgat balancd-budgts quality rsults in th Walras law. But as Davidson (1994, p. 178) pointd out, markt claring is a sufficint condition for markt quilibrium; it is not a ncssary condition. In Kyns s approach, markts, spcially th labour markt, may b at quilibrium without having clard. 14

15 Kyns s aggrgat markts articulation (ndognous mony, xognous wags) a 4 k ) Y*(i,E) 3) 1) N*(i,E,K) p*(i,e,w,k) 5 k ) M*(i,E,K,w) a) Th shifting natur of th modl lis in th shifting natur of E and in th ffct of th shifting liquidity prfrnc on i. figur n 4 Intrst and wag dtrmination: th stabilizing rol of institutions Th ffctiv dmand principl would b limitd to a mr tmporary phnomnon if wag flxibility was abl to straightn th aggrgat dmand in all circumstancs; th supply sid would dominat vntually. That had to bcom th mainstram's position, and could disastrously turn out official 17. But, just as th intrst rat dos not adjust automatically so as to nsur Say law, wags flxibility hardly could rstor th ffctiv dmand systmatically to th full mploymnt lvl. As far as th 'invisibl hand' fails to implmnt th optimal quilibrium, ral wags ar highr than th marginal disutility of labour (quation (2) in tabl n 1, which rprsnts th "scond Classical postulat", dos not hold). That suggsts that comptition btwn workrs will rduc th nominal wags. But, although such a mchanism somtims works to som xtnt, it may fail to rmov unmploymnt and vn mak things wors bcaus of possibl ngativ ffcts on th dmand sid, spcially through th marginal fficincy of capital (Th Gnral Thory, 1936, ch. 19). Whn th wags dcras dos not stimulat th ffctiv dmand, or vn dos amplify th dprssion 18, wags continu to fall towards zro until workrs ar abl to stop th dcras in wags, unlss th dprssion in output and prics succd in pulling th dmand for mony and th rat of intrst in such a way that th ffctiv dmand vntually rach th full mploymnt lvl. In th most favourabl cas whr it stimulats th ffctiv dmand, wags flxibility can rmov unmploymnt compltly, 17 In his papr 'Intgration of growth and cycl: an altrnativ viw of th history of macroconomics' Yamazaki (2006, p 123) wrot: Kyns ovrmphasizd short-trm fluctuations of conomy or businss cycls Th apparntly lost viwpoint of growth, howvr, was rvivd bnath th surfac of th circl viw [ ]. Following a priod of frmnt and confusion, what is calld ral-businss cycl thory intgratd th two viwpoints [ ]. In th minds of macroconomists, th conflict among schools is now a thing of th past. I argu that w historians of conomics must also chang our prspctiv as w dscrib our historis of macroconomics." 18 Expctations of furthr wags dcrass tnd to dlay invstmnts. S Tobin (1975) and Pally (2006b) about th cumulativ dprssion involvd in such a contxt. Thos authors also mphasiz a potntially dstabilizing ffct owing to th Fishr ffct. 15

16 ithr by itslf, or, possibly, with th hlp of th intrst rat. That is th only vntuality th mainstram considrs. But, in th Kynsian thory, it is only on out of many lsshappy outcoms which dpnd on th lvl whr th stat of confidnc, togthr with workrs ability to rsist, fixs th ffctiv dmand and, thrfor, th quilibrium lvl of mploymnt. Ths rsults show that thr is no, strictly spaking, flx-pric comptitiv quilibrium with Kynsian unmploymnt, as Kyns himslf statd: "If [ ] monywags wr to fall without limit whnvr thr was a tndncy for lss than full mploymnt, [ ] thr would b no rsting-plac blow full mploymnt until ithr th rat of intrst was incapabl of falling furthr or wags wr zro. In fact w must hav som factor, th valu of which in trms of mony is, if not fixd, at last sticky, to giv us any stability of valus in a montary systm.' (Th Gnral Thory, 1936, p ). But that is not to say that flx-pric comptitiv markts nsur full mploymnt, nor is it to say that th caus of unmploymnt holds in th rigidity of prics as statd in th Bnassy (1984)-Malinvaud (1980a,b) rang of modls (in this litratur, it was argud that flxibl prics would vntually lad th conomy toward th Walras outcom) 19. In Kyns s conomics, flx-pric markts do not rmov unmploymnt ncssarily, and may vn incras it. Nominal rigiditis in this cas ar not th caus of unmploymnt, but th ncssary stabilizing consqunc of a vicious circl of incrasing unmploymnt and dcrasing wags. Contrasting with th orthodox macroconomics, whr comptition inducs flxibl wags and optimal mploymnt lvl, in th Kynsian uncrtain world, comptitiv forcs may induc rigid mony-wags and unmploymnt. 4. Conclusion Kyns s Gnral Thory, bsids bing abl to xplain th widst rang of unmploymnt situations in comptitiv systms, finally suggsts that comptitiv forcs triggr institutions rsponss which aim at prsrving th conomic systms against cumulativ dprssion and instability. Rsistanc of unions and macro-policy support ar th mor visibl and dirct of ths rsponss. Kyns's approach to comptitiv conomis invits to invstigat th way thos institutional forms intract with ach othr in producing durabl stability and confidnc, for it could b a bttr way to rach high lvls of mploymnt and output than unbridl comptitiv forcs. 19 In Malinvaud (1980) howvr prics flxibility could produc a cumulativ dprssion in cas of unmploymnt, but that rsult was obtaind within a two-markt conomy (labour an goods). Th cumulativ procss rsultd from th assumption that th dcras in prics producd by th supply xcss of goods is strongr than th dcras in wags (hnc th ral wag incrass, so that firms rduc th production lvl), without any considration for th stabilizing Kyns ffct that would hav bn triggrd in th prsnc of a mony markt. In Kyns thory, on th othr hand, th so calld Kyns s ffct may b countrd in cas of a shift in th stat of confidnc and in th liquidity prfrnc. 16

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