JKH — The General Theory of Employment, Interest, and Money – Chapters 11 and 17

In a recent post, David Glasner tackles an aspect of John Maynard Keynes’ General Theory of Employment, Interest, and Money. In Chapter 11 of the GT (The Marginal Efficiency of Capital), Keynes questions the meaningfulness of the Fisher equation, suggesting that the decomposition of nominal return into its real and expected inflation components may have a (rough) connection to the marginal efficiency of capital but not to the interest rate. David claims this view is inconsistent with Keynes’ treatment of the interest rate elsewhere, including the analysis found in chapter 17 (The Essential Properties of Interest and Money). I found this most interesting. Keynes is always a challenge to understand, and the two chapters in question are very meaty indeed. His analysis in Chapter 17 of why money is the asset with the most ‘significant’ interest rate is a tour de force in brute logic. And Glasner’s ‘Uneasy Money’ is one of my favorite blogs, where his posts are unfailingly thoughtful, well written, and scholarly....

Here is David’s post

And here is a (final) comment I left at the post, offering an alternative interpretation of the connection between the two GT chapters:

This is a bit wonkish, but if you were following David Glasner's post and missed JKH's comment, as I did, it is of interest in the study of the General Theory.

Monetary Realism
The General Theory of Employment, Interest, and Money – Chapters 11 and 17

JKH

Simon Wren-Lewis — Whatever happened to the General Theory

My paper in the Review of Keynesian Economics is out. It is a special issue on the relevance of the General Theory 80 years after its publication. My paper is about the New Classical Counter Revolution (NCCR). At first this may seem an odd fit, but I think quite the opposite. If we go back 40 years, macroeconomics as it was then practiced could be justifiably described as being a development of that great work. In contrast students today would not see the General Theory as the foundation of macroeconomics. The change in view is the result of the NCCR.

I also think that many heterodox economists, who tend to read this journal, have failed to come to terms with the NCCR. They are critical of course, but often they fail to address the obvious question: why was the NCCR so successful? Revolutions may be plotted by a small number of individuals to whom you can ascribe (fairly or unfairly) ideological motives, but you also need to account for why the revolution succeeds. Do heterodox economists think that generations of PhD students who continue to ignore their arguments are being forced to do so against their will?

My paper is in part an attempt to begin to answer this question.…

Mainly Macro
Whatever happened to the General Theory
Simon Wren-Lewis | Professor of Economics, Oxford University

Matias Vernengo — On Keynes and the Quantity Theory

Naked Keynesianism
On Keynes and the Quantity TheoryMatias Vernengo | Associate Professor of Economics, Bucknell University

Lars Syll — ‘How I became a Keynesian’ — Richard Posner

When my information changes, I alter my conclusions. What do you do, sir? — John Maynard Keynes 

Reply to a criticism during the Great Depression of having changed his position on monetary policy, as quoted in "The Keynes Centenary" by Paul Samuelson, in The Economist Vol. 287 (1983), p. 19; later in The Collected Scientific Papers of Paul Samuelson, Volume 5 (1986), p. 275; also in "Understanding Political Development: an Analytic Study" (1987) by Myron Weiner, Samuel P. Huntington and Gabriel Abraham Almond, p. xxiv; this has also been paraphrased as "When the facts change, I change my mind. What do you do, sir?" — Wikiquote

Richard Posner apparently agrees. What about the rest of them?

Lars P. Syll’s Blog
‘How I became a Keynesian’ — Richard Posner
Lars P. Syll | Professor, Malmo University

Roger Farmer — Thought for the Day: Animal Spirits as a New Fundamental

In IS-LM models there is always something in the background shifting the IS curve. What is it?

In my view that 'something' is Keynes' animal spirits that we should add to our models as a new fundamental.

Roger Farmer's Economic Window

Thought for the Day: Animal Spirits as a New Fundamental
Roger Farmer

J. M K., GT, 12.VII —

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die; — though fears of loss may have a basis no more reasonable than hopes of profit had before.

It is safe to say that enterprise which depends on hopes stretching into the future benefits the community as a whole. But individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death.

This means, unfortunately, not only that slumps and depressions are exaggerated in degree, but that economic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man. If the fear of a Labour Government or a New Deal depresses enterprise, this need not be the result either of a reasonable calculation or of a plot with political intent; — it is the mere consequence of upsetting the delicate balance of spontaneous optimism. In estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends.

We should not conclude from this that everything depends on waves of irrational psychology. On the contrary, the state of long-term expectation is often steady, and, even when it is not, the other factors exert their compensating effects. We are merely reminding ourselves that human decisions affecting the future, whether personal or political or economic, cannot depend on strict mathematical expectation, since the basis for making such calculations does not exist; and that it is our innate urge to activity which makes the wheels go round, our rational selves choosing between the alternatives as best we are able, calculating where we can, but often falling back for our motive on whim or sentiment or chance.

Lars P. Syll — ‘How I became a Keynesian’ (Richard Posner)

Comparable to Nixon's "We are all Keynesians now," Richard Posner embraces Keynes and throws Mankiw under the bus. This is a quote you will want to keep and cherish.

Lars P. Syll’s Blog
‘How I became a Keynesian’Lars P. Syll | Professor, Malmo University

Leigh Caldwell — On the identity and methods of behavioural economics

My view, which I think concurs with Laibson's: a single broader theory is possible. I think we've hit a theoretical dead end with the traditional maximising agent, so it will have to be based on more psychologically realistic foundations, such as those of Velupillai, Gigerenzer or Bettman, Payne & Johnson. To achieve this, we need to carefully choose the right elements to build into our model of decision-making in a way, so that it can make useful predictions of how those elements might operate. I have a paper coming out later this year which suggests one direction towards this.

Knowing and Making
On the identity and methods of behavioural economics
Leigh Caldwell | CEO, Inon Pricing Advisers

The innovative disruption behavioral economics has introduced is impelling the search for a general theory incorporating behavioral (empirical) research and is pushing economics closer to psychology and the other social sciences. That can only be a good thing.

Non-behavioural economists have considered consumers' imperfect ability to learn the preferences of other consumers, or the rules of the "game" they are playing, as a factor in non-optimal decisions. But psychologists know much more about exactly how people learn than economists do - so a successful model of learning as part of economics can only be built with an openness to psychological research. Where Levine may be right is that behavioural economics will not replace mainstream economics, but instead the two fields will merge - with the behaviour of consumers predicted by a combination of objective economic, and subjective psychological, factors.
Anyway, arguments over the boundaries of disciplines are rarely productive: I don't really mind if Levine considers a model to be behavioural or not, as long as the model advances the cause of making successful predictions.

The real questions are: does standard economics fail to address some important problems? How good is behavioural economics at addressing them instead? And does behavioural economics need a unified approach in order to address them?

Most of the people mentioned above have different answers to those questions.....

Lord Keynes — Keynes and Marginalism

The subsequent history of the emergence of Post Keynesianism as a school is of course complicated but, fundamentally, involves rejecting the last mistaken marginalist ideas of Keynes, along with superior theories of capital, prices and distribution.

Social Democracy For The 21St Century: A Post Keynesian Perspective

Keynes and Marginalism
Lord Keynes

General theory and special cases in Modern Monetary Theory

In the general - special case theoretical approach of Modern Monetary Theory (MMT). The general theory sets forth the parameters of a fiat currency, showing what falls in bounds and out of bounds operationally. The major alternatives regarding monetary systems are convertible or non-convertible currency, or fixed or floating exchange rates. MMT focuses on the non-convertible floating rate regime since it is operative globally at present, since FDR ended convertibility during the Great Depression in order to increase policy space, and Nixon shut the gold window internationally for the same reason.

Within those basic parameters, various options are available for constructing special cases. One of the sets of alternatives that MMT describes for constructing a special case as an option within those parameters of a non-convertible floating rate regime involves issuing bonds as a reserve drain for rate setting, or not issuing bonds and paying IOR instead, or setting the rate to zero permanently, or setting the rate to zero as a general rule and only using rate setting as need by unusable conditions.

While it is possible to run more than one of these at the same time, only one is dominant in setting monetary policy. For example, the US has chosen politically to issues bonds but the law allows the Fed to override bond issuance as a reserve drain operation by paying interest on reserves (IOR) to manage the interest rate as an alternative.

This shows that bond issuance is a political choice within the bounds of the general theory, rather than an operational requirement of the present monetary regime. The operational requirement of the system is that if the central bank opts to set the rate, then in must manage reserves to do so, or else pay IOR if it chooses to let the amount of reserves float free.

Thus, the general theory accounts for why and how choice among these alternatives is optional in constructing institutional arrangements that result in special cases within a monetary regime. There are many alternative such as this on involving interest rates. Every country selects from a variety of alternatives in establishing a special case as an option for running a non-convertible floating rate regime.

Note that some alternatives that can be selected are out of bounds. If the politicians that choose among alternatives in constructing a special case do not realize this, then the special case will run into problems due to deficiencies in the institutional arrangements. MMT economists and others cognizant of the general theory points this out at the time the Eurozone treaties were being entered into.

Secondly, there are economic consequences of these choices — monetary, financial, and non-financial — that MMT economists also articulate. Different choices of alternative policies used in constructing special cases as options define in law and regulation the institutional arrangements that result in the special cases we observe in the different countries. MMT analyzes these special cases by inspecting laws and regulations, as well as a county's behavior, since work-arounds are used when deemed necessary in extraordinary conditions.

These special cases, exhibited by the different countries in the global economy, which is now on a non-convertible floating rate regime generally all have different implications for the nation's policy space, for example, as well as the interests that are winners and losers. Thus, the institutional arrangements that define a national monetary system also affect its application of monetary economics, with macro implications as well.

Not all countries in the global economy choose to run a floating rate system, however. Emerging countries may choose to peg their currency to another currency like the $dollar (USD). China does this, instance. Switzerland has also set a floor for its currency against the euro. These are special cases within the special cases of non-convertible floating rate currency.

But such extraordinary measures are ordinarily presumed to be temporary, erected under special conditions that are not expected to be permanent. They are extraordinary means for increasing policy space internationally due to the effects of exchange rate fluctuation on the domestic economy. When those conditions cease to exist, the nation again conforms to the norm of floating rates.

As far as recommending policy, MMT uses the MMT macro approach to show how choosing wider policy space and using certain tools — such as the MMT JG (job guarantee), which includes a buffer stock of employed and a wage floor as price anchor — lead toward a potential balancing production, employment and price stability.

These macro conclusions derived from the general theory must be applied differently in different countries, owing to the special case differences set forth in law and regulation,and adapted to political exigencies prevailing at the time. These are strategic and tactical considerations that are subservient to the general theory, which only deals with general operational parameters.

Macroeconomists in general take these three factors to be macro goals, which are used as criteria for evaluating the effectiveness and efficiency of a set of assumptions on policy and policy on anticipated outcomes. All approaches to macro seek to optimize efficiency and effectiveness with respect to these three persistent challenges that a modern economy faces and the overall challenge is to do this in integrated way that enhances them all. The objective is policy formulation based on theoretical insight that yields overall beneficial effects for the country socially, politically, and economically.

UPDATE:

Here's a comment I put up at The Center of the Universe in explication:

Basically, what this says is that countries can decide on an international monetary standard and the choice is essentially between convertible or non-convertible currency, and fixed or floating rates. There are other choices, too, such as a system that generally relies on central banking or on that does not. These and other options have historical precedents.

This post focus on having made the choice in favor of non-convertible currencies and floating rates, which is now enshrined in international treaty post-1973 when Nixon’s unilateral decision to shut the gold window two years before was formally ratified.

That established a framework within which countries agreed to operate but it let considerable choice to individual countries regarding specifics. The general theory articulates the framework in terms of the boundary conditions that the agreement imposes. The specific ways to implement this in each county constitutes the actual special cases, although other cases are also possible since all the options are likely not exhausted. Countries are also free to alter the specifics within the general framework that has been agreed to.

What is so difficult to understand about this? It’s all legally formalized in international agreements and laws and regulations of the different countries.

Bill Mitchell — We do have a choice – we just need to identify it

Bill Mitchell has a good summary of how a modern monetary system works in general terms, hence the analogy of government as a big firm or household is false. It begins here:

The statement “recharging the fiscal batteries” which is sometimes expressed in terms of “building a war chest, or in negative terms as “running out of bullets” etc is commonplace in the public debate.

I hear expressions such as these used every day by politicians, commentators, academics, and citizens.

It is a demonstration of how ill-informed the public debate really is and why when it comes to exercising our obvious choices those choices do not seem to be so obvious to most of us.

It is a total fallacy to suggest that the government has some stockpile of “spending capacity” that it has to recharge and buildup just in case it needs to “turn the lights on” in the future.

 The fundamental principles that arise in a fiat monetary system are as follows:

Read it at Bill Mitchell — billy blog
We do have a choice – we just need to identify it
by Bill Mitchell

This is the basis of MMT as a general theory of modern money.