John Maynard Keynes

John Maynard KEYNES Hyman P. Minsky Professor of Economics, Washington University

St. Louis, Missouri

M

© Columbia University Press 1975 Softcover reprint of the hardcover 1st edition 1975

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First published in tbe U.S.A. 1975 First published in tbe United Kingdom 1976

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Preface

John Maynard Keynes's special status rests upon his "revolutionary" work, The General Theory of Employment, Interest, and Money. This study focuses upon that work and the claim that it rev­olutionized economic thought: the theme is that The General Theory does embody a revolutionary change in economic theory, but that in the process of arriving at today's standard version of what Keynes was about the revolution was aborted. Thus an attempt is made to recover the revolutionary thrust of The General Theory.

This book concentrates on The General Theory and virtually ignores the substantial body of Keynes's earlier work on monetary theory. The huge literature that developed, explained, interpreted, and formalized Keynes is also virtually ignored. The reason for these omissions is not that I deem Keynes's prior work or the literature to be unimportant, but be­cause a thorough, documented study of Keynes's work and the discus­sion it triggered would get in the way of my message, which is that in the neglected facets of The General Theory there is a theory of the proc­esses of a capitalist economy that is much more appropriate for problems of economic analysis and policy now confronting us than is contained in the standard economic theory.

The interpretation of Keynes put forth here evolved over a number of years. One input was my work on financial instability. Another input was the work of economists who, each in his own way, took issue with

vi Preface

the standard interpretation: Joan Robinson, G. L. S. Schackle, Nicholas Kaldor, Sidney Weintraub, Paul Davidson, Robert Clower, and Axel Leijonhufvud are prominent among the dissidents who affected my thinking. It would take a far longer volume than this for me to detail points of agreement and disagreement with those colleagues in dissent, and such disputation and detailing of views would interfere with the message I want to send.

A further input into the evolution of my views was discussions I had during a most pleasant sabbatical year in Cambridge. In particular I want to thank Donald Moggridge, who at the time was beginning to delve into the Keynes papers to prepare .what has since appeared as Volume XIII (The General Theory and After: Part I, Preparation) and Vol­ume XIV (The General Theory and After: Part II, Defence and Developement) of The Collected Works of John Maynard Keynes, for some very good talks. However in this work, the material in Volume XIII and XIV is not taken into account explicitly. My manuscript was at the publishers by the time these volumes appeared. Furthermore, any detailed examination of this material is the subject matter of a quite different sort of book.

In addition to Donald Moggridge, I want to thank Professors Joan Robinson and W. B. Reddaway as well as Aubrey Silberston and Alan Roe for bearing with me while I was in Cambridge. I owe very much to the perceptive comments and criticisms of Phyllis Freeman, Laurence H. Meyer, Maurice Townsend, and Bernard Shull. None of the above are responsible for the errors and misinterpretations which may follow.

I want to thank the Social Science Research Council, the National Science Foundation, and of course my home base, Washington Univer­sity, for support in this endeavor. They, too, are not responsible for what follows. Ms. Connie Pritchard was rapid, efficient, and conscien­tious in the typing and clerical support; Ms. Susan Shiff very efficiently took over the checking of galleys and prepared the index. Bernard Gronert and Karen Mitchell of Columbia University Press were both patient and helpful.

For permission to quote extensively from The General Theory of Em­ployment, Interest and Money, by John Maynard Keynes, thanks are due to Harcourt Brace Jovanovich, Inc. and The Royal Economic Society.

A special thanks goes to my wife Esther, who aided and abetted this work in many quiet ways.

Hyman P. Minsky June 1975

Introduction

There are times in the intellectual history of a discipline when its theoretical house is in good order; at other times this house is in disarray. When the house is in good order there is a broad consensus about its content and it seems to yield useful results, both in interpreting observations and as a guide to policy or technology. When the theoretical house is in disarray, qualified practitioners disagree about the contents: there are competing theories, and for every competing theory there exist observations which are difficult to explain. Every theory seems to be of limited usefulness; anomalies abound.

A few years ago-in the early to mid-1960s-macroeconomics and monetary theory appeared to comprise a well-behaved and mature disci­pline. At that time, in spite of the existence of various mavericks and deviants, which seems to be unavoidable in the social disciplines, most professional economists seemed to agree that the neoclassical synthesis, which integrated the innovations of Keynes with the apparatus and re­sults of the classical tradition, was the appropriate framework to guide both theoretical and empirical research, as well as economic policy analysis and prescription. Today, in good part because policy failures, acting as proxies for critical experiments, revealed shortcomings in the

Introduction viii

analytical foundations, macroeconomic and monetary theory are m disarray.

The last paragraph of Keynes's most famous work, The General Theory of Employment, Interest and Money, contains the oft-cited passage: "ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else" (GT, p. 383). In the sentence preceding the above Keynes noted: "At the present moment people are unusually expectant of a more fundamental diagnosis; more particularly ready to receive it, eager to try it out, if it should be even plausible" (GT, p. 383).

At this writing the mood in the United States is similar to that Keynes described. Even without the proximate cause of a great worldwide de­pression, but perhaps because of the persistence of inflation, the aware­ness of poverty not only in the midst of plenty but also because of plenty, the renewed experience and fear of financial instability, and the unsettled conditions of international trade and finance, there is a gnaw­ing dissatisfaction with the state of both the economy and economic thought and a growing disenchantment with the policy measures that have been adopted to affect the economy. It follows that the theoretical framework which, when applied, indicated that these policy choices were apt requires reexamination.

Thus, in the 1970s the climate apparently is ripe for another "intellec­tual revolution" like the one The General Theory triggered in the 1930s.

In this book, which interprets Keynes's major contribution to eco­nomics, I contend that the ingredients for such a "second revolution" in our way of thinking about advanced capitalism exist in some neglected facets and logical extensions of the argument that Keynes advanced in The General Theory. My view is that what became popular and was ac­cepted into the fold of conventional economics is but a part of the sub­stance of Keynes's argument. Those ideas were accepted which both were most easily assimilated into the body of the older ideas-what Keynes called classical economics-and had the greatest relevance to the immediate problems facing the world in the late 1930s and early 1940s: the stagnant aftermath of the Great Depression and the mobilization for and waging of the Second World War. I also hold that what has been neglected or lost is a major part of the substance of The General Theory; this lost portion makes a sharp break with the formulations fundamental

ix Introduction

to the older classical doctrines and is more immediately relevant to prob­lems the advanced economies are now facing. Thus the integrated Keynesian classical economic theory-what is labeled the neoclassical synthesis-does violence to both the spirit and the substance of Keynes's work.

The substance of what was neglected in the development of the syn­thesis can be grouped under three headings: decision-making under un­certainty, the cyclical character of the capitalist process, and financial relations of an advanced capitalist economy. In the neoclassical synthesis Keynes's emphasis upon disequilibrium, i.e., upon "the fact that it is in the transition [among never-attained positions of equilibrium] that we actually have our being" (GT, p. 343), is ignored. The models of the neoclassical synthesis are essentially timeless, whereas Keynes in The General Theory was always conscious of time, process, and the transitory nature of particular situations. Furthermore, while The General Theory quite explicitly dealt with an economy with particular institutional characteristics, the standard interpretation abstracts from institutional detail. In particular, in the vario~s versions of the neoclassical synthesis the financial mechanism, which is central to Keynes's interests, is almost always treated in a most truncated fashion.

Once the usually neglected aspects of the argument of The General Theory are taken into account, a model of the capitalist process emerges which is more useful in explaining the behavior of American and other advanced capitalist economies in boom, recession, and inflationary high­level stagnation, and more relevant for determining policy than is today's conventional theory. As reinterpreted here, Keynes challenges the domi­nance in our economic thinking of the basic constructs of the neoclassical system-the production function and invariant preference systems-and so opens the door to serious policy proposals addressing the "what kind" and "for whom" questions so important today.

Keynes's theory as conventionally interpreted legitimized the use of monetary and fiscal policy instruments to attain full employment; such policy is now quite orthodox. Standard economic theory tells us that the kind of output and the distribution of this output are determined by the fundamental production and preference characteristics of the economy. The perspective derived from the alternative interpretation of Keynes enables us to go beyond a generalized full-employment policy and turns the question of what kind of employment and how (to whom) income is

Introduction X

distributed into a policy decision. Once again, the dimensions of legiti­mate policy are broadened.

Within the argument of The General Theory a number of different threads can be discerned. Some threads lead back to the older classical theory and reflect Keynes's failure to fully escape from the "habitual modes of thought and expression," (GT, p. viii) of which he warned. Other threads lead to a successful escape from the old ideas. Keynes never clearly differentiated between the threads. In only one instance, his rebuttal to Professor Viner's review (which is central to our argu­ment), did he publicly discuss the validity of an interpretation of his book. Viner's review tied Keynes's new theory into the old, and Keynes quite explicitly denied the validity of Viner's interpretation. Other in­terpretations, which looked back to the old, were either ignored or casu­ally accepted by Keynes. As a result of this neglect to repudiate the standard interpretation, which ties Keynes into the classical doctrines he believed he was replacing, the standard interpretation has some claim to legitimacy. However, these perhaps legitimate offspring did not inherit these attributes of The General Theory that reflected Keynes's success in escaping from the confines of the orthodox economic theory, attributes which point to an alternative way of looking at an advanced capitalist economy.

Because of my emphasis upon the new in The General Theory, I will virtually ignore Keynes's extensive writings as an economist prior to The General Theory. (However in delineating the social philosophy and' public policy implications of The General Theory, I will show that the implica­tions Keynes drew were clearly consistent with the public-policy views he held in the 1920s.) I will also neglect other dimensions of his many­faceted career. My focus is narrow: it is upon The General Theory of Employment, Interest and Money as an effort to revolutionize economics.

In what follows I will argue, as Keynes did in The General Theory, as if we are dealing with a closed economy. Obviously, in the applications of the theory-whether standard or reinterpreted-allowance must be made for international impacts and feedbacks. In particular, in my rein­terpretation of Keynes, financial relations, disturbances, and instability play a major role in the successions of systems states that characterize the path of the economy. In the light of the evidence of the 1960s and the early 1970s it is clear that in the semi-open system that rules among the advanced capitalist economies, the significance of financial disturbances

xi Introduction

and instability is if anything greater than if each of these economies were treated in isolation. Thus the phrasing of the argument, which treats financial systems as if they related to closed economies, is a matter of expository convenience and necessity. The essence of a cyclical and financial-instability interpretation of Keynes can be presented within this framework, and the opening up of the domain of interest to a system of interrelated open capitalist economies can only reinforce, not attenuate, the strength of this argument.

Contents 1.

The General Theory and its Interpretation 1

2. The Conventional Wisdom: The Standard lnterpretatioh of Keynes 19

3. Fundamental Perspectives 55

4. Capitalist Finance and the Pricing of Capital Assets 69

5. The Theory of Investment 93

6. Financial Institutions, Financial Instability, and the Pace of Investment 117

7. Some Implications of the Alternative Interpretation 131

8. Social Philosophy and Economic Policy 14 5

9. Policy Implications of the Alternative Interpretation 161

Bibliography 171

Index 173

John Maynard Keynes