History of Modern Macroeconomics Lecture 2. The Great Depression: Keynes and His Critics (the 1930s) Kevin D. Hoover Department of Economics Department of Philosophy Center for the History of Political Economy Duke University

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History of Modern MacroeconomicsLecture 2. The
Great Depression Keynes and His Critics (the
1930s) Kevin D. HooverDepartment of
EconomicsDepartment of PhilosophyCenter for the
History of Political EconomyDuke University
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John Maynard Keynes(1883-1946)
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Keynes is the Most Influential Economist of the
20th Century (by articles in JSTOR)
Economist Name in Title Name in Article
Keynes 1,428 30,249
Friedman 130 17,828
Samuelson 110 14,524
Lucas 44 9,535
Prescott 10 4,846
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Keyness Paternity Natural and Academic
Alfred Marshall (1842-1924)
John Neville Keynes (1852-1949)
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Some Bloomsburies
Lytton Strachey 1880-1932 (by Dora Carrington)
Duncan Grant 1885-1978 (Self-portrait)
Virginia Woolf 1882-1941
E.M. Forster 1882-1941
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Keynes and the Arts
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Maynard and Lydia
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Keyness Books circa 1930
1919
1921
1930
1923
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If the books seem dry . . . Maynard and Lydia
again
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A Doctrinaire Quantity Theorist and the Urgency
of the Present

• Now in the long run the neutrality of money
  is probably true. If, after the American Civil
  War, the American dollar had been stabilized and
  defined by law at 10 per cent below its present
  value, it would be safe to assume that . . . p
  would be just 10 per cent greater than it
  actually is and that the present values of k
  and y would be entirely unaffected. But this
  long run is a misleading guide to current
  affairs. In the long run we are all dead.
  Economists set themselves too easy, too useless a
  task if in tempestuous seasons they can only tell
  us that when the storm is long past the ocean is
  flat again.
• Keynes, A Tract on Monetary Reform

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Malthus as a Precursor to Keynes

• Theoretical writers are too apt, in their
  calculations, to overlook these intervals i.e.,
  trade cycles but eight or ten years, recurring
  not unfrequently, are serious spaces in human
  life. They amount to a serious sum of happiness
  or misery, according as they are prosperous or
  adverse, and leave the country in a very
  different state at their termination.
• T. Robert Malthus, Principles of Political
  Economy

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Perfectionist and Imperfectionists Accounts of
the Business Cycle

• Ricardo-Malthus debate as a prelude
• Says Law
• Supply creates its own demand
• Capital always finds productive uses
• No natural barriers to full employment
• No general gluts
• Imperfectionist Labor resistance (implicit or
  explicit) to real wage cuts the source of
  unemployment
• Perfectionist (Keynes) unemployment in the
  nature of the economy

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The General Theory of Employment Interest and
Money (1936)

• Monetary theory of production
• Perfectionist account of the business cycle
• Real output not prices the central theoretical
  focus

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Mr. Keynes and the Classics The Most
Influential Interpretation of the General Theory
Sir John Hicks(1904-1989)
IS-LM Model
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The IS-LM (originally IS-LL) Model 1
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The IS-LM (originally IS-LL) Model 1
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Hicks IS-LM Interpretation of Keynes
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Keynes Heterogeneity

• Relative social position in labor markets and
  aggregate supply
• Coordination failure (ex ante and ex post)
• Fallacies of composition
• Monetary economy

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Uncertainty and Rationality 1

• Risk vs. Uncertainty (Treatise on Probability)
• the prospect of a European war is uncertain, or
  the price of copper and the rate of interest
  twenty years hence, or the obsolescence of a new
  invention, or the position of private wealth
  owners in the social system of 1970. About these
  matters there is no scientific basis on which to
  form any calculable probabilities whatever. We
  simply do not know.
• Keynes 1937, pp. 113-14 Collected Works,
  vol. 14.

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Uncertainty and Rationality 2

• Conventions as a solution to uncertainty
• a convention . . . assuming that the existing
  state of affairs will continue indefinitely,
  except in so far as we have specific reasons to
  expect a change . . .
• Keynes General Theory, p. 152

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Uncertainty and Rationality 3

• Room for psychology and temperament (animal
  spirits) but not irrationality
• . . . 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 motives on whim or sentiment or
  chance.
• Keynes, General Theory, p. 163
• Rationality requires decision

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Implications of Uncertainty
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The Trade Cycle

• Investment major source of fluctuations
• marginal efficiency naturally falls as boom
  progresses
• large shifts from reassessments of future profits
  dimmed animal spirits
• firms hesitate to cut wages
• wage cuts reduce income and have adverse
  multiplier effects

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Policy to Fight a Slump

• Government expenditure (especially public works)
  can replace investment socialization of
  investment
• Indirect effect on expected future profits and
  firms confidence (animal spirits) dominate

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Policy to Maintain a Boom

• Predictable and consistent monetary and fiscal
  policy supports conventional response to
  uncertainty
• In estimating the prospects of investment, we
  must have regard . . . to the nerves and hysteria
  of those upon whose spontaneous activity it
  largely depends. Keynes, General Theory, p.
  162

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The Central Message (or Central Innovation) of
The General Theory

• Perfectionist account of the failure of real wage
  changes to clear the labor market
• Distinction between aggregate supply and demand
• The multiplier
• Liquidity preference
• The liquidity trap
• Activitist (fiscal) policy
• Focus on uncertainty

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• Thanks
• ??
• The End