How, and For How long, did keynes maintain the treatise theory?
BY
I.
INTRODUCTION
Many historians of economic theory have by now
studied how Keynes developed his theory from the Tract on Monetary Reform through the Treatise on Money to the General Theory. After the pioneering
studies by Moggridge (1973) and Patinkin (1976; 1982), there followed Dimand (1988),
Amdeo (1989), Clarke (1988;1998), Meltzer (1988), Moggridge (1992), Skidelsky
(1992), Laidler (1999) and others. This is no wonder, for the Keynesian
Revolution remains the most singular phenomenon that economic theory and policy
have ever seen.
Although the
objective of our entire project has been to shed new light on this important
and interesting phenomenon, examining and analyzing the processes of
theory-building and re-building which constitute Keynes’s intellectual journey
(see Hirai(1977-79)), the
present paper focuses solely on one chapter in the long story of the transition
through his three major works. The very fact of addressing the questions, “How did Keynes maintain the theory developed in the Treatise after its publication (October 1930),
and for how long?” narrows the period under study to roughly two years which span
roughly from October 1930 through October 1932. Our scrutiny will range over the
original texts and primary material such as manuscripts, lecture notes, and
correspondence produced over this period, and our findings will rest on the meticulous
analysis of material of crucial importance for a clear understanding of Keynes’s
theoretical situation. We will also offer our comments on the earlier efforts
insofar as they relate to the period in question.
When we have answered our questions we will be able to say
clearly when Keynes had finished with the Treatise
theory, and when the ground was laid for the arrival of the General Theory.1
The period concerned
has so far been examined in a very fragmentary way. To take a few examples,
Patinkin (1976) deals with the MTP manuscript in less than one page (see p.86),
while Amadeo (1989) confines his treatment of it – and only from the
development of the multiplier – to one page alone and Dimand (1988) offers no examination
of it.
Before
entering upon the main topic, we must outline our basic view of Keynes’s theoretical
development. The point we wish to stress is that Keynes was able to reach
his theory of employment (and unemployment) as a result of abandoning “Keynes’s
own theory” (to be explained below) and accepting the criticisms of several
people with whom he corresponded. Although Keynes still clung to the idea of
the TM supply function until late in 1932, his manuscript “The Parameters of a
Monetary Economy”, which was written at the end of 1932, marks a clear turning
point from the Treatise toward the General Theory. We have
already clarified that the TM supply function
was abandoned in this manuscript2 and Keynes’s abandonment of it
shook the foundations of his theory as it had stood up to mid-1932: the main
components of the General Theory were
to be built as a consequence. We must also point out that the core of the Keynesian
Revolution lies in the theory of underemployment equilibrium, which emerged in
1933, and for which we have three manuscripts.3
After
a spell of “seven years off and on” since the publication of A Tract on Monetary Reform Keynes
published the Treatise on Money in October 1930).4
Although the Treatise sill showed some
traces of Dennis Robertson’s great influence on his thought, Keynes was setting
off on his own path. And the Treatise
received an extraordinary degree of attention.5
As we shall see later, the Treatise has two theories: “Keynes’s own
theory” and a “Wicksellian theory”. For some time after the publication of the
book, Keynes went on using and extending “Keynes’s own theory”, stressing the
TM supply function in the face of criticism from various sides, including Robertson,
Hawtrey, the “Cambridge Circus” and Hayek6 (interestingly enough, Keynes
seldom refers to a “Wicksellian theory”.)
After explaining the theory developed in the Treatise in preparation, our examination
proceeds thus, looking into: (1) Hawtrey’s criticism; (2) the sources from June
1931 to early 1932, which include two interesting manuscripts not contained in JMK; (3) a manuscript consisting of four chapters (JMK.13,
pp. 381-396; hereafter “The Monetary Theory of Production” manuscript or the
MTP manuscript7); (4) Criticism of the “Cambridge Circus”; and (5)
two 1932 tables of contents.
II.
THE TREATISE THEORY
In
our view, the most significant feature of the Treatise theory is the coexistence of a Wicksellian theory and “Keynes’s
own theory”.
1. Wicksellian
Theory8
The
monetary economics stemming from Wicksell and subsequently developed
by various economists can be called the “Wicksell Tradition”. Wicksell’s basic insight involved a separation between the
theory of relative prices and the theory of money prices in neo-classical
economics.9 Wicksell put forward the “cumulative
process” theory to explain money prices, while Myrdal, Hayek and
Mises constructed their own versions of monetary economics based on Wicksell’s
theory of cumulative process, criticizing the neoclassical system per se.
The Treatise
also belongs to the Wicksell Tradition. Putting the market rate of interest
together with the natural rate at its centre, distinguishing between investment
and saving, and accepting Wicksell’s three conditions of monetary
equilibrium, it explains fluctuations of money prices and recommends stability
of the price level as an objective. Keynes’s Wicksellian
theory, in which the second fundamental equation is used, plays a crucial role
in the second volume of the Treatise.
2.
KEYNES’S OWN THEORY10
Keynes
develops his own theory in two parts, one of which addresses the determination
of variables relating to consumption goods and investment goods in “each period”.
(Mechanism
1) The cost of production and the volume of output are determined at the
beginning of the current period. Once the expenditure for consumption goods is
determined on the basis of earnings, it is automatically realized as the sale
of consumption goods proceeds, and the price level and amount of profit are
simultaneously determined.
It should be noted that Mechanism 1 is
substantially the same as the first fundamental equation.
(Mechanism
2) The cost of production and the volume of output are determined at the
beginning of the current period. The price level of investment goods is
determined either in the stock market (bearishness function) or as the demand
price of capital goods. As a result, profit is determined.
The
other part of Keynes’s
theory concerns the determination of variables from one period to the next.
(Mechanism
3) The TM supply function
The behaviour of
entrepreneurs is such that, if they make a profit (take a loss) in the current
period, they expand (contract) output in the next.
Now “Keynes’s
own theory” can be expressed as a dynamic process composed of Mechanisms 1 and
2 working through Mechanism 3. As a
result, the economy may or may not reach long-period equilibrium. This
interpretation sees the Treatise
theory as articulating a dynamic process inclusive of price levels and volumes
of output.
III.
HAWTREY’S CRITICISM
1.
HAWTREY’S ECONOMICS
Hawtrey’s trade cycle theory originates in Hawtrey (1913).
It is a cumulative process theory of the banker-dealer connection based on two lags:
the lag in the rate of interest behind change in rising or falling prices, and
the lag in the demand for currency behind change in credit.
Hawtrey
(1919) makes use of his key concepts of “consumers’ income” and
“consumers’ outlay”, although the theory presented here is a revised version of
the theory set out in Hawtrey (1913).11
Then we have Hawtrey (1928) and Chapter III of
Hawtrey (1932), which further elaborate his theory and
demonstrate that he held on to his earlier idea for many years. Let us explain his theory starting with the key
concepts:
The total of the
incomes which people … have to spend I call the consumers’ income; the total
which they do spend I call the consumers’ outlay (Hawtrey, 1928, p. 83).
He
finds the essence of the trade cycle in the variations of “effective demand” ─ variations,
that is, in the consumers’ outlay ─ and the cause of these variations in the movement of bank credit .12
The
trade cycle takes place in the transitional period during which the consumers’
income and outlay show divergence. If the banks judge that the level of their reserves
relatively to the amount of credit money is lower (higher) than is appropriate,
they then proceed to raise (lower) the rate of interest. In turn, the dealers, who hold stocks of commodities and
stand between manufacturers and consumers, contract (expand) their
bank credit and decrease (or increase) their orders to the manufacturers, who
produce less (more) and reduce (increase) employment.
A
contraction (expansion) of bank credit induces a return of currency to the
banks (release of currency from the banks) and a decrease (increase) in
consumers’ income, which in turn brings about a decrease (increase) in
consumers’ outlay. A decrease (increase) in consumers’ outlay brings about an
accumulation of unsold stocks, so that dealers give fewer orders to producers,
who in turn reduce their production and employment. Production then decreases
and unemployment increases, which induces a decrease (increase) in consumers’
income. During this process prices and profits fall (rise), followed – with a
lag – by wages.
The
process has a tendency to accelerate. That is, the divergence between consumers’
income and consumers’ outlay becomes wider and wider with the help of the
above-mentioned lags.
Eventually
the banks notice that the ratio of the reserves
over the amount of credit money is higher (lower) than is appropriate, and lower
(raise) the rate of interest.
Thus
Hawtrey concludes that trade depressions must be due to deficiency in consumers’
outlay owing to credit squeezes.
2.
HAWTREY’S CRITICISM
Hawtrey
testified before the Macmillan Committee on 10 and 11 April 1930, and subsequently
submitted three papers to the Committee.
On 23
April (Tm/1/2/8413) Keynes sent Hawtrey a batch of the proofs for Volume I of the Treatise, followed by a batch of
proofs for Volume
II on 24 June (Tm/1/2/89). Hawtrey responded to Keynes with long critical notes
on 7 (Tm/1/2/94-151) and 9 (Tm/1/2/152-166) July.14
Throughout
these exchanges Hawtrey stuck firmly to his own theory outlined above.
Here let
us take a look at a few passages from his critical notes.
Mr Keynes’
formula only takes account of the reduction of prices in relation to costs, and does not recognise the
possibility of a reduction of output being caused directly by a contraction of
demand without an intervening fall of price (Tm/1/2/106).
The sequence
here assumed is first a fall of prices, and then a contraction of output. With that
assumption
the unemployment inevitably appears as consequential upon the excess of saving
over investment, [i.e.] the fall of prices (relative to costs) under another name (Tm/1/2/107).
It is …
misleading to treat the discrepancy between investment and saving as an
operative cause of monetary phenomena. … The cause of the divergence [between
prices and costs] … is to be found in a change in demand, i.e. in the
consumers’ outlay (Tm/1/2/110-111).
… while a
windfall loss … produces a tendency to a reduction of output, this has not been … a
contributory cause of actual … unemployment (Tm/1/2/116).
Hawtrey,
questioning the TM supply function, emphasizes “present demand” based on the
consumers’ “income” and “outlay”. He also stresses the role which the
adjustment of goods in stock plays, attributing unemployment to a contraction
of demand.
3.
KEYNES’S RESPONSE
Keynes
took his time before responding to Hawtrey’s criticism, on 28 November 193015,
which shows just how much the TM supply
function had been occupying his thoughts.
Firstly,
Keynes was of the opinion that realized profits influence anticipated profits.
… I
have laid too much stress on realised profits in respect of the production
period just ended as influencing anticipated profits in respect of the
production just beginning … (JMK.13,
p.145).16
… there
is not likely to be more than a transitory departure from the optimum level of
output unless there is an actual or anticipated profit disequilibrium … (JMK.13, p.145).
Secondly,
he explained that because ‘how much reduction of output’ is not a monetary
problem, it is not dealt with in detail.
The
question how much reduction of output
is caused, … by a … fall of price17 …, is important, but not
strictly a monetary problem. I have not attempted to deal with it in my book
[the Treatise] , though I have done a
good deal of work at it (JMK.13, p.145).
Thirdly,
he feels the need to link monetary theory to the theory of short-period supply.
… I
am not dealing with the complete set of causes … determin[ing] volume of
output. For this would have led me an endlessly long journey into the theory of
short-period supply and a long way from monetary theory…. If I were to write
the book again, I should probably attempt to probe further into [making the two
theories run together]; but I have already probed far enough to know what a
complicated affair it it is.
As it is I have gone no further than that
anticipated windfall loss or profit affects the output of entrepreneurs and
their offers to the factors of production; but I have left on one side the
question how much output is affected
and also whether output can be affected in any other way (JMK.13, pp.145-146. The parentheses are
mine).
It would
be interesting to know how he thought the Treatise
should be rewritten if time permitted in November 1930. We can say that the
above idea was to take shape in the General
Theory.
It
should be noted that Hawtrey’s theory anticipates the General Theory although it is not a theory of
employment or income, but one of income-outlay repercussion induced by bank
credit. Hawtrey’s criticism of the Treatise’s
fundamental equations and his stress on the importance of effective demand seem
to have made a great contribution to weaning Keynes from the Treatise framework, to set off – after
some hesitation – in the direction of the General
Theory.18
IV.
JUNE 1931-EARLY 1932
1.
JUNE 1931
In
June 1931 Keynes delivered the lectures19, “An Economic Analysis of
Unemployment” in Chicago (JMK.13,
pp. 343-367).
Bridel
(1987, p. 152) correctly regards these lectures as belonging to the Treatise framework. He tends to take the
Treatise theory in terms of interest
rate as equalising investment and savings, although he takes the quantity
adjustments into account. In our view, the former is related to a Wicksellian
theory, the latter to Keynes’s own theory. Vicarelli (1984) considers that with
these lectures “Keynes had made another fundamental break with the theory of
the Treatise” (p. 106).
In
these lectures Keynes discussed a trade cycle mechanism, emphasizing the TM
supply function:
... when
... the value of current investment [I] is less than the savings [S] …, the
receipts of the entrepreneurs will be less than their costs, so that they make
a loss [profit = I - S]. That is … the clue to the scientific explanation of
booms and slumps .... [W]hen [I] increases [decreases] (with no change in S)
business profits increase [decrease] (JMK.13, p. 353).
A given
deficiency of investment causes a given decline of profit [which] … causes a
given decline of output (JMK.13, pp. 355-356).
In these
lectures Keynes argued that the economy is inclined to proceed cumulatively,
and might reach “a kind of spurious equilibrium”20 (JMK.13, p.
356).
Patinkin (1976, p. 68) rightly points out that
this differs from the unemployment equilibrium of the General Theory. It would lead to the long-period equilibrium of the
MTP manuscript.
In the face of the Great Depression Keynes
emphasized the importance of reviving investment:
The cure of
unemployment involves improving business profits [, which] can come about only
by an improvement in new investment relative to saving (JMK.13, p. 362).
To
increase investment, he argues, the solution is to lower the long-term rate of interest.21
Although he believes in the direct effect of the short-term
rate on the long-term rate, Keynes suggests three other ways to this end:
(i) to increase the quantity of liquid assets;
(ii) to diminish the attractions of liquid assets
by lowering the deposit rate of interest;
(iii) to increase the attractions of non-liquid
assets.
He also
mentions three lines of approach for the Great Depression, attaching great
value to (3)22:
(1) restoration of confidence to lender and
borrower;
(2) new construction programmes under the auspices
of the public authorities;
(3) a
reduction in the long-term rate of interest.
He then goes on to question the practicality of
(2), while fully accepting its theoretical validity.
Theoretically… [(2)]
can play an extremely valuable part in breaking the vicious circle. … I applaud
the idea and only hesitate to depend too much in practice on this method alone …
(JMK.13, p. 364).
Together with the lectures, we also have Keynes’s
contributions to the Round Table on “Unemployment as a World Problem” (JMK.13,
pp. 367-373). In one noteworthy instance he proposed:
… let us consider
the totality of industries. You have over a short period something of the
nature of a supply curve which tells you that for a given level of prime profit
there will be a given level of output… Every increase in aggregate prime profit
will enable somebody to expand, … so if you have a supply curve…, you could
only increase … output by increasing prime profit (JMK.13, p. 368).
[Y]ou then
aggregate all the curves and you can get a supply curve for industry as a whole
in which the quantity of output is unequivocally related to the aggregate excess
receipts over prime costs [profit] … (JMK.13,
p. 372).
These observations
attest to Keynes’s view that the quantity of output, both for an individual
industry and for the whole industry, is related to profit, which keeps him tied firmly to his conception of the
supply function in the Treatise.23
2.
20 SEPTEMBER 1931 AND TWO MANUSCRIPTS
In
his letter to Kahn (20 September 1931. JMK.13,
pp.373-375)24, Keynes argues out the possibility of underemployment
equilibrium, which now makes its first appearance:
… if, starting
with equilibrium, an increase of I makes Q positive, O increases and S
increases but Q/O gradually diminishes. If Q/O reaches zero before O reaches
maximum, we have ‘long-period unemployment’, i.e. an equilibrium position short
of full employment. Similarly if a
decrease of I decreases Q, O decreases and S decreases with the result that Q
gradually increases until it is zero, which will be likely to occur before O is
zero (JMK.13, pp. 374-375).
Behind this observation lie an
idea that ‘profit is the difference between the value of investment and saving’
and a TM supply function — the theoretical framework of the Treatise. And, based on the TM supply
function, a state of equilibrium, ‘long-period unemployment’, is explained in
which employment stands at a level between zero and full. This idea might be
the starting point for the idea found in GT,
p.254 — “we oscillate … round an intermediate position
…”.
For the same period we also have the
manuscripts, “Why Are the Equations for Consumption-Goods and Investment-Goods
Asymmetrical?”25 and “The Determination of Price”.26
In the
manuscript, “Why Are the Equations for Consumption-Goods and Investment-Goods
Asymmetrical?”, which may be closely related to Chapter 1, “The Differential of Consumption-goods and Capital-goods”, of
Book III, “The Determination of Price”, of the First
Table of Contents (probably written prior to April
1932. to be dealt with in Section VII below), Keynes sets
out to explain, in response to Robertson’s criticism, why the equation
determining the price of consumption goods is asymmetrical with that
determining the price of investment goods.
Keynes’s
main argument is that, given E, Q, and M, P1 depends on the difference
between saving and investment, or on the propensity to save defined as S = φ
(E, Q, P1, P2) while P2 depends on the
propensity to hoard defined as M = ψ (H,
P2) (E denotes the earnings, Q profit, M money supply, P1 and P2 the price levels of
consumption goods and investment goods respectively, S saving and H hoarding).
Dealing
with P1, he comes to the first fundamental equation of the Treatise.
Equalling
the flow of money directed towards stomach-goods [consumption-goods] with the
product of the price and quantity of such goods we have
E – S
= … = R.P1
It is
this equation which I re-analyse in my Treatise
into the form
P = E/O
+ (I’ – S)/R where I’ = (E/O).(O-R) (GTE/1/27-28)
With regard to P2, he develops the
following argument:
… we can equal the flow of new money …
against the product of the quantity and the price of new hump-goods [investment
goods] coming into the market. … Thus S + Q + dM = CP2 – (A3 +B3)P2
… We
can, if we like, deduce from this P2
= - dM/ (A3 +B3)
But
this is only another way of saying
P2
=ψ’(M) (GTE/1/33-34)
(C
denotes the quantity of investment goods, A3 the release of
consumption goods by the banks, B3 the release of investment goods
by the banks.)
Here Keynes explains how the price of
investment goods is determined in relation to money supply. He also uses the
term, “bull-bear position”, which shows that he has not dropped the Treatise theory of the bearishness
function.
The
manuscript entitled “The Determination of Price” is very similar in content to
the above manuscript. It explains how the price level of consumption-goods is
determined, and then goes on to see how the price level of capital-goods is
determined, emphasizing the difference between the two.
A
significant difference from the above manuscript is, however, to be seen in the
presence of the supply schedules, which
make their first appearance here.
Let P1
= f1(A1)
and
P2 = f2(A2)
be the supply schedules of the two types of goods in the sense that A1
and A2 will be the quantity of each marketed for money … in response
to prices P1 and P2 (GTE/5/469)
(where A1=
O1+ Δ B1 and A2=
O2+Δ B2. Oi and
ΔBi respectively denote output, and the change in the stock of goods
i [i= 1, 2] held by the public, where goods 1 are consumption goods and goods 2
capital goods.)
Keynes
explains the price level of the consumption-goods based on the first
fundamental equation of the Treatise,
arguing that it depends on the “saving propensity”. With respect to the “saving
propensity” S, Keynes argues as follows:
S will depend, apart
from fundamental changes in popular psychology, on O, the community’s real
income, on Q [profit] as determining the distribution of the real income and on
P1 itself relatively both to P1 and to P2
(GTE/5/474)
This anticipates the propensity to save
in the General Theory.
Keynes
accounts for the price level of capital-goods taking into consideration the “curve
of bearishness” or “hoarding propensity”. His argument runs thus:
P2 = ΔM/ΔB2 =Φ(M)
Where M is the
total stock of money and Φ(M) what I have called the curve of bearishness, i.e. Φ(M) is the price for
capital-goods at which … the public desire to hold an amount of money M rather
than either to increase by purchase or to decrease by sale their holdings B2
of capital-goods (GTE/5/473).
Both
manuscripts probably precede the manuscript “The Monetary Theory of Production”,
for they adopt the same line as the Treatise on the bearishness
function, and on the determination of the price levels of consumption and
investment goods. In the manuscript “The Monetary Theory of Production”, as
will be seen below, we find the theory of liquidity preference in embryo, while
in the two manuscripts money is treated solely in relation to the price level
of capital-goods, without referring to the rate of interest.
However, there is a possibility that the two
manuscripts may have been written immediately after “The Monetary Theory of Production”
manuscript, for the “supply schedule”, defined as the function of the price,
appeared in the manuscript entitled “The Determination of Price”, while the “propensity
to save” appeared in the other two manuscripts.
V.
“THE MONETARY THEORY OF PRODUCTION” MANUSCRIPT (THE MTP MANUSCRIPT)
This
manuscript is probably preceded in time by the preface to the Japanese edition of the Treatise (5 April 1932. TM.1, pp. xx-xxvii) which states the
determination of the price level of capital goods in terms of “bearishness” (“the
propensity to hoard”) but contains neither the determination of the rate of
interest nor the term “liquidity preference”, whereas the MTP manuscript reveals
the seeds of the liquidity preference theory.
Let us
review the main points of the manuscript, and then assess it in terms of
Keynes’s theoretical development.
1.
THE SHORT-PERIOD ANALYSIS
In
the MTP manuscript, the fluctuations of the economy and the possibility it
faces of cumulative deterioration are analyzed using the TM supply function.
(A) The TM Supply Function
Keynes’s
analysis below might be considered to be a defensive response to Hawtrey’s
criticism (see Section III-2 above), showing deeper insight into the TM supply
function. In “Notes on the Definition of Saving” which Keynes sent to Robertson
on 22 March 1932, he places stress on the TM supply function: “it is not a
matter of indifference in what proportions the income E′ of the community is divided
between E [earnings] and Q [profit]. For if Q is positive, entrepreneurs will
be under a stimulus to increase output, whilst if Q is negative they will tend
to decrease output. This is a good reason for wishing to split up E′ into its
constituents E and Q, and for “bothering"
about the effect on Q of changes in F [expenditure on consumption] and I ′ [cost
of investment]” (JMK.13, p. 279).
The
following passage clearly demonstrates the importance that Keynes attaches to the
TM supply function:
The essence of
the monetary theory of production ... can be expressed quite briefly, starting
from the equation
Δ Q =Δ I - Δ S,
or, …
Δ Q = Δ I
+ Δ F -Δ E,
or Δ Q =
Δ D - Δ E
where Q stands
for profit, I for investment, S for saving, F for spending, and D for
disbursement. …
…we
have started with the assumption that …entrepreneurs tend to increase [decrease]
their output according as their profit is increasing [decreasing]. Thus we are
led to…the vital generalisation
that increases [decreases] in the volume of output … depend upon the changes in
disbursement relatively to earnings ... or in investment relatively to
savings.... Throughout this Book we
shall be engaged in developing … this
central generalisation (JMK. 13, p. 381. E denotes earnings).
Q is
formulated as either I - S or D - E. To obtain the first formulation from the
second, the equation F = E - S is required.
The MTP
manuscript assumes an economy in which the total volume of output, fixed at the
beginning of each period, is sold in that period. This is related to the TM
supply function, in the context of which, as in the Treatise, both
investment I and spending F are taken to be the sale proceeds realized as a
result of the total volume of output being sold. The intrinsic logic of this
function is developed as follows.27
The quantitative
effect on output of a given decrease - Δ Q
… will depend on: (i) the margin between each entrepreneur’s receipts and his
variable costs...; (ii) the distribution of the total reduction - Δ Q between different entrepreneurs; and (iii)
the duration of the period of diminished profit relatively to the durability of
his fixed capital....[If (i) is sufficiently large initially, (ii) equal and
(iii) short], … there is no reason to expect any significant decline of output,
....
Nevertheless, even so, an initial movement -
Δ Q is likely to aggravate itself....
As a net result of … [a cumulative deterioration of - Δ Q, and the existence of firms in which the initial (i) is
insufficient, the inequality of (ii) and the prolongation of (iii)], it is …
reasonable to expect that a point will be reached at which there is some
elasticity of supply in response to diminished profit, the initial reduction in
entrepreneurs’ profit aggravating itself until, having reached an amount - Δ Q, it causes a reduction - Δ O … and a reduction - Δ E … (JMK.13, pp. 382-383).
From
this we gather that Keynes regards the TM supply function as a useful
analytical tool operating with some time lag.
(B) THE POSSIBILITY OF CUMULATIVE DETERIORATION
Using
profit and the TM supply functions as pivotal concepts, Keynes argues that the
economy might proceed along a course of cumulative deterioration:
... an initial
movement - Δ Q is likely to aggravate
itself. For the reduction in entrepreneurs’ profit will have a tendency to
retard new capital development [investment] in respect both of value and
volume…; and at the same time it may stimulate economy by diminishing both the
[consumption] expenditure of entrepreneurs whose incomes are reduced and also
the [consumption] expenditure of other consumers who can maintain their
previous standard of life at a lower money cost. In short, the initial decline
in disbursement is likely to generate ... a further decline in disbursement ...
(JMK.13, pp. 382-383).
Here
Keynes argues that a reduction in profit generates a further decline in
disbursement, which in turn generates a further decline in profit, so that the
deterioration becomes self-reinforcing. Behind this argument lies the idea that
the volume of production of both investment goods and consumption goods is
determined by the TM supply function.
He
also discusses the case in which the economy deteriorates cumulatively even if
the extent of the decline in profit remains the same as before:
Let us...assume
that … the amount of disbursement declines by about the same amount as the
decline in earnings.... On this assumption, the deficiency in the profit of
entrepreneurs as a whole will remain exactly the same in absolute amount as it
was before. But it will be spread over a smaller number of units of production,
as a result of a certain number having fallen out of production. Consequently
the average loss will be greater than it was, with the result that the next
most vulnerable section of entrepreneurs now falls out of production.
Thus if we can imagine the entrepreneurs
ranged in a continuous series according to what percentage reduction in their
receipts impels them to close down production, it might be that a very small
diminution -ΔQ in the total receipts of entrepreneurs might by a sort of
inverse tontine process gradually close down one after another of them, until
production was at a total standstill (JMK.13, pp. 384-385).
Thus
Keynes argues that the economy in which a decline in disbursement initially generates
a decline in profit can enter upon a process of cumulative deterioration, due
either to a falling off in profit itself or to an increase in the average loss
as a result of a decrease in the number of units of production.
2.
THE LONG-PERIOD EQUILIBRIUM
How
long does the economy continue to deteriorate cumulatively? Is there a
possibility that it may reach a long-period state of equilibrium? Keynes
answers the latter question in the affirmative.
In the
MTP manuscript he emphasizes the relation between spending (consumption
expenditure) and earnings (income). This relation is similar to that in the Treatise,
and not directly connected with the GT
consumption function. The following passage is to be read in this context:
... it is
natural to expect that, as the earnings of the public decline, a point will
eventually be reached at which the decline in total expenditure … will cease to
be so great as the decline in [earnings] (JMK.13, p. 386).
Here
“total expenditure” does not mean disbursement but consumption expenditure: the
passage implies that the marginal propensity to consume (in terms of the General
Theory) increases as earnings increase.
In the
Treatise, the relation between spending and earnings is a factor causing
a collapse in the credit cycle while, in the MTP manuscript it is regarded as
warranting a kind of long-period equilibrium after a series of short-period
equilibria. What the two share is the idea that spending has no influence on
the production of consumption goods, but determines their price level, and that
the profit from consumption goods determines their volume of production in the
next period.
Keynes
argues that the long-period equilibrium thus attained is characterized as a
state of underemployment:
… provided that
spending always increases [decreases] less than earnings increase [decreases] …
[with investment stable] ...any level of output is a position of stable
equilibrium. For any increase [decrease] of output will bring in a retarding [stimulating]
factor, since ΔS will be positive [negative] and consequently I being assumed
constant, Δ Q will be negative
[positive] … (JMK.13, p. 387).
Here it
is regarded as an important condition for stable equilibrium that the rate of the
change in spending be smaller than that in earnings. Equilibrium generally
brings about a state of underemployment equilibrium.28
... there is no
presumption…that the equilibrium output will be anywhere near the optimum
output. The essence of the above process is that the real income of the
community has to be forced down to a level at which the rate of saving is not
so excessive relatively to investment at the current rate of interest as to
produce a crescendo of business losses… (JMK.13, p. 387).
3.
THE RELATION OF INVESTMENT TO THE LEVEL OF OUTPUT
The
MTP manuscript stresses the role of investment in determining the level of
output, and of the government in promoting investment. However, it is no easy
task:
... if we regard
the response of individual spending to any given conditions of earnings and
profits as something …determined by nature and habit…, then the level of
output, which will be a stable level, entirely depends on the policy of the
authorities as affecting the amount of investment.... [W]hen the output of the
community increases a point comes eventually … when its spending … ceases to
increase as rapidly as its earnings; … though we may … for a time maintain
disbursement as a whole by increasing investment as rapidly as [savings] rises,
a critical point comes when…we cease to be able to increase investment at an
adequate pace, with the result that forces come into operation which prevent a
further increase of output (JMK.13, p. 388).
We
need to consider the relation between the short-period analysis applying the TM
supply function and the proposition that the level of output depends on
investment. Keynes seems to be saying that if investment increases in the
initial period, then output will continue to increase over a period of time, resulting
in an increase in output at a new long-period equilibrium. When he says “the
level of output, which will be a stable level, entirely depends on the policy
of the authorities as affecting the amount of investment”, he is stressing the
influence that both investment and the investment policy of the authorities
have on the level of output at a long-period equilibrium.
Keynes
also says that “output will finally settle down to a position of equilibrium
which is stable, so long as no extraneous influence interposes to change the
value of I” (JMK.13, p. 388). He may seem here to be expressing reliance
on an automatic mechanism driving the economy towards long-period equilibrium,
but actually this is not the case. Having serious doubts about any such mechanism,
he stresses the importance of a low interest rate policy for attaining optimum
output: “there is no safeguard against savings increasing faster than … investment,
except a monetary policy deliberately aimed at making a rate of interest
sufficiently stimulating to investment” (JMK.13, p. 396).
As for
the relation between monetary policy and long-period equilibrium, Keynes
explains it clearly in the lecture draft for 14 November 1932.
4.
THE ORIGIN OF THE THEORY OF LIQUIDITY PREFERENCE
The
Treatise brings the focus on the “degree of bearishness” which is
concerned with a portfolio selection between money as bearing interest, and
equities. Contrastingly, the General Theory, which does not assume
identity of equities and capital goods, brings the focus on the liquidity
preference which is concerned with a portfolio selection between money as bearing
no interest, and debts.
The term appears for the first time in the title of Chapter
20 in the table of contents, “The Monetary Theory of Production”29.
Bridel (1987) argues that “ the ‘liquidity preference’ doctrine was already
part and parcel of the Treatise” (p.
149), expressing it as ‘MD = M１(Y)
+ M(r)’ (p. 133) which he even describes as an “anticipation of the
liquidity-preference equation of the General
Theory'” (p. 207). In our view, this is misleading, for the rate of
interest as a policy variable in the Treatise
is directly concerned with the prices of equities (and the price level of
investment goods). The similarity between the theory of the bearishness
function and the theory of liquidity preference should be noted, without,
however, ignoring the difference. Otherwise it would be impossible to
understand Keynes’s subsequent development in this field.
In the MTP
manuscript we see the liquidity preference making its first appearance.
... as output
and prices decline, the proportion of the stock of money to income will...tend
to increase. This growing relative abundance of money will, unless the general
desire for liquidity relatively to income is capable of increasing without
limit, lead…to a decline in the rate of interest (JMK.13, p. 395).
This
may be read in terms of the General Theory as follows:
(i) a decrease
in the demand for money due to the transactions motive makes money relatively
abundant;
(ii) the
abundance of money causes a decline in the rate of interest, unless the liquidity
preference due to the speculative motive is infinitely elastic.
Here the
MTP manuscript abandons two of the ideas in the Treatise: (i) that the price level of investment goods is
determined in the financial market dealing with savings deposits and equities30;
(ii) that the rate of interest is a policy
variable.
In
short, the role of the financial market switches from determining the price
level of investment goods to determining the rate of interest. The rate of
interest thus determined is expected to influence investment, which in turn
influences the level of output through the TM supply function.
This
change represents an enormous transformation in monetary theory. From the viewpoint
of Keynes’s theoretical development, however, it is nothing like the change in the
theory of the commodity market, for it does not undermine the grounds for the
MTP manuscript to be argued within the Treatise framework.
5.
THE PLACE OF THE MTP MANUSCRIPT
Patinkin (1976, pp. 71-73) finds several original ideas
leading to the General Theory, although he correctly regards the MTP
manuscript as being within the Treatise framework. Amadeo (1989, pp. 74-75)
sees the embryo of the multiplier mechanism in the MTP manuscript, although he
points out that “the adjustment process is based on the same causation scheme
used in the Treatise” (p. 74).
We are
now in a position to evaluate the place of the MTP manuscript31 in
the development from the Treatise to the General Theory. Five
points are worth noting in particular.
(1)
Its fundamental framework belongs to the
Treatise theory, for it maintains (i) profit and the TM supply function as
determining the level of output, (ii) the relation, similar to Mechanism 1, between
consumption and earnings, in that it determines not the level of output but the
price level of consumption goods, and (iii) the value of investment, determined
in the same way as in Mechanism 2.
(2) The basic
theoretical structure is put forward as the dynamic process of Mechanisms 1 and
2 working through the TM supply function, while Wicksellian theory is no longer
used.
(3) The TM supply function and profit are
discussed in detail. This is particularly significant, for they are insufficiently
discussed in the Treatise. ( (2) and (3) are not mentioned in Patinkin
(1976; 1977)).
(4) The theory of liquidity preference
appears for the first time – an
important advance in monetary theory.
(5) We can pick out three salient features of
the MTP manuscript – (i)
the possibility of cumulative deterioration, (ii) underemployment equilibrium,
and (iii) the role of investment and its fragility –
back to the Treatise32 in (i) and the first half of (iii),
and to the Chicago lectures “An Economic Analysis of Unemployment”33 in
(ii) and the second half of (iii).
In the
MTP manuscript Keynes describes the fluctuations of the economy using the TM
supply function. He also describes long-period equilibrium as the economy reaching
through a series of short-period equilibria, and thereby attempts to analyze
short-period disequilibrium and long-period equilibrium in tandem. This was to come
in for criticism from the Cambridge Circus –
criticism which he resisted for some time, but which was eventually to prompt a
great transformation in Keynes’s thinking.
VI.
THE CRITICISMS OF THE CAMBRIDGE CIRCUS: MAY 1932
Immediately
after the publication of the Treatise, several economists, including
Kahn, Sraffa, Meade, and Austin and Joan Robinson, formed a group – the “Cambridge Circus” (January - May
1931) – to study it. The members attended
Keynes’s lecture of 2 May 1932 and responded with a “Manifesto”, to which Keynes
replied.
Patinkin (1976, Chapter
7) identifies three stages in the supply of criticism by economists that contributed
to Keynes’s theoretical development: (i) Cambridge Circus, Hawtrey and Hayek’s
criticism of the Treatise; (ii)
discussions with Kahn and J. Robinson in 1932 and 1933; (iii) Hawtrey and
Robertson’s criticisms of the galley proofs of the General Theory. Patinkin endorses (i), but not (ii) and (iii); he
feels some difficulty in judging (ii) because of lack in documentation.
1.
THE 2 MAY 1932 LECTURE
We
can reconstruct Keynes’s lecture from some surviving fragments, probably his
preparatory notes (JMK.29, pp. 39-42). The picture that emerges is
substantially similar to the MTP manuscript, for the proposition, ‘the volume
of output and employment depends predominantly on the amount of investment’, is
stressed in terms of the TM supply function.
The
argument begins by making two assumptions: (i) Δ O and Δ E΄ have the same
sign; and (ii) Δ E΄ - Δ F and Δ E΄
have the same sign, where O denotes the volume of output, E΄ earnings plus
profit, F spending, and Δ X an
increment in X.
On
these assumptions Keynes attempts to establish a positive relation between the
volume of output and that of investment.
He then
goes on to examine the case in which this relation does not hold. By looking
closely into his procedure we can understand the relation between the positive
output/investment relation and the TM supply function:
If..., whenever
there was an increase in investment, there should also be such an increase in
rates of earnings that the increase in aggregate earnings on the basis of the
old output was greater than the increase in investment, and if earners were to
save these increased earnings whilst entrepreneurs maintained their expenditure
at their previous level, then every increase in investment would be associated
with a decrease in profit and therefore in output. / Thus we are left with the
remarkable generalisation that…the volume of employment depends on [that] of
investment, and that anything which increases [decreases] the latter will
increase [decrease] the former (JMK.29, p. 40).
Keynes
argues for this relation in the context of “generalisations of far-reaching
practical importance” (JMK.29, p. 40), stressing Δ Q = Δ I
+ Δ F - Δ E, which appeared in the MTP manuscript. He discusses the relation
between the positive output/investment relation and the TM supply function in
terms of not only the long period but also the short:
The general
upshot of this…seems to be that the fluctuations of output and employment for a
given community over the short period…depend almost entirely on the amount of
current investment (JMK.29, p. 41).
The key to a proper understanding of the
lecture lies in Keynes’s attempt to link the positive output/investment
relation with the TM supply function. His analysis centres on the short-period
process; long-period equilibrium is simply the point towards which the economy
is moving. This is essential in understanding the differences between Keynes
and the Circus.
2.
THE CAMBRIDGE CIRCUS
The
lecture drew criticism from the Circus in the form of a “Manifesto” by Kahn and
the Robinsons (JMK.29, pp. 42-45), which, arguing that Keynes’s
procedure for the proposition ‘an increase in investment (I) brings about an
increase in the volume of output (O)’ lacks generality, puts forward an
alternative way of proving it:
The problem
seems to us to be susceptible to treatment by the method of Supply and Demand.
For the truth of the proposition … , the two following conditions appear to us
to be sufficient…:
(a)
That an increase in I will lead per se
to a rise in the demand for consumption goods, ….
(b)
That the conditions of supply of
consumption goods are not affected by a change in I.
When these conditions are fulfilled, an
increase in I will lead to a rise in the demand curve for consumption goods
without raising the supply curve, and so must lead to an increase of output of
consumption goods, and a fortiori to an increase in total output (JMK.29,
pp. 43-44).
Keynes put forward the proposition in terms of
the TM supply function, while the Circus did so in the framework constructed by
Kahn (1931)34, disregarding the function. The Circus’s position is very
clear in Joan Robinson’s letter to Keynes:
You begin by
increasing I. Now … tell me the elasticity of supply of capital goods i.e. how
much increase in output does this ΔI entail. Then I will tell you for any set
of conditions of supply of consumption goods what increase in E would be
necessary to prevent O from increasing ....
In this sense I consider our method more
general than yours. You announce in advance that yours only works when Δ Q and Δ O
have the same sign. Ours is designed to overcome that limitation (JMK.29,
p. 47).
The
Circus’s argument was based on two considerations: (i) the elasticities of
supply in capital and consumption goods industries; and (ii) the influence of
an increase in investment on the demand for consumption goods.
On 8
May Keynes discussed the whole matter with Kahn and Joan Robinson. The next day
he wrote a letter to Robinson, revealing some doubt about his own argument,
while having no less doubt about Robinson’s:
[W]hich is the
best of two alternative exegetical methods [?] ... my present belief is that
... your way would be much more difficult and cumbersome. … I lack at present
sufficient evidence to the contrary to induce me to scrap all my present
half-forged weapons (JMK.13, p. 378).
The
“two alternative exegetical methods”35 are: (a) the credit cycle
theory by way of the TM supply function; (b) the multiplier theory, including
the method of supply and demand. The point of contention is unmistakably the
supply function.
Kahn’s stance had already become clear in
Chapter 4, ‘Supply Schedule of an Industry under Perfect Competition’ of Kahn
(1929;1989). He was a virtual co-author of J. Robinson (1933). Moreover, Keynes
‘exercised a stimulating influence on [Kahn’s] progress’ (Kahn, 1989, p. xi).
Taking these into consideration, it is evident that Keynes intentionally
adopted method (a).
Robinson
replied to Keynes on 10 May.36
Then the supply
price for each output is (on your view) the average prime cost + the profit per
unit just sufficient to retain the marginal entrepreneurs .... I believe that
like the rest of us you have had your faith in supply curves shaken by
[Sraffa]. But what he attacks are just the one-by-one supply curves that you
regard as legitimate. His objections do not apply to the supply curve of output
…37 (JMK.13, p. 378).
In mid-1932
Keynes was still using the average principle of the Treatise. The first sentence
can be taken to mean that profit per unit is defined as the difference between
the (supply) price as determined in the period, and the (average) prime cost as
determined at the beginning of the period.
Let us
now see how Robinson’s answer continues. First, she suggests that Keynes thinks
that a supply curve, in the ordinary sense, is useful for the analysis of an
individual firm or an individual industry, while Sraffa rejects this. Second,
the supply curve of output [of the economy as a whole] lies outside Sraffa’s
theory.
Here Robinson’s
reference is to an article by Sraffa (1926) of epoch-making
importance for the imperfect competition revolution, in which he maintains that
increasing returns are applicable to the industry in the narrower range:
the more nearly [an
industry] includes … only those undertakings which produce a given type of
consumable commodity ― the
greater will be the probability that the forces which make for increasing
returns will predominate … [if the more nearly [an industry] includes all the undertakings,
… decreasing returns will predominate] (Sraffa, 1926, p. 538).
Thus
the “supply curve of output” works under diminishing returns, while the
“one-by-one supply curves” work under increasing returns.38 Robinson
seems to have this in mind.
If we understand
Robinson’s comments aright, it follows that she fails to recognize that: (i)
Keynes thinks that the TM supply function is useful for analysis not only of
the economy as a whole, but also of an individual industry, considering that
the ordinary supply curve is not useful in either case; (ii) Keynes had so far never
used the “supply curve in the ordinary sense”. It was in mid-1933 that he came
to accept the so-called “first postulate of the classical economics”.39
Indeed,
Keynes stressed the TM supply function in a letter to Joan Robinson of 12 May:
About all one
can say is that ... an increment in aggregate profit can reasonably be expected
to produce an increment of aggregate output ―
which is in substance what I have said.
…
even when one is dealing with separate industries, or separate groups of
industries, my supply curve is one which relates output and profit, not one
which relates output and price (JMK.13, p. 380).
By the
end of 1932, however, he had come to accept the Circus criticisms. He abandoned
the TM supply function and adopted “the method of Supply and Demand”, following
the lines laid down by Kahn and Robinson.
These lines were also adopted by Harrod (1936). Harrod criticised
the analysis in terms of the TM supply function in the Treatise on the grounds that (i) it does not take into
consideration a temporary equilibrium state; (ii) it does not take into
consideration a marginal entrepreneur (p. 66).
This
is not, however, to say that Harrod’s criticism of the Treatise was comparable with that of the Cambridge Circus. For
‘Keynes’s Treatise Influence on
Harrod, 1930-39'’ see Young (1989, pp. 48-50). Also see Harrod (1969, Chapter
7, esp. pp. 163-165) which emphasises the importance of the Treatise in terms
of (i) the distinction between cost inflation and demand inflation, (ii) the
treatment of investment and saving.
VII.
TWO TABLES OF CONTENTS (1932)
We now have extant two draft Tables of Contents that Keynes
wrote in 1932 while he was in the early stages of developing the General Theory. This material
is indispensable
for a proper understanding of Keynes’s theoretical development.
1.
KEYNES AND KITOH
In
the preface to the Japanese edition of the Treatise (5 April 1932), Keynes
announced his intention “to publish a short book of a purely theoretical
character, extending and correcting the theoretical basis … in Books III and IV
…” (Tm/1/3/255). Kitoh, the translator, asked Keynes about the progress of the
book (30 June. Tm/1/3/270). Keynes replied that “…[it] is…still many months
off” (20 July. Tm/1/3/271). On 18 September he remarked to his mother that “I
have written nearly a third of my new book on monetary theory” (JMK. 13,
p. 380).
When Kitoh
repeated his enquiry to Keynes (20 October 1933. Tm/1/3/273), he replied: “…[My
book] may possibly be published some time next year” (9 November. Tm/1/3/272),
followed by a letter saying that “I am hard at work on my further book on the
Pure Theory of Money …. But it will be some months more before … printing” (22
June 1934. Tm/1/3/274).
2.
TWO TABLES OF CONTENTS
We
have two tables of contents drawn up in 1932 (JMK.29, pp.49-50: hereafter the First Table of Contents, and the
Second Table of Contents). It is a pity that the two tables contain nothing of
the relevant text, but they nevertheless offer help in filling out the picture
we are piecing together.
As we shall see below, the work to which Keynes
referred in his letters of 1932 both to Kitoh, dated 20 July, and to his mother,
dated 18 September probably had to do with a third (missing) table of contents.
(A)
The First Table of Contents
The
table of contents entitled “The Monetary Theory of Production” has several
points worth noting:
(i)
The titles of Chapters 1 - 4 (Book I)
suggest that they may argue disbursement, profit, earnings, and output in the same way as the MTP
manuscript in terms of the equation ΔQ = ΔI +ΔF - ΔE =ΔD - ΔE;
(ii) The title
of Chapter 2, “The Relation of Profit to Output”, may point to the TM supply
function;
(iii)
Chapter 6, “Generalisations” (Book I) may have to do with the “vital
generalisation” referred to in Section 4 (1(A));
(iv) Chapter
7, “Historical Retrospect” (Book I) may be related to a note, “Historical
Retrospect” (JMK.13, pp. 406-407);
(v)
Chapter 1, “The Differential of Consumption-Goods and Capital-Goods” (Book II)
may be related to the manuscript “Why Are the Equations for Consumption-Goods
and Investment-Goods Asymmetrical?”
(vi) The
title of Chapter 2, “The Meaning and Consequences of ‘Bearishness’ ” (of Book
III) may suggest the Treatise theory of money.
(B)
The Second Table of Contents
The
untitled table of contents, whose main chapters are almost the same as in the
First Table of Contents, shows the following features:
(i) The title of
Chapter 20, “The Factors Determining Liquidity Preference”, may propose the
liquidity preference theory;
(ii) Chapters 23 - 27 (Book IV) bear titles
regarding economic policy. No such chapters re-appear thereafter.
(C)
Chronological Order
Let
us consider the chronological order of this material. Obviously the First Table
of Contents, referring to “bearishness”, precedes the Second Table of Contents,
referring to “liquidity preference”.
The MTP
manuscript was probably written on the basis of a third table of contents subsequent
to these two table of contents, as indeed is suggested:
(i) by
the chapter titles of the MTP manuscript, which have no corresponding titles in
the two tables of contents;
(ii) by
the fact that the MTP manuscript contains the seeds of the theory of liquidity
preference.
However, this is not to deny
that the two tables of contents are closely related to the MTP manuscript.
VIII.
Conclusion
With the following three steps, it is possible to answer clearly
and conclusively the question, “For how long did Keynes maintain the theory he
had developed in the Treatise on Money?”
(i) Clarification of how Keynes set about defending
and extending his own theory developed in the Treatise, expressed as a dynamic process composed of Mechanisms 1
and 2 through the TM supply functions.
Through the Chicago lectures, “An Economic
Analysis of Unemployment” and the
Round Table on “Unemployment as a World Problem” (June 1931) we saw how much stress Keynes placed on the TM
supply function in his analysis. I also argued that the MTP
manuscript (possibly
prior to April 1932) analyzes the fluctuations of the economy and its
possibility of cumulative deterioration by means of the TM supply function, and
describes long-period equilibrium as a point reached after a series of
short-period equilibria. Moreover, we saw that the MTP manuscript stresses the
role of investment in determining the level of output, and of the government in
promoting investment, and contains the seeds of liquidity preference. It should
be noted that the MTP manuscript discusses the TM supply function and profit in
more detail than the Treatise does.
(ii) The
significance of two criticisms of the Treatise.
The first criticism came from Hawtrey in 1930, who,
questioning the TM supply function, emphasized effective demand. The
correspondence between Hawtrey and Keynes is very instructive in the sense that
Hawtrey criticized Keynes’s theory from the standpoint of his own theory, which
to some extent anticipates the General
Theory, while Keynes reveals his state of mind concerning the TM supply
function and the need to link monetary theory to the theory of short-period
supply.
The second came from the “Cambridge Circus”, which,
questioning the TM supply function, put forward the proposition in
terms of Kahn (1931). Around May 1932 there was a controversy over the credit
cycle theory between Keynes (the TM supply function) and the Cambridge Circus (the
multiplier theory, including the method of supply and demand).
By the end of
1932, however, he had come to accept the Circus criticisms. 40 He
abandoned the TM supply function and adopted “the method of Supply and Demand”,
following the lines laid down by Kahn and Robinson.
(iii)
A careful examination
of
two manuscripts probably written prior to the MTP manuscript: “Why Are the Equations for Consumption-Goods and
Investment-Goods Asymmetrical?”, and “The Determination of Price”.
Both can be seen to argue that the price level
of consumption goods is determined by Mechanism 1, the price level of
investment goods by Mechanism 2, and in this respect they are in line with the Treatise theory. However, they also
contain the beginnings of the propensity to save, and the latter manuscript has
the “supply schedule” as a relation between price and output appearing for the
first time. These indicate some change toward the General Theory.
From
these crucial developments we
can clearly trace out the time span between October 1930 and
October 1932 during which Keynes held to his Treatise theory. The latter
date calls for some explanation. It has to do with the Michalemas lecture
(October – December 1932) and the manuscript “The Parameters of a Monetary
Economy” written at the end of 1932. Although Keynes still clung to the idea of
the TM supply function, “The Parameters of a Monetary Economy” manuscript drawn
up at the end of 1932 together with the sixth (14 November) and seventh lecture
(21 November) nevertheless mark a turning point from the Treatise toward the General
Theory.41
Finally,
although the present paper focuses solely on
the period during which the Treatise theory
was maintained, it
must be said that the core of the Keynesian Revolution lies in the
theory of underemployment equilibrium, which emerge clearly from the three 1933
manuscripts.
Notes
1) One of the major obstacles to studies of Keynes’s
developmental process is the established understanding formed prior to serious
studies based on the primary material. According to this “common knowledge”,
the Treatise deals with the
determination of price levels only, assuming given quantities of income, while
the General Theory treats the
determination of income assuming given price levels. This understanding
permeates not only the Income-Expenditure Approach but also the Disequilibrium
Approach. The Keynesian Revolution, therefore, is seen in the light of this
widely shared perception to lie in the fact that Keynes established the theory
of income in the General Theory, abandoning
the theory of prices in the Treatise.
If we view Keynes’s developmental process with this conviction in mind, there
is a real risk of serious misunderstanding. Indeed, the material between the
two major works seems to have received arbitrary treatment. Our understanding
is that both the Treatise and the General Theory treat both prices and
quantities, albeit in a different way.
2) On
which, see Hirai (2004).
3) On
which, see Hirai (1997-9, Chapter 10).
4)
On which, see Hirai (2004).
5)
On which, see Keynes Papers TM/1/3.
6) Interestingly enough, Pigou (1931) rates the Treatise highly. For example, he
remarks: “[Keynes] claims for his new equation … that it enables the causal
sequence, in many sorts of industrial disturbances, to be followed with a surer
eye. This is, I think, a valid claim” (544). The only point of criticism is
concerned with the TM supply function: “… as it seems to me, the relation of
falling prices to industrial activity can be studied more effectively on the
lines made familiar by Professor Irving Fisher than on those that … are
followed by Mr. Keynes” (544). The
correspondence between Pigou and Keynes survive very fragmentarily (see JMK.13, 214-218). Keynes stresses the
advantages of his fundamental equations over the Cambridge equation in his
letter dated 11 May. We have an impression that Pigou’s understanding of the Treatise as revealed in the letter dated
May 1931 is on the right track. See Bridel and Ingrao (Macuzzo=Rosselli, 2005,
pp.157-158).
7)
This is not Keynes’s paper in the Festschrift for A. Spiethoff (JMK.13, pp.408-11).
8) On
which, see Hirai (2005).
9) See,
for example, Wicksell (1936, p.23).
10) On
which, see Hirai (1997-9, Chapter 7).
11) See Hawtrey (1913, pp. 42-44, 107-110 and 124-126).
12)
See Hawtrey (1928, p.84 and p.94).
13)
“Tm/a/b/c” (where a, b, c stand for numbers) is a paging system actually
adopted in Keynes Papers.
14)
It should be noted that “ADDENDUM” (JMK.13,
pp.150-164) is an excerpt produced from these by the editor. We shall,
therefore, make use of the original ones.
15)
The typescript is, however, dated 19 November 1930. See Tm/1/4/54.
16)
We quote this passage as attesting to Keynes’s acceptance of Hawtrey’s
criticism.
17)
This seems to be Keynes’s response to Hawtrey’s above-mentioned comment, “The
sequence here… prices”. JMK.13, 152’s
reference to “8” might not be appropriate.
18) See
Davis (1980), Cain (1982) and Deutscher (1990, p. 105).
19)
See two sets of lecture notes prepared for the New School of Social Research in
New York (11 June 1931. Keynes Papers, AV/1/40-53. “AV/1/bc” (where a, b, c stand
for numbers) is a paging system actually adopted there). He advocates raising
prices by increasing investment with lowering of the long-term rate of
interest. The first fundamental equation and a kind of multiplier theory underlie
his argument.
20) This
is cited by Samuelson (1946) as adumbrating the General Theory.
21)
See JMK.13, p. 366.
22) Keynes did
not advocate deficit financing here, nor, let it be noted, did he in any other
context throughout his entire career. See
Clarke (1997) and Bateman (2005) in criticism of Buchanan and Wagner (1977).
23) The
quotation above shows that he does not accept marginal analysis, for it is a
response to H. Schultz’s argument based on the short-period marginal cost
curve. See JMK.13, p.372.
24) Although
Patinkin (1976, p. 84) erroneously regards the letter as showing an
equilibrating mechanism, it is still within the Treatise framework.
25) Keynes Papers, Reel 33, GTE/1/23-41
(GTE/a/b. “GTE/a/b” (where a and b stand for numbers) is a paging system
actually adopted there). Pen-written, and not contained in JMK.
26)
Keynes Papers, Reel 35, GTE/5/474-499. Pencil-written, and not contained in JMK.
27) We
can ascertain from the Keynes Papers that Chapter 8 of the MTP manuscript was
initially entitled ‘Notes on the Effect of Changes in Output’. Another
manuscript with the same title survives (Keynes Papers, Reel 35, GTE/5/424-437).
Crossed out in the former is the passage: “So far we have assumed that the
quantity of output is constant. And, indeed if we did not distinguish between S
and S ′, we should have no clue to the effect on output of changes in the
Investment and Economy Factors. But the problem can be attacked starting from
the equation ΔQ = ΔI + ΔF - ΔE. Let us take the case where ΔQ becomes negative
as a result of I decreasing more than F is increasing”. The former manuscript
seems to have been written earlier than the latter.
28) Keynes expresses this with the term
“involuntary unemployment” in a note, “Historical Retrospect” (1932. JMK.13,
pp. 406-408), which is still argued in terms of the I-S difference. Here Keynes
refers to Mercantilist and protectionist policies, anti-usury laws, etc. It may
quite possibly precede the final lecture of the Michaelmas term of 1932: the
title of the note is the same as that of Chapter 7 in the table of contents of
‘The Monetary Theory of Production’ (JMK.29,
p. 49). Judging from the titles of Chapters 1 - 4, the table of contents is indubitably
related to the MTP manuscript, although this note is thought to have been
written after the table of contents.
29) See JMK.29,
p.50.
30) The MTP manuscript maintains an
idea that the price level of investment goods is determined by discounting the
prospective yields at the rate of interest.
31) There exist two sets of material related
to the MTP manuscript: (i) “Notes on the Definition of Saving”, where the TM
supply function (JMK.13, p. 279) and the possibility of a cumulative
deterioration of the economy (pp. 288-289) are argued: Keynes wrote this note
immediately before the MTP manuscript, and, by using the fundamental equation
ΔQ = ΔI + ΔF (where Q denotes profit, I the value of investment, F spending, Δ
an increment in X), developed a critique of the theory of forced saving which was
advocated by Robertson and others; (ii) the 1932 spring lectures (JMK.29,
pp. 35-48): the draft for the lecture of 2 May is in line with the MTP
manuscript.
32) See TM. 1, pp. 259-261.
33) See JMK.13, pp. 355-358 and 364
respectively.
34) On this paper in relation to the
aggregate supply function, see Marcuzzo (2002, Section 3). Kahn’s fellowship
dissertation (Kahn, 1989) was submitted to King’s College in 1929. The “short
period” was evidently based on Marshall’s idea, which Robinson (1962) admired. The
dissertation was to influence greatly Keynes’s path to the General Theory. See Kahn (1989, p. xi). It is also to be borne in
mind that Kahn had delivered his first lectures on the Short Period in the Lent
Term of 1931: on the position adopted in his lectures, see, e.g., Kahn’s
Michaelmas lectures for 1932 (Kahn Papers).
35) Aslanbeigui, N. and Oakes, G. (2002,
p.20) argue that “[Keynes] had no theoretical analysis to support his proof”.
In fact, however, he had theory (a) from the Treatise on. This is why he hesitated to adopt theory (b).
36) There
were heated discussions on the supply curve between J. Robinson, Kahn, and
Sraffa around this period, for which see Marcuzzo (2003, pp.3-4). See also
Robinson’s remark made in the summer of 1931; “Actually the supply of goods in
the short period is likely to be fairly inelastic …, but not completely so”
(1933, p.82).
37) For a theoretical rift between Kahn=Robinson and Sraffa,
see Marcuzzo (2003).
38)
Sraffa (1926, p. 543) says that “a very large number of undertakings … work
under … diminishing costs”.
39) Keynes first discussed it critically in ‘The
First Manuscript’ (1933. JMK.29, p. 66). He accepted it in ‘the Second Manuscript’
(1933. JMK.29, p. 72) as well as in the 1933
Michaelmas lectures (JMK.13, p. 420). See Hirai (1997-1999, Chapter 10).
40) By contrast, however, Keynes did not
accept Roberson’s and Hayek’s criticisms.
41) See Hirai (2004). “The Parameters of a
Monetary Economy” manuscript has been almost entirely neglected — a significant
point distinguishing our interpretation of what marked the end of the Treatise period from the others.
REFERENCES
Amadeo, E., 1989. Keynes’s Principles of Effective Demand,
Edward Elgar.
Aslanbeigui, N. and Oakes, G., 2002. “The Theory Arsenal: The Cambridge
Circus and the Origins of the Keynesian Revolution.” Journal of the History of Economic Thought, no.1.
Backhouse, R. and Bateman, W. eds. 2006. The Cambridge Companion to Keynes, Cambridge University Press.
Bateman, B. 1996. Keynes’s
Uncertain Revolution, University of Michigan Press.
Bateman, B. 2005. “Scholarship in Deficit: Buchanan and
Wagner on John Maynard Keynes.” History
of Political Economy, Summer.
Bridel,
P. 1987. Cambridge Monetary Thought, London: Macmillan,.
Buchanan, J. and
Wagner, R. 1977. Democracy in Deficit,
Academic Press.
Cain, N. 1982. “Hawtrey
and the Multiplier.” Australian Economic
History Review, 20, pp. 1-27.
Clarke, P. 1988.
The Keynesian Revolution in the Making
1924-1936, Clarendon Press.
Clarke, P. 1997.
“Keynes, Buchannan, and the Balanced Budget Doctrine” in Maloney, J. ed.
Clarke, P. 1998.
The Keynesian Revolution and its Economic
Consequences, Edward Elgar.
Davis, E.G.
1980. “The Correspondence between R.G. Hawtrey and J.M. Keynes on the Treatise.” Canadian Journal of Economics and Political Science, XIII,
pp.716-724.
Deutscher, P.
1990. R.G. Hawtrey and the Development of Macroeconomics, London:
Macmillan.
Dimand, R. 1988. The Origins of the Keynesian Revolution, Edward Elgar.
Harrod,
R. 2003. The Collected Interwar Papers and Correspondence of Roy Harrod,
Electronic
Version,
ed. Besomi, D., Cheltenham, Edward Elgar
Hawtrey,
R. 1913. Good and Bad Trade, London: Longmans,
Green and Co.
Hawtrey, R. 1919. Currency and
Credit, London: Longmans, Green and Co.
Hawtrey, R.
1928. Trade and Credit, London: Longmans, Green and Co.
Hawtrey, R. 1932. The Art of Central Banking, London: Longmans, Green and Co.
Hirai,
T. December 1997 – March 1999. “A Study of Keynes’s Economics (I) - (IV).” Sophia
Economic Review, 43(1[pp. 67-136], 2[pp.
13-121]), 44 (1[pp. 35-127], 2[pp. 29-96]).
Hirai,
T. 2004. “Keynes’s Theoretical Development from A Tract on Monetary Reform to A
Treatise on Money” read at the History of Economics Society Annual Meeting,
Toronto, June.
Hirai, T. 2004. “The
Turning Point in Keynes’s Theoretical Development,” History of Economic Ideas, XII-2, pp.29-50.
Hirai, T. 2005. “How
Did Wicksell’s Theory of Cumulative Process Influence Keynes and His
Contemporaries?” read at the History of Economics Society Annual Meeting,
Tacoma, June.
Kahn, R. 1931. “The
Relation of Home Investment to Unemployment.” Economic Journal, 41, 173-198 (in R. Kahn 1972, Selected Essays on Employment and Growth, Cambridge: Cambridge
University Press, 1-34).
Kahn, R. 1929, 1989. The Economics
of the Short Period, London: Macmillan.
Kahn’s Papers,
RFK 4/15/1-13 (Kahn’s Lecture Notes in the Michaelmas Term of 1932 taken by
Tarshis), King’s College, Cambridge.
Keynes,
J.M., Keynes Papers, Reel 27, Treatise on Money, Tm/1/2.
Keynes, J.M., Keynes Papers, Reel 27,
Treatise on Money, Tm/1/3.
Keynes,
J.M., Keynes Papers, Reel 33, GTE.
Keynes,
J.M., Keynes Papers, Reel 35, GTE.
Keynes,
J.M., Keynes Papers, Reel 41, American Visits 1931 and 1934, AV/1.
Keynes,
J.M. 1930, 1971. A Treatise on
Money I & II, London: Macmillan..
Keynes, J.M.
1936, 1973. The General Theory of Employment, Interest and Money, London:
Macmillan.
Keynes J.M. 1973a. The General
Theory and After: Part I, Preparation, London: Macmillan (JMK.13).
Keynes J.M. 1973b, The General
Theory and After: Part II, Defence and Development, London: Macmillan (JMK.14).
Keynes J.M. 1979. The General
Theory and After: A Supplement, London: Macmillan (JMK.29).
Laidler, D. 1999. Fabricating the Keynesian Revolution, Cambridge University Press.
Laidler, D. and Sandilands, R., “An Early Harvard
Memorandum on Anti-Depression Policies”, History
of Political Economy, 2002, 34/3, pp.515-552.
Leijonhufvud, A. 2006. “Keynes as a Marshallian” in
Backhouse and Bateman eds.
Maloney, J. ed. 1997.
Debt and Deficit, Edward Elgar.
Marcuzzo, M.C. 2002. “The Demise of the Quantity Theory of
Money”, History of Economic Ideas,
X/1, pp.49-62.
Marcuzzo M. C. 2002. “The Collaboration between J.M.
Keynes and R.F. Kahn from the Treatise to
the General Theory”, History of Political Economy, 34(2), pp.
421-447.
Marcuzzo M.C. 2003. “Joan Robinson and the Two Strands of
Cambridge Economists”, Prof. K. Yagi’s Workshop, Kyoto Univ., Dec.
Marcuzzo M. C. 2004. “From Market ‘Imperfections’ to
Market Failures: Some Cambridge Challengers to Laissez-Faire”, Annals of the
Society for the History of Economic Thought, 45, pp. 1-10.
Marcuzzo,
M. C. and Rosselli, A., eds., Economists
in Cambridge: A Study through Their Correspondence 1907-1946, Routledge,
2005.
Meltzer, A.
1988. Keynes’s Monetary Theory,
Cambridge University Press.
Moggridge, D. 1973.
“From the Treatise to the General Theory”, History of Political Economy, Spring.
Moggridge, D.
1992. Maynard Keynes, Routledge.
Patinkin, D.
1976. Keynes’ Monetary Thought, Durham: Duke University Press.
Patinkin, D.
1982. Anticipations of the General
Theory? And Other Essays on Keynes, University of Chicago Press.
Patinkin,
D. and Leith, J. eds. 1977. Keynes, Cambridge and the General Theory, London:
Macmillan.
Pigou, A.C., 1931. “Mr. Keynes on Money”, The Nation and Athenaeum, 24 January,
pp.544-545.
Robinson,
J., 1933. “The Theory of Money and the Analysis of Output.” Review of
Economic Studies, 1(1), pp. 22-26.
Robinson, J., 1933. The Economics of Imperfect Competition, London, Macmillan.
Robinson, J., 1962. “The General Theory after Twenty-Five Years” (in The Collected Economic Papers, Vol. III,
Basil Blackwell, 1965, pp. 100 - 102).
Skidelsky, R.
1992. John Maynard Keynes. Vol.2. The
Economists as Saviour 1920-1937, Macmillan.
Sraffa, P. 1926.
“The Laws of Returns under Competitive Conditions.” Economic Journal, 36,
pp. 535-550.
Tarshis, L.
1979. “The Aggregate Supply Function in Keynes’s General Theory.” In Boskin, M.J. ed., Essays in Honor of Tibor Scitovsky, New York: Academic Press.
Vicarelli F. (translated by Walker, J.) 1984, Keynes, Philadelphia: University of
Pennsylvania Press.
Wicksell, K. (translated by Kahn, R.) 1936.
Interest and Prices, Macmillan (original in 1898).
#
Faculty of Economics, Sophia University, Tokyo. E-mail: hirai-t@mva.biglobe.ne.jp The paper
originates in Hirai (1997-1999, Chapter 8). The author
appreciates invaluable comments by Profs. Omar Hamouda (York University,
Canada) and Mauro Boianovsky (University of Brasilia, Brazil). The earlier
version was read at the Annual Conference of the European Society for the
History of Economic Thought, University of Stirling, Scotland, in June 2005, in
which I got invaluable comments from Prof. Victoria Chick (University College
London) and Dr Geoff Tily (University College London). The author also
appreciates anonymous referees’ invaluable comments.
