Book Review: The Economics of Keynes: A New Guide to The General Theory

Mark G. Hayes, The Economics of Keynes: A New Guide to The General Theory (Cheltenham and Northampton: Edward Elgar, 2006) pp.xvi, 257, ￡25, ISBN 13:978-1-84720-082-2.


I.
Readers might feel bewildered by the unusual composition of this book: short texts and long appendices, almost equal in page length. Moreover, each appendix comprises several sections, and is cross-referenced to both text and appendix, which might entail some groping before grasping what the author intends to argue.
The book is subtitled “A New Guide to The General Theory”, and one might expect it to be an easily understandable introduction for those who have not read The General Theory. In fact this is not the case.
It might more appropriately have been called a “guide” to the author’s own interpretation of The General Theory. The author sets out to show readers what he regards as the essence of the General Theory, without referring to the various other interpretations so far made — we might mention Gordon ed. (1970), in which the then leading economists expound what they regard as the essence of The General Theory, and Leijonhufvud (1968), to take but two examples. The book also does not examine Keynes’s other writings such as A Tract on Monetary Reform (1923) and the Treatise (1930). Readers are asked to have The General Theory at hand, for in his argumentation the author only gives the page references of The General Theory, adding difficulty for those who have not read it. Again, the book finds room only for the author’s own interpretation of The General Theory and is written for those already familiar with it .


II.
Let us now look into the substance of the book. In this reviewer’s understanding, two points are presented as the essence of The General Theory: one is concerned with equilibrium analysis, and the other with expectations and liquidity.

My aim has been to show more clearly how Keynes extended Marshall’s theory of supply and demand, or competitive equilibrium, to take account of the true nature of the monetary production economy … The major corollary is that equilibrium analysis in economics can be rigorous … only in a given state of expectation, which for most purposes means only at a point in time (p.206).

It should be borne in mind that the above quotation somehow concerns four “propositions of The General Theory” (p.1): equilibrium, competition, money and expectation (the rest is liquidity).
As the reviewer takes it, in The General Theory Keynes sees the market economy as possessing two contrasting potentialities: (i) stability, certainty and simplicity; (ii) instability, uncertainty and complexity. His fundamental perception of the market economy can be summarized as follows: “The market society is stable in the sense that it can remain in ‘underemployment equilibrium’, but if it goes beyond certain constraints, it becomes unstable” (Hirai, 2008, pp.180-181). With this understanding the reviewer endorses the author’s above interpretation.

Equilibrium Analysis
The author emphasizes that “[t]he core of The General Theory must be understood as an equilibrium theory” (p.4). Here, according to him, equilibrium should: (i) be grasped in the “mechanical” sense (see pp.3 and 75); (ii) follow Marshall’s tradition (see p.175). Thus he is critical of views regarding The General Theory as a long-run theory (see pp.206 and 221).

The argument for this can be seen at least in two places.
First we have Chapter 3, “The Principle of Effective Demand” (of The General Theory), for the author regards it as “the core of the book” (p.54).

… Keynes extends Marshall’s analysis of competitive supply and demand from partial to system equilibrium, by introducing the principle of effective demand (p.60).

The author’s unique position emerges when he says that “the point of effective demand is a
short-period equilibrium position” (p.59), for “short-period” is defined as extremely brief period – as daily basis or a point in time, with which this reviewer cannot agree.

Since Keynes’s short period is his day, …, this means that aggregate demand and supply are in static equilibrium at all times (every day) (p.59).

Secondly, the author talks about “the equilibrium sub-system of The General Theory” (p.175), admitting “IS-LM model” interpretation:

… section I of G..T.’s Chapter 18 describes a set of simultaneous equations …. Although
Hick’s claim to have Keynes’s blessing for IS-LM is controversial, Keynes undoubtedly
assented to the interpretation (p.175).

“Sub-system” here means that the three independent variables (the propensity to consume, the state of long-term expectation and the preference for liquidity) go “beyond the reach of equilibrium analysis”. They are closely related to expectation and uncertainty (another feature of The General Theory). This is why he describes Ch.18, “The General Theory of Employment Re-Stated”, “as a short-term equilibrium model nested within a larger open system, in which comparisons of different positions of static equilibrium of the model can be made, but which cannot itself be modelled in equilibrium terms” (p.176. Underlines are mine).

Throughout the book Keynes is described as the economist who extended Marshallian theory (e.g. pp.70-72 and 84). No reference is made to the fact that Keynes criticized the classical dichotomy and Say’s law as advocated by Marshall, as well as both Marshall’s theory of interest and his quantity theory — which is why, regarding Marshall as a classical economist, he put forward a theory of underemployment equilibrium. The author’s argument on the relationship between the two does not deal with this point.

Expectations and Liquidity
Let us turn to another point focused upon by the author: expectations and liquidity (the fourth and fifth propositions of The General Theory). Although the author develops a variety of arguments in this respect, we will confine our attention to the main point for lack of space.
In Ch.4 (of this book) the author explains, as features of The General Theory, “Keynes’s three macroeconomic functions” (the propensity to consume, the schedules of liquidity preference and marginal efficiency of capital) and “his system of classification” (consumption goods and a larger compartment composed of money, bonds and capital assets), arguing that “the common foundation … [of them] is our uncertainty about the future” (p.140. See also p.144).
Here the author places particular stress on Ch.17, “The Essential Properties of Interest and Money”, in which, he remarks, a broader definition of liquidity preference (“Liquidity means more than convertibility and includes the degree to which the value of an asset…, is independent of changes in the state of long-term expectation” [p.151]) and the above two schedules (see p.143) are argued.
The author emphasizes, above all, the rate of interest in this respect.

… the rate of interest has a life of its own, based on our well-founded distrust of forecasts of the long-term future and on the security offered by money, as the store of value least affected by changes in such forecasts (p.154).

The reviewer agrees that Ch.17 is very important in understanding The General Theory. However, it occupies a unique position, for the argument there is developed in stock terms [of all the assets], and “the price of each asset is held under perfect competition at the equilibrium point where the net advantage … from holding any asset is the same” (p.140), while in the rest of The General Theory the argument is developed in flow terms (of income, saving and investment). There is no guarantee that the stock equilibrium, in which, thanks to its liquidity, money rules the roost and under-employment equilibrium occurs, should be compatible with the flow equilibrium, at which the level of employment is determined (as argued in Ch.3 or Ch.18). The two cannot be compatible, for the period in the case of stock equilibrium is long (capital assets are changeable) while in the case of flow equilibrium it is short (capital assets are assumed to be fixed) – a point not considered in this book.

III.
The author declares in the Epilogue that “The purpose of this book has been to set forth a perspective on The General Theory which resolves many puzzles and paradoxes that have been found in it by other writers over 70 years” (p.221).
This is indeed an extremely difficult task. Readers who have never read The General Theory are in no position to evaluate this book in relation to it, while the readers who have read and studied it, like the present reviewer, will find themselves agreeing in some places, and disagreeing in others. After all, eventually all the readers have to address The General Theory as it is, and come to their own evaluations of it.
As the author says in his Preface, “this book will draw some fire, although I trust also some support, from [both the Classical and the Post Keynesian Schools)” (p.xi).


References

Clower, R., 1965. The Keynesian counterrevolution: a theoretical appraisal. In F. Hahn and F. Bechling ed. The theory of interest rates. London: Macmillan, pp.103-25.
Gordon, J. ed., Milton Friedman’s monetary framework. Chicago: University of Chicago Press, 1970.
Hirai, T., 2008. Keynes’s theoretical development – from the Tract to the General Theory. London and New York: Routledge.
Leijonhufvud, A., 1968. On Keynesian economics and the economics of Keynes. Oxford: Oxford University Press.

(Journal of the History of Economic Thoughtより）