The
Turning Point in Keynes’s Theoretical Development
From A Treatise on Money to the General Theory
Toshiaki
Hirai*
Faculty of Economics, Sophia University ,
Tokyo , Japan
Our findings indicate that Keynes reached a turning point
towards the end of 1932, meaning by this not his establishment of the theory
determining the level of employment (or output), but his construction of a new
model which we refer to as ‘Model 1’ below. The crucial evidence comes from two
sources: the manuscript entitled «The Parameters
of a Monetary Economy», and Keynes’s 1932
Michaelmas lectures.
We also show that the Cambridge Circus, with Kahn as the central figure,
greatly contributed to prompt Keynes’s to reconstruct his theory along new
lines after a period of contrast with the Circus.
1.
Introduction
How did Keynes
proceed from A Treatise on Money
(hereafter the Treatise) to the General Theory? What was it that enabled
him to change from the world of the former to that of the latter, and where
exactly is the change to be located? These
questions are crucial in understanding the Keynesian Revolution, and many
interpretations have consequently been put forward. In our view, however, they lack
the groundwork of thorough investigation. The present paper seeks to answer
these questions convincingly with a new interpretation.
Naturally, our investigation is made in relation to how we understand
both the Treatise and the General Theory. Section 2 will outline
our understanding of the two books. Then, in Sections 3 and 4 – forming the
focal point of our paper – we go on to examine, respectively, «The
Parameters of a Monetary Economy» and
Keynes’s lectures. In Section 5 we discuss the contribution made by Kahn to
Keynes’s turning point.
2. The Relation between the Treatise,
the Wicksell Connection,
and the GeneralTheory
The most significant feature of the Treatise theory should be the
coexistence of a Wicksellian theory and ‘Keynes’s own theory’.
We
designate the monetary economic tradition, stemming from Wicksell and developed
by various economists, as the ‘Wicksell Connection’. Wicksell approved of the
separation of the theory of relative prices from that of money prices in
neo-classical economics, putting forward the theory of cumulative process,
while Myrdal, Lindahl, Hayek, Mises and so forth endeavored to construct their
own brands of monetary economics, criticizing the neoclassical system per se.
The Treatise belongs to this stream of thought
in explaining the fluctuations of the economy in terms of the natural and money
rates of interest, and accepting Wicksell’s three conditions of monetary
equilibrium.
At the same
time, however, Keynes develops his own theory, which consists of two parts, one
of which addresses the determination of variables relating to consumption goods
and investment goods in ‘each period’ (Mechanisms 1 and 2, respectively).
(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 proceeds of consumption goods, and the
price level and the profit amount are simultaneously determined.
(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 or as
the demand price of capital goods. As a result, profit is determined.
The other part
deals with the determination of variables between one period and the next.
(Mechanism 3)
The TM supply function
The
behavior of entrepreneurs is such that, if they make a profit (loss) in the current period, they
expand (contract) output in the next.
We will
refer to this behavioral function as the TM supply function in that it is
peculiar to the Treatise on Money.
Now,
‘Keynes’s own theory’ can be expressed as the dynamic process consisting of
Mechanisms 1 and 2 working through Mechanism 3.2 As a result of this process, 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.
2.2.
After the Treatise
We further argue that
Keynes’s own theory is crucial to an understanding of his theoretical
development, while the Wicksellian theory is abandoned after the Treatise. He defended his dynamic
theory against attacks from Hawtrey, Robertson, Hayek, the «Cambridge Circus» (to
be explained later) and others. The noteworthy feature of the period ending
around October 1932 is the stress he places on the TM supply function,3 which suggests that a lead may be found
by examining his attitude towards this function.
We might
even say that Keynes’s abandonment of the function shook the foundations of his
theory up to mid-1932, and the main components of the General Theory were built as a consequence. Of course, the
Keynesian Revolution did not simply come about through abandonment of the Treatise’s output mechanism. Its core
lies in the formulation of a theory determining the level of employment,
although it was abandonment of the mechanism that opened the way to it.
2.3. The General Theory4
The striking feature of the General Theory is that Keynes sees the market economy as possessing
two contrasting ranges of potentialities: stability, certainty, and simplicity
vs. instability, uncertainty, and complexity. We might summarize his
fundamental perception as follows:
The market economy is
stable in the sense that it can remain in ‘underemployment equilibrium’, but
this stability is guaranteed only subject to certain constraints. If it goes
beyond these, the economy becomes unstable and falls into chaos.
Although we
should not overlook the second aspect, what most mattered to Keynes was
maintenance of full employment. He seems sure that the prospect of the economy
being undermined through the collapse of the second aspect is remote, and an
economy in underemployment equilibrium could be cured by means of economic
policy.5
Keynes puts
forward his theory of underemployment equilibrium as a matter of monetary
economics, as distinct from real economics. His fundamental idea is succinctly
expressed in Section I of Chapter 21. He presents two ways of dividing up
economics. One is a division «between the theory of the individual industry or firm and of the rewards
and the distribution between different uses of a given quantity of resources on
the one hand, and the theory of output and employment as a whole on the other
hand» (The General Theory [hereafter GT], 293). The other is a division «between
the theory of stationary equilibrium and the theory of shifting equilibrium» (GT, 293). In both cases, the criterion of division hinges on whether we need pay
attention to money. Keynes insists that when we are dealing with determination
of the level of output and employment as a whole, we cannot proceed without
taking into consideration the significant role of money.
Keynes argues that monetary economics remains «a
theory of value and distribution, not a separate theory of money» (GT, 294). That is, monetary economics should be a theory in which value and
distribution are treated as inseparable from money.
He rejects two classical theories ― the classical theory of the
rate of interest and the quantity theory of money. In their place, he puts
forward, respectively, the theory of liquidity preference and the theory that
the effect of changes in the quantity of money on the general price level
should consist of the effect on the wage-unit and that on the volume of
employment.
With his rejection of the
classical theory of labor, moreover, he advances the theory that the volume of
employment is determined by effective demand.
It is in Section II of Chapter 3
and Section II of Chapter 18 that the ‘General Theory’ - the theory of the determination
of the volume of employment (or income) - is most succinctly stated.6 In the former place Keynes summarizes
the theory in terms of how an equilibrium volume of employment is determined,
while in the latter he summarizes it in terms of how a new equilibrium level of
income is obtained after some change in the level of investment.
The following statements are
extracted from Section II of Chapter 3:
The
amount of current investment will depend...on what we shall call the inducement
to invest; and the inducement to invest will be found to depend on the relation
between the schedule of the marginal efficiency of capital and the complex of
rates of interest on loans of various maturities and risks.
Thus, given the propensity to consume and the
rate of new investment, there will be only one level of employment consistent
with equilibrium ... Hence the volume of employment in equilibrium depends
on...the aggregate supply function...the propensity to consume...and...the
volume of investment.... This is the essence of the General Theory of
Employment.
(GT, 27-29)
In Section II of Chapter 18,
having explained his theory of investment, Keynes states that
...an
increase (or decrease) in the rate of investment will have to carry with it an
increase (or decrease) in the rate of consumption... The relation between the
increment of consumption which has to accompany a given by the marginal propensity
to consume. The ratio, thus determined, between an increment of investment and
the corresponding increment of aggregate income, both measured in wage-units,
is given by the investment multiplier.
Finally, if we assume...that the employment
multiplier is equal to the investment multiplier, we can, by applying the
multiplier to the increment (or decrement) in the rate of investment brought
about by the factors first described, infer the increment of employment.
(GT, 248)
3. «The
Parameters of a Monetary Economy»
In this section we examine the manuscript entitled «The
Parameters of a Monetary Economy» (hereafter PME. JMK.13, 397-405 [JMK.y means The Collected Writings of John Maynard Keynes, Vol.y. See
References]). We begin by discussing three ideas introduced for
the first time, which signpost the ‘turning point’ toward the General Theory. We then point out that
PME is, nevertheless, still incomplete on several points.
3.1.
Progressive Ideas
The Concept of «Complex» – In PME Keynes
rejects the concept of «index» and instead utilizes that of «complex». In the
case of assets, for example, this results in a vector of prices instead of an
index of the prices of individual assets. The latter is different from the
former, as it is obtained, on the basis of the prices of individual assets,
through some formula representing the price level as a whole. Methodologically,
the concept of «complex» represents the starting point on the road to the General Theory.7
The
reader should note that we are here interpreting P2, not as the average price of assets..., but as the
complex of prices of assets. For, since the supply schedules of different
industries will not be the same, the same average price may lead to a different
volume of investment if it is differently made up.
(JMK.13, 399)8
When
reading this, we should recall his great expertise on the index problem,
typically shown in «The Method of Index Numbers» (1909; Keynes, 1983, Chapter
2) and Book II of the Treatise, and
the fact that the General Theory adopts
«two fundamental units of quantity» (GT,
41).
A New
Formula for a System of Commodity Markets – Of the three ideas introduced in PME, a new model
for a system of commodity markets is the most important, marking a breakthrough
that would lead to the General Theory.
In this model, Keynes adopts an idea similar, in certain respects, to the
multiplier theory and formulates a supply schedule as a function of a complex
of prices.
The model is described by:
P2 = B (ρ) (1)
I΄= C (P２) (2)
I = P2 × I΄ (3)
P１= G (I,
H) (4)
R = H (P１) (5)
Where ρ denotes the complex of interest rates, P1 and P2 the price complex of consumables and that of capital assets, B the
complex of expected quasi-rents, I΄ the current volume of investment, H and C
the supply schedule of investment goods and that of consumables, I the value of
investment, G the general state of time preference, and R the output of
consumables.
The model
runs as follows. Given the complex of interest rates, the price complex of
capital assets is determined by equation (1). Once we have this, the volume of
investment is determined by equation (2). The value of investment is determined
by equation (3). From this and equation (5), the price complex of consumables
and the output of consumables are determined by equation (4).
Let us
examine each equation in turn. Equation (1) is a theory determining the
price level of capital assets by their prospective yields and the rate of
interest. The price complex of the total stock of assets is assumed to regulate
that of currently produced assets.9
In fact,
equation (1) is virtually the «demand price of the investment» of the General Theory (GT, 137). The time series of quasi-rents which a capital asset is
expected to yield («prospective yield» in the General Theory) is compared with the «present value of a debt
which would have an interest yield year by year» (JMK.13, 398).
In
addition, the mechanism determining the rate of interest and the method of
valuing assets are clearly distinguished. In this connection, Keynes refers to «the
failure of the attempt to avoid [the] circularity which makes Marshall
Keynes
defines two supply schedules as functions of the price complex.11 Although PME provides no evidence of
what they look like, we can infer from the lecture given on 21 November 1932
that they are the same as the «first postulate of the classical economics» in
the General Theory. In these
schedules, the volumes of output in both sectors depend on the prices in the
current period. This is his first attempt to use the first postulate, although
up to ‘the Second Manuscript of 1933’ (JMK.29,
63, 66-73, 87-92, 95-102) he hesitates to use it.12
Equation
(4) deals with consumption:
When we
... deduce from the general state of time preference,..., what part of the
community’s aggregate income will be spent and what part will be reserved, we
are soon in difficulties. For the amount of total expenditure responds
immediately to the amount of total income, whilst, for the community as a
whole, the amount of total income depends ... directly and immediately on the
amount of total expenditure. We ...must approach our goal...by a different
route.
(JMK.13, 400)
Interestingly, Keynes appears to reject an idea which later leads to the
consumption function. The «different route» adopted here is a theory to the
effect that the price level of consumables is determined where investment
becomes equal to saving:
...since
the amount of money reserved by the public out of their incomes must always be
exactly equal to the amount of current investment, the level of prices...has to
rise to a point at which the amount of money which the public desire to reserve
[saving], having regard to the general
state of time preference, is equal to
the amount of current investment.
(JMK.13, 401)
Or
P１= G (I) (4)΄
Equation
(4) is an improved version of equation (4)΄:
Hence we
must bring in the supply schedule … of consumables, namely R= H (P１) ..., and re-write our equation for P１ as P１= G (I, H).
(JMK.13, 403)
Thus, with
the supply schedule taken into consideration, the price level (and output) of
consumables is determined in such a way that investment becomes equal to
saving. This equality13 is crucial, for it means a shift from a theory of
investment-saving deviation to that of investment-saving equilibrium, which
gave him a chance to change his model building.14
In order to
complete the model, Keynes puts forward the equation for the complex of
interest rates:
ρ = A (M) (6)
where A denotes the state of liquidity preference
and M the quantity of money.
The
public have no power to determine the available aggregate of liquid funds of
money. ...the rate of interest has to move until the amount of money which the
public desire to hold, having regard to their liquidity preferences, is equal
to the amount of money which the banking system is creating.
(JMK.13,
400-401)
Keynes
argues that liquidity preference determines the rate of interest, a concept
that makes its first appearance here apart from the seminal elements contained
in «The Monetary Theory of Production» (JMK.13,
381-396; hereafter MTP). Expressions such as «a debt which would have an
interest» (JMK.13, 398), and «the
price of debts (i.e. the rate of interest) » (JMK.13, 405), indicate that he conceives of money and debts on
equal terms (in the Treatise money
was compared with assets and debts together). Notwithstanding the difference in
the commodity market mechanism, however, both MTP and PME share the view that
the role of the rate of interest is confined to determination of the price
complex of capital assets (and investment goods).
The system
(1)-(6), which we call ‘Model 1’, has six endogenous variables, so that it can
be solved. Equation (4) is the most important, for equilibrium of investment
and saving is used to determine the price complex of consumables in the current
period. We should also pay attention to the mechanism by which the values of
investment and consumption are determined. This works in such a way that their
prices and volumes of output are determined simultaneously, the TM supply
functions being dispensed with. The following passage dealing with consumption
should be read with this in mind:
The
simplest condition for stable equilibrium is that when aggregate income
changes, the change in aggregate expenditure should be the same in direction
but smaller in absolute amount.15
(JMK.13,
401)
«Aggregate
expenditure» refers to consumption expenditure, while «condition» connotes a
stability condition for P1 and can be understood as a
version of the だ«fundamental
psychological law» ― the first appearance of this idea, though here it relates to the
stability of P1.
To sum up,
Model 1 contributes to the General Theory
on the following points:
(1) the supply schedule based on
the first postulate;
(2) the equality of investment and
saving;
(3) the value of investment, the
general state of time preference, and the supply schedule of consumables, as
factors determining the mechanism of the consumption goods sector;
(4) the theory of liquidity preference.
Point (3) is similar to the multiplier
theory of the General Theory in which,
given the value of investment, the prices and quantities of consumables are
determined by the propensity to consume and the supply schedule of consumables.16
The Variables in a System of Simultaneous
Equations and Their Causal Relations – In PME Keynes consciously builds his
theory as a system of simultaneous equations. In this connection, the following
is very instructive, for he attaches importance to the causal relations as
well:
These
parameters ...are not entirely independent of one another and the schedules
expressing them should be stated...in the form of simultaneous equations. But
for purposes of analysis they are as distinct from one another as economic
factors ever are. Incidentally they yield between them the price complexes of
the three classes of purchasable things, ... and...there is significance in the
statements that, given the quantity of money, the price of debts... is
primarily determined by the state of liquidity preference; that, given the rate
of interest, the price of assets is primarily determined by the expectation of
quasi-rent; and that, given the price of assets, the price of consumables is
primarily determined by the state of time preference.
(JMK.13, 405)
It is
crucial to grasp Keynes’s conception of the causal relations, for it reveals
his position concerning the relation between his model and the real world, and
illuminates his policy outlook.
He stresses
the ability of the monetary authority to adjust the rate of interest in such a
way that the economy can attain an optimum level of output. Here we approached our
discussion starting from the commodity markets, but it is our contention that
the money market plays a crucial role in PME. The following is from «9 The
Parameters of a Monetary Economy» ― the same approach runs through the General
Theory:
Let us
imagine that we have been asked to explain what consequences will result to
prices, output and incomes if the monetary authority decides to increase the
quantity of money by a given amount. In what way will it be most instructive
for us to give our explanations? For to lay down the general principles on
which questions of this kind can be answered is the object of the monetary theory
of production.
(JMK.13, 396-397)
Considering
PME in terms of the part it plays in Keynes’s development, we may evaluate it
as follows. Keynes here abandons construction of a dynamic model making use of
the TM supply function, introducing in consequence the theory of
investment-saving equilibrium (as determining the price level of consumables).
Moreover, Model 1 offers a key to understanding the General Theory, the roles of prices and the ‘supply side’ being
more explicitly expressed here.
It should
be noted that PME has so far been either ignored or at any rate undervalued. For
example, Patinkin (1982, 21-23), who makes no reference to PME in Patinkin
(1976; 1993), regards PME as being largely in the Treatise mold. In Amadeo (1989), Hession (1984, Chapter 12), and Moggridge (1992, Chapter
21), PME finds no mention.
Even the scholars who stress the importance of PME such as Vicarelli (1984),
Hishiyama (1993), Kojima (1997) and Okada (1997), seem to fall short of grasping
its true significance. Asano (1987), having detected certain progressive elements in PME,
argues that Keynes still adheres to the Treatise
theory.
3.2. The
Incompleteness
For the above reasons we attach great importance to
PME as the turning point, but this is not to say that it is theoretically
consistent. In fact, three incomplete points can be picked out.
First,
notwithstanding the presentation of Model 1, Keynes still clings to the TM
supply function:
In the
foregoing we have assumed that the supply schedules of assets and consumables
are dependent on the prices of the articles produced. This would be reasonable
for a single industry... But it is not reasonable for industry as a whole,
...it is more nearly accurate to think of the supply schedule as relating
output to profit.
(JMK.13,
403)
He then
puts forward a model with equations (2) and (5) as
replaced by (2)΄ and (5)΄ respectively:
P2 = B (ρ)
(1)
I΄ = C΄ (Q2) (2)΄
I = P2×I΄
(3)
P1 = G (I, H΄) (4)΄
R = H΄ (Q1) (5)΄
ρ = A (M) (6)
where Q1 denotes
profit of the consumption goods industry, Q2 profit of the capital goods industry, C΄ and H΄ a supply function defined
as a function of profit in the capital goods industry and the consumption goods
industry respectively.
This
system, which we call ‘Model 2’, is virtually the same as the model in «9 The
Parameters of a Monetary Economy» (JMK.13,
396-397).
As far as the rate of interest and
the price complex of capital assets are concerned, Model 2 is the same as Model
1. The profit per unit of output in the capital goods industry, q2, is determined as the difference between the price
complex of capital assets P2 and their cost w, which is
assumed to be constant. Then, I΄ is determined by equation (2)΄ and Q2= q2×I΄. Taking Q1= q1×R,
where q1 denotes
the profit per unit of output in the consumption goods industry, into
consideration, equation (5)΄ can be taken as exhibiting the relation of q１to R. Let us express this as R = h (q1).
Together with P1= q1 + w and
R = h (q1), equation (4)΄ determines q1, P1, and R.
The problem
with Model 2 lies in equations (2)΄ and (5)΄. They are not the TM supply
functions, although Keynes takes them to be so. It should be noted that even in
Model 2 profit plays no dynamic role, and the volumes of output are determined
in the current period.
Second,
Keynes advances the theory that, given the rate of interest, the prices of
capital assets are determined by expected quasi-rents, which means that the
marginal efficiency of capital has yet to appear.
Third,
Model 1 does not provide an argument in terms of macro-variables such as the
aggregate supply and demand functions in Chapter 3 of the General Theory. It was not until 1933 that he developed such an
argument.17
We might be
tempted to regard PME as still belonging to the Treatise world in consideration of the fact that (i) Keynes still
clings to the TM supply function, and (ii) both Models 1 and 2 deal with the
price levels only, and (iii) the liquidity preference theory is not the same as
that in the General Theory.
However, to
regard PME in this way would be to overlook its importance. In either Model
both the price levels and the volumes of output are determined in the current
period in which profit plays no role. Among other things, we should note that
in Model 1 the price level of the consumables is determined in such a way that investment
becomes equal to saving.
4. 1932
Michaelmas Lectures
Further
important material indicating the turning point is to be found in the 1932
Michaelmas lectures, for which we have notes taken by Bryce, Cairncross and
Tarshis18, as well as the lecture drafts for 10
October and 14 November (JMK.13,
50-57).
Before
examining the lectures, let us briefly see how the 1932 lectures have been
dealt with so far. Clarke (1988; 1998, 93 and 95) sees the inception of the General Theory arriving at the end of
1932. In Clarke (1988; 1998, 96-97), however, reference goes up to the third
lecture of 1932, while Clarke (1988; 1998, Chapter 4) pays no attention to
Model 1 in the seventh lecture. Skidelsky (1992, 459-466) deals with the
lectures as showing «the embryo of the General
Theory» or «the main building blocks of a theory of output». Although he
does not refer to Model 2, and Model 1 cannot be taken as a theory of effective
demand, Skidelsky’s evaluation is close to ours.
On the
other hand, Milgate (1983, 195),
who does not mention Model 1, regards the 1932 lectures as
orthodox marginalist thought. Patinkin (Patinkin and Leith (eds) 1978, 14) and
Dimand (1988) maintain that the 1932 lectures are within the Treatise framework. Dimand (1988, 153-5),
without distinguishing Model 1 from Model 2, judges that «windfall profits or
losses, investment minus saving, are at the centre of the analysis of the
Michaelmas 1932 lectures ..., just as in the Treatise».
Bearing MTP and PME in mind, let us examine the lectures.
In the
first lecture Keynes argues that in the monetary theory of production the
real-world economy is treated in terms of the monetary economy, whereas
economic theory up to this point had analyzed only a «neutral money» economy.
He puts forward an employment theory, albeit not very clearly. He argues that,
in the monetary economy, «the short-period supply price of labour is nearer
horizontal» (JMK.29, 51), and
proceeds to consider the case in which the short-period disturbance occurs due
to «a change in demand as a whole relatively to supply as a whole due to
deficient disbursement» (JMK.29, 53).
These ideas might be said to be the origins of Chapter 2 of the General Theory. Keynes aims at analyzing
the situation in which deficient disbursement induces entrepreneurs’ losses and
a decrease in employment. Thus he endeavors to formulate the chain of causation
which deficient disbursement induces in the monetary economy, and to part with
the neutral economy theories.
In the
second and third lectures Keynes develops an argument to the effect that total income is equal to aggregate disbursement,
presenting an equation:
Total
Income = E + Q = Aggregate Disbursement
where E is earnings and Q windfall profits.
Incomes of
individuals continue to change until total income equals aggregate
disbursement, and entrepreneurs continue to revise the scale of their
production unless Q is zero. Thus equilibrium is attained where Q becomes equal
to zero. Keynes then analyses the causal sequence induced by insufficient
disbursement.
The idea that
changes in output depend on changes in the difference between disbursement and
earnings is similar to the TM supply function in MTP19, suggesting that the lectures at this
stage were influenced by it.
From the
equation showing that aggregate disbursement is composed of the amount of
investment, I, and the expenditure on consumables, F, and the above equation,
the following is derived:
Q = I - S
where S (= E - F) is
voluntary saving.
This is
followed by some extremely interesting discussion regarding voluntary saving
which concludes that
whatever
spending the public and entrepreneurs adopt, the amount of surplus remains
always the same and equals the amount of investment. What will be changed will
be the price of consumables. If we hold I as given, what S determines is the
price level [of consumables]. Or increased saving permits [the] same investment
at a lower price level [of consumables].
(Rymes [Tarshis] 1988, I-13 [This means Mr X’s
– here Tarshis’s – notes transcribed by Rymes.])
Given the
value of investment, the price level of consumables is determined by the amount
of voluntary saving. This argument is used in the equation P1= G (I, H), and possibly opened the way to the «time preference» in the
seventh lecture. Although some ambiguities exist in relation to investment,
saving, and profit, Keynes seems to be thinking of both the short and the long
periods.20
The fourth
lecture deals with the theory of liquidity preference, the fifth lecture with
the theory of investment. It should be noted that Keynes discusses both topics in
the context of MTP theory.
Keynes
develops his own theory as follows. «The rate of interest measures the return
in terms of money which can be returned in exchange for parting with the
control of that money for a stated time for a debt....[The rate of interest is]
the rate of exchange between money and debts» (Rymes [Tarshis], 1988, I-15). He
argues that the rate of interest is no more than an expression of liquidity
preference. Furthermore, the «rate of interest is fixed with the policies of
the bank and the preferences of the people for keeping control of their money»
(Rymes [Bryce] 1988, A-28). Given M as the amount of money, A the state of
liquidity preference and ρ the rate of interest, then the following holds good:
ρ = A
(M)
This
equation generally has a negative slope.21 He touches on both the concept
later called the «liquidity trap»22
and the possibility of a flight from the currency.
At this
point Keynes completed the shift from the theory of bearishness to that of
liquidity preference. A fragment from the lecture draft for the sixth lecture
states:
The rate
of earnings will fall, and output will fall.... Consequently the demand for
money in the active circulation will fall, which in turn will affect the state
of liquidity preference so that there will be a lowering...of the rate of
interest corresponding to the given quantity of money.
(JMK.29, 56)
In the
fifth lecture Keynes first argues that the value of capital assets is the
present value obtained by discounting the stream of expected quasi-rents at the
current rate of interest. He takes the price of capital goods in stock to regulate
the price of new capital goods, which is the standpoint Keynes had adopted
since the Treatise. He then argues
that investment takes place if the price of an asset exceeds its current cost
of production, so that «the volume of investment is determined by [the streams
of] prospective quasi-rents, ... [the] rate of interest and [the] cost of
production» (Rymes [Bryce] 1988, A-32). This idea is not to be found in the Treatise.
In the
sixth and seventh lectures Keynes proposes the «astronomical structure» and the
«mechanical structure» models.
The astronomical structure has two versions, depending on an assumption
concerning the supply function. The first version is the same as Model 1, while
the second is based upon the idea that a supply function should be expressed as
a function of profits, and is the same as Model 2 except for an «earnings
reaction» function.
However, we
find the second version unsatisfactory: firstly, it follows from the fact that
(voluntary) saving is supposed to be in equilibrium with investment in the
equation P1= G (I, H) that Q1 and Q2 are zero; secondly, it is
not clear how I΄, P1 and R are determined in this model; and thirdly, it
is not clear what roles the supply functions play.
Keynes first
proposes Model 1, and then Model 2, apparently preferring the latter to the
former.
Finally, he
refers to the «mechanical structure», which is expressed as follows:
ΔQ =ΔI -
ΔS = ΔD - ΔE
When
disbursement, D, increases faster than earnings, E, first profits increase, and
then output. That is, whether output increases or not depends upon whether
investment increases faster than saving. In this structure something like the
TM supply function plays a central role, so that the amount of investment does
not necessarily equal the amount of saving.
We should
also note that in the lecture draft for 14 November, Keynes discusses the trade
cycle and underemployment equilibrium within the MTP framework.
What emerges
here is that Keynes is wavering between the world of the Treatise, to which Model 2 (at least superficially) and the «mechanical
structure» belong, and that of the General
Theory, to which Model 1 belongs.
However,
Keynes’s state of mind is one thing, his true state of development another.
First, the supply function in Model 2 is not the TM supply function any longer.
Second, Model 1 includes new ideas contributing towards the General Theory, and should therefore be
taken more seriously. If we see that Model 2 fails to fulfill its intended
role, we can then say that his economic theorizing goes through transition at
this point, which is why we regard both PME and the 1932 lectures as the turning point.
In his
final lecture, Keynes considers the views of earlier economists which might
support his theory. This naturally leads to Chapter 23 of the General Theory.23
He also outlines
an embryonic argument which leads to Chapters 19 and 21 of the General Theory, as Tarshis’s note shows.
labour is
essentially the standard of value — the level of wages determines prices ---
explanat[ion] of prices was to be found in
effective demand — raising incomes raising prices, etc.
(Rymes
[Tarshis] 1988, I-28)
The term «effective
demand» makes its first appearance, and is argued in relation to Malthus, who
also makes his first appearance in Cairncross’ note (Rymes 1988, D22) as well
as Bryce’s (Rymes 1988, A51).24
Keynes
concludes the lectures with a statement of the argument, along the lines of the
«mechanical structure», to the effect that the normal tendency is for saving to
far exceed investment, so that loss of profits and unemployment ensue.
As we have
seen, in the light of the above points we find Keynes wavering between the
world of the Treatise and that of the General Theory.
Here the two ideas ― the idea of the TM supply function maintained since the Treatise, and the idea which leads to
the General Theory ― are developed in a confusing
way. We can safely say that he first wrote MTP, then delivered his lectures on
the basis of it, and finally wrote PME at the later stages. Keynes sticks to
the TM supply function to the last, notwithstanding the inconsistency of Model
2. We would stress, however, that what matters most is the appearance of Model
1.
5.
Kahn’s Contribution
Given the results of the above examination we
cannot help wondering why Keynes set out to change the way of constructing his
economic model at this particular time. What was it in particular that drove
him to do so, and who was behind it?
Hard as it
may be to answer this question exactly, the contribution made by the Cambridge
Circus merits some consideration.25
Immediately after
the publication of the Treatise, several economists, including Kahn,
Sraffa, Meade, and Austin and Joan Robinsons, 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»26,
to which Keynes replied.
The controversy
between the two can be summed up as follows. Keynes put forward the credit cycle theory by way of
the TM supply function, while the Circus put forward the multiplier theory,
including the method of supply and demand, based on Kahn (1931), criticizing
the TM supply function.
The Circus position is very clear in Joan
Robinson’s letter to Keynes in May 1932 (JMK.29,
47). It 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.
The point of contention is unmistakably the
supply function.
By the
end of 1932, however, he was 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. This transformation can be clearly seen in PME
and the 1932 Michaelmas lectures, which is why we believe that at this point it
is worth turning our attention to Kahn (1972[1931], 1-27]), a central figure in the Circus. Although the article dates from 1930, we
discuss it here because Keynes did not incorporate the idea into his own theory
until 1933.
Kahn looked
back on those days in 1971:
...I
circulated a very early version to the members of the Committee of Economists
... in September 1930. This version was revised and considerably expanded as a
result of discussions with Colin Clark..., and with James Meade and others in Cambridge
(Kahn 1972, vii)
As for Kahn’s
influences, we would suggest two points in particular.
The first
is that the standard supply-demand analysis is developed.27 The following idea which Keynes
adopted when he accepted the first postulate in
mid-193328, should be read with the Cambridge Circus29 criticisms
of the Treatise theory in mind:
The price-level
and output of home-produced consumption-goods, just like the price and output
of any single commodity, are determined by the conditions of supply and demand.
If the conditions of supply can be regarded as fixed, both the price-level and
the output are determined by the demand; and there is a unique correlation
between price-level and output....The volume of employment engaged in producing
consumption-goods and the price-level of home-produced consumption-goods are
uniquely correlated.
(Kahn,
1972, 5-6)
The second
point is that the multiplier theory is developed as a concrete formula.30 The original idea of the multiplier goes
back to Lloyd George’s pledge of April 1924. The concept was subsequently
developed through a series of studies within the Liberal Party, Keynes playing
a central role.31
In «Can Lloyd George Do It? » (Keynes and Henderson, May 1929; JMK.9, 86-125), it is argued that the
promotion of a national development policy can increase the number employed,
not only directly but also indirectly, and that this brings about a cumulative effect
on production activity, the expenses involved being much lower than might be
expected. In their argument they criticize the «Treasury View»32:
Kahn (1931)
gives substance to this idea by fleshing out how much employment will be
brought about by an increase in employment in the investment goods sector,
given constant money wages, profit, and prices. In the memorandum dated 21
September 1930 (JMK.13, 178-200),
with the help of the multiplier theory Keynes advocates government home
investment schemes:
Mr Kahn
has produced an argument, which seems to me convincing, for supposing that in
present conditions in Great
Britain
(JMK.13, 188)
Again, he
uses the multiplier theory as an indicator assessing the excess of saving over
investment within the Treatise framework;
we may
assess the existing excess of saving over investment at £187,500,000 per annum.
This follows from taking our abnormal unemployment at 1,500,000 and the output
corresponding to the employment of a man for a year at £250.
(JMK.13, 188. The multiplier is 2)
In the
Draft Report dated 6 October 1930 (JMK.20,
437-443), Keynes explained the multiplier theory as follows:
Apart from
the primary employment..., there is...a further source of secondary employment,
... For the newly employed men and others whose receipts are increased as a
result of the new investment may spend these receipts...on increasing their own
consumption, with the effect of increasing employment in industries producing
consumption goods; and those engaged in these consumption industries will also
have more to spend; and so the ripple of increased demand will spread over the
whole pool of employment.
(JMK.20, 439)
It was not
until 1933, however, that Keynes placed the multiplier theory at the center of
his theoretical system. This is shown by the following facts:
(1) In the
seventh of the 1933 Michaelmas lectures he argues for the multiplier theory;
To sum up, the method of supply and demand and the multiplier theory
advocated in Kahn’s paper was eventually to be adopted by Keynes. By the end of
1932 his adoption of the former is evident in PME and the 1932 Michaelmas
lectures, although he still sticks to the TM supply function. As far as the
multiplier theory is concerned, it was in 1933 that Keynes incorporated it into
his theory.
6.
Conclusion
Our considerations show that PME and the 1932
Michaelmas lectures occupy a crucial place in Keynes’s theoretical development.
Model 1, above all, is decisive. Although he still clings to the TM supply
function idea, PME nevertheless marks a turning point.
Why did
Keynes change his way of constructing his economic model at this particular
time? Even before this, he had tried to build a model explaining how the volume
of output is determined. Before PME, however, his model was constructed in such
a way that only when the volume of output in the initial period was given could
the volumes of output in the succeeding periods be determined ― a restriction that he must
surely have been dissatisfied with. Around May 1932, Keynes’s views were
criticized by the Cambridge Circus, the central figure of which was Kahn. This
criticism was to prompt him to change his theory after a period of contrast
with the Circus. The central problem for him lay in how to deal with the supply
function. He subsequently abandoned the TM supply function, adopted the first
postulate of the classical economics, and constructed Model 1.
For these
reasons we regard PME and the Michaelmas lectures of 1932 as a turning point.
Despite their crucial importance, they have been largely ignored or misinterpreted.
This may have to do with the failure to appreciate the role played by the TM
supply function from the Treatise to
the end of 1932.
References
Amadeo E.
1989, Keynes’s Principle of Effective
Demand, Cheltenham and Brookfield
Amadeo E. 1994, «Changes in Output in Keynes’s
Treatise on Money», in J. Davis (ed.)
1994, The State of Interpretation of Keynes,
Boston, Kluwer Academic Publishers, 13-26.
Asano E. 1987, The Developmental
Process Leading to Keynes’s General Theory, Tokyo
Bridel
P. 1987, Cambridge Monetary Thought, Basingstoke ,
Macmillan.
Bryce, R., «An Introduction to a Monetary Theory of
Employment» (1935. Reprinted as JMK.29, 132-150).
Cain, N.
1982, «Hawtrey and the Multiplier», Australian
Economic History Review, 22(1) 68-78.
Chiodi G.,
1991, Wicksell’s Monetary Theory, New York , St. Martin ’s
Press.
Clarke P.
1988, The Keynesian Revolution in the
Making 1924-1936, Oxford
Deutscher
P. 1990, R.G. Hawtrey and the Development
of Macroeconomics, Ann Arbor , University of Michigan
Dimand R.
1988, The Origins of the Keynesian
Revolution, Cheltenham and Brookfield
Dimand R.
1997, «Hawtrey and the Multiplier:Comment on W.A. Darity Jr. and W. Young», History of Political Economy, 29 (3)
549-556.
Eatwell J. and M. Milgate 1983, Keynes’s Economics and the Theory of Value
and Distribution, London
Harrod R. 1936, The Trade Cycle, Oxford
Hawtrey R. 1925, «Public
Expenditure and the Demand for Labour», Economica,
o.s., 5, 38-48.
Hession, C. 1984, John
Maynard Keynes , New York
Hirai T., December 1997-March 1999, «A Study of Keynes’s Economics
(I)-(IV)», Sophia Economic Review,
43(1[67-136],2[13-121]), 44(1[35-127],2[29-96]).
Hirai, T.
1998, «Recent
Japanese Studies in the Development of Keynes’s Thought: An Evaluation», Annals
of the Society for the History of Economic Thought, 36, 128-137.
Hirai T.
2003, Keynes’s Economics, Tokyo , University
of Tokyo Press
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.
1984, The Making of Keynes’ General
Theory, Cambridge , Cambridge University
Kates S. 1998,
Say’s Law and the Keynesian Revolution,
Cheltenham and Brookfield
Keynes J.
M. 1971 [1923], A Tract on Monetary
Reform, London
Keynes J. M. 1971 [1930], A
Treatise on Money I: The Pure Theory of Money, London
Keynes J.
M. 1971 [1930], A Treatise on Money II:
The Applied Theory of Money, London
Keynes J.M.
1972 [1931], Essays in Persuasion, London
Keynes J.
M. 1973 [1936], The General Theory of
Employment, Interest and Money, London
Keynes, J.M. 1937, «The General Theory of Employment», Quarterly Journal of Economics, xiv,
109-123.
Keynes J.M. 1973a, The General Theory and After: Part I,
Preparation, London
Keynes
J.M. 1973b, The General Theory and After:
Part II, Defence and
Development, London
Keynes
J.M. 1979, The General Theory and After:
A Supplement, London
Keynes J.M. 1981, Activities
1929-31, London
Keynes
J.M. 1981, Activities 1922-9, Part 1
and Part 2, London
Keynes J.M.
1983, Economic Articles and
Correspondence, London
Kojima H.
1997, The Origins of Keynes’s Theory,
Tokyo
Komine
A. 1993, «Merchants in Hawtrey’s Theory», Hitotsubashi
Ronsou, Hitotsubashi
University
Laidler D.
1991, The Golden Age of the Quantity
Theory, New York
Leijonhufvud, A., «The Wicksell Connection» in Information and Coordination,
Oxford , Oxford University
Liberal Party 1928, Britain’s Industrial Future, London
Marcuzzo M.
2002, «The Collaboration between J.M. Keynes and R.F. Kahn from the Treatise to the General Theory», History of
Political Economy, 34(2), 421-447.
Meade J. 1993, «The Relation of Mr Meade’s
Relation to Kahn’s Multiplier», Economic
Journal, 103, 664-665.
Meltzer A.
1988, Keynes’s Monetary Theory, Cambridge
Milgate M. 1983, «The ‘New’ Keynes Papers», in Eatwell J.
and M. Milgate (eds), 1983, 187-199.
Moggridge
D. 1976, John Maynard Keynes , New York
Moggridge
D. 1992, Maynard Keynes, London
Ohara H.
1999, «On the Supply Mechanism of Keynes’s Treatise
on Money», Meidai Shougaku Ronsan (Meiji University
Okada M.
1997, The Development of Macroeconomic
Theory, Nagoya , Nagoya University
Patinkin D.
1976, Keynes’ Monetary Thought, Durham
Patinkin
D. and J. Leith (eds) 1997, Keynes, Cambridge and the General Theory, London
Patinkin
D. 1982, Anticipations of the General
Theory? And Other Essays on Keynes, Chicago ,
University of Chicago
Patinkin D.
1993, «On the Chronology of the General
Theory», Economic Journal, 103,
647-663.
Peden
G., 1984, «The ‘Treasury View’ on Public Works and Employment in the Interwar
Period», Economic History Review,
37(2), 167-181.
Presley J.
1979, Robertsonian Economics, New York
Robertson
D. 1940, Essays in Monetary Theory, London
Robinson
J. 1933, «The Theory of Money and the Analysis of Output», Review of Economic Studies, 1(1), 22-26.
Rymes T.
transcribed, 1988, Keynes’s Lectures,
1932-35, Department of Economics, Carleton University
Rymes T.
transcribed, edited, and constructed, 1989, Keynes’s
Lectures, 1932-35, Ann Arbor , University of Michigan Press
Skidelsky
R. 1992, John Maynard Keynes, Vol.2, London
Vicarelli
F. (translated by Walker, J.) 1984, Keynes,
Philadelphia , University of Pennsylvania
Press
*E-mails:hirai-t@sophia.ac.jp. The paper
originates in Hirai (1997-1999,
Chapter 9). The earlier versions were read at: the International Workshop on
the Cambridge School, Hitotsubashi University, Japan, in December 2002; History of Economics Society, the University of Leeds,
UK, in September 2003; Prof. C. Marcuzzo’s workshop, the University of Rome «La
Sapienza»,
Italy, in November 2003; and Prof. Richard Arena’s seminar, the University of
Nice-Sophia, France, in March 2004. All of them greatly contributed to
revision. The author also appreciates valuable comments by the anonymous
referees.
[1] The present author’s understanding of Keynes’s
achievement, with regard to the Treatise
and the General Theory, differs from
Leijonhufvud’s. In consequence, although the discussion here covers the same
historical ground as Leijonhufvud (1981), it provides a different analysis of
the Wicksell Connection. This is examined in Hirai (1997-9, Chapters 3 and 7).
See also Chiodi (1991) and Laidler (1991).
2 Amadeo (1989;1994), which is in
contrast with Dimand (1988, 39) and Meltzer (1988, 76-77), is very close to it.
5 This is our basic understanding of the General Theory, in contrast with the
stance viewing the General Theory
exclusively in terms of the second aspect.
13 This idea appeared for the first time in «Notes on the
Definition of Saving» (JMK.13,
275-289. Esp. 276), enclosed in Keynes’s letter to Robertson of 22 March 1932.
14 Referring to the relation between income and
consumption in connection with the stability condition for P1, Keynes does not
explicitly delineate the relations between saving, consumption and income.
16 See GT, 115-116, 122 and 286. See also
Keynes (1937), JMK.13, 457-468 (5
June 1934) and JMK.14, 58. The same
idea is found in Kahn (1931), Bryce (1935).
18 Rymes, 1988, A-1 - A-52, D-2 - D-22, and I-1 -
I-28. We also have Rymes’s reconstruction (Rymes 1989, 47-84).
22 «Suppose we have [the] case where
everybody wants to hold» (Rymes [Bryce] 1988, A-29). See also JMK.13, 422, and 424.
23 «Historical Retrospect» (JMK.13, 406-408) precedes this. Malthus, Hobson, and
Douglas are yet to be mentioned.
24 Keynes’s reference
to «effective demand» and «Malthus» is brief. Kates (1998, 140) regards the
last lecture as decisive, stressing Keynes’s reading of Malthus’s letters.
25 Our view of the
role played by Kahn is in the same direction as Marcuzzo (2002), although she
states that, accepting Kahn’s theory by the summer of 1932, Keynes developed an
aggregate supply-aggregate demand analysis, and regards the lectures at the
Harris Foundations and MTP as belonging to the General Theory world. On the other hand, Patinkin (1993, 651)
underestimates the importance of Kahn (1931).
26 The «Manifesto» (JMK.29, 42-45) and some related letters (JMK.13, 376-380 and JMK.29,
46-47) are worth noting. See Hirai (1997-9, Chapter 8, Section 3). The relation
of «Mr Meade’s relation» to Kahn’s multiplier is clarified by
Meade (1993). Robinson (1933, 24) criticizes Keynes’s
position in the Treatise. See also
Moggridge’s comments (JMK.13, 340).
Bridel (1987, 155-156) regards Robinson (1933) itself as confined within the Treatise theory.
27 This point is stated by Kahn both in his letter to
Patinkin dated 11 October 1978 and on p. 11 of the typescript of
Kahn (1984, the fourth lecture), for which see Patinkin (1993, 659). Keynes
(1939) refers to the same thing. Kahn (1984, 99-100) argues that because his 1931 article is not free from the Treatise, it fails to put sufficient
stress on the supply-demand theory as a whole.
Bridel (1987) does not refer to ‘the standard supply-demand analysis’, although
he points out,
as the crux of Kahn’s paper, the disposition of the «Treasury View», and a precise formulation of the
multiplier (1987, 153).
Bridel,
however, is rather critical of Kahn (1931), saying that
it belongs to the Treatise world.
28 See JMK.29, 72, 101-102 and Hirai (1997-9,
Chapter 10, Section 2). Harrod (1936, 71) regards the adoption of the marginal
analysis in the General Theory as a
remarkable improvement.
29 For a theoretical
cleavage between Kahn and J. Robinson on the one hand and Sraffa on the other,
see Marcuzzo (2003).
30 Davis
31 Keynes’s
activities began immediately after Lloyd George's pledge. See «Does Employment Need a Drastic Remedy?» (May
1924; JMK.19, Part I, 219-223), the
Liberal Party (1928), and «A Draft
Report» (October 1930; JMK.20,
437-443). However, he did not mention the multiplier theory in his Harris
Foundation lectures (June 1931. JMK.13,
343-367), which were within the Treatise
framework.
32 The Treasury View
is based upon Hawtrey (1925). On this basis the Treasury officials produced a
memorandum which became the Cabinet paper CP53(29). This was a rejoinder to the
Liberal Party (1928) and became the basis of the White Paper in May 1929. See
Peden (1984), and Clarke (1988, Chapter 3).
