IV. Summary and Conclusion
As I have
noted elsewhere, [Blackford (2016)] Keynes did not
present his general theory in terms of a system of simultaneous equations.
That was done by A. H. Hansen , J. R. Hicks, P. A. Samuelson, D.
Patinkin, and countless other Keynesians. Their approach was Walrasian, and
as a result of their efforts a Walrasian revolution took place in economics
in the name of Keynes following the publication of The General Theory. This
revolution took Keynes’ name in spite of the fact that Keynes was a protégé
of Marshall, not Walras, and Keynes refused to specify sophisticated
mathematical models that ignore the details.
He spent his entire life examining the details in an attempt to discover the
causal relationships that drive the economic system through time.
the details, among many other things, it became clear to him that 1) the
ultimate justification for production is to satisfy the demands of
consumers, 2) the true causal variables in a market system in which
the processes of production takes time are expectations with regard to the
future, 3) the rate of interest is a purely monetary phenomena determined by
the supply and demand for liquidity as the prices of assets adjust to equate
wealth-holder demands for assets to the existing stocks of assets, 4) given
the supply of money, the rate of interest cannot change in a significant way
in response to an increase in the propensity to save until there is a change
in expectations with regard to the profitability of continuing to produce at
the current level of employment and output, and 5) there is no a priori
reason to believe that a change in expectations with regard to the
profitability of continuing to produce at the current level of employment,
output, and income in the face of a decrease in demand for consumption goods
will leave expectations with regard to the profitability of investment
These are all
crucial insights that lie at the very core of Keynes’ general theory,
especially the realization that the rate of interest is a purely monetary
phenomenon determined by the supply and demand for liquidity. What this
means is that investment is determined by the rate of interest, not the
other way around. It also means that monetary policy is limited in its
ability to stimulate the economy by the propensities of wealth holders with
regard to their demands for liquidity, and once rates of interest have
reached the lower bounds set by the propensities of wealth holders the level
of economic activity is determined by the propensity to consume and the
demand for investment goods. And since the demand for investment goods is
ultimately determined by expectations with regard to future consumption, and
since expectations with regard to future consumption are largely determined
by current consumption, the level of economic activity must be largely
determined by current consumption and, ultimately, by the way in which
current consumption changes over time.
When all of
these insights are put together, as Keynes did in The General Theory of
Employment, Interest, and Money, what you find is that consumption is
the driving force for economic growth, not saving. All of this would
seem to be rather straightforward, and, yet, this way of looking at the
economic system was not taught or even acknowledged in graduate schools when
I was in academia, and I suspect is still not taught or acknowledged in
graduate schools to this day. Instead, graduate students were taught the
Walrasian paradigm with tâtonnement/recontract dynamics while the
Marshallian paradigm from which the dynamics of Keynes is drawn was pretty
much ignored other than in undergraduate courses. [Blackford
It is obvious,
or at least it should be obvious, that something is wrong here. In point of
fact, neither households nor firms are constrained in their choices in the
real world by a Walrasian budget constraint at the point in time at which a
choice must be made. They are constrained by a) the value and liquidity of
their assets, b) the availability of sellers of goods at various prices, c)
the availability of buyers of goods at various prices, and d) in their
access to credit. They have no choice but to be guided by their
expectations with regard to the future, as Keynes insisted, but they are not
constrained in the present by what actually happens in the future.
The rate at which decision-making units receive income at the point in time
at which a decision must be made has no way of affecting that decision other
than through its effect on expectations as any consumer who has ever
purchased a home, a car, or has simply walked the aisles of a supermarket
knows implicitly, and as any businessman who has ever had to meet a payroll
knows implicitly as well. These are simple, empirical facts, and yet the
Walrasian budget constraint presupposes that a) all prices, quantities, and
incomes are known at the time a choice must be made, b) all choices are made
simultaneously, and c) that those choices are constrained by income. This
sort of thing can correspond to actual behavior only in a world in which
expectations are always realized and markets always clear, that is, a
world in which the economic system is in always in static equilibrium.
[Clower] The Walrasian budget constraint has no relevance at all when the
system is not in static equilibrium. [Blackford (1975;
1976)] There is no
mystery about this. It is well known that Walrasian dynamics is empirically
irrelevant by virtue of its reliance on the mythical auctioneer of the
Walrasian tâtonnement/recontract assumption. [Jaffe]
It seems quite
clear to me that the primary cause of the financial crisis that began in
2007, and the reason mainstream economists are unable to understand its
cause or the nature of the disaster that is developing in its wake, is the
fact that mainstream economists have ignored those aspects of Keynes’s
general theory they were either unable or unwilling to incorporate into
their Walrasian models—the very aspects of Keynes’s general theory that
contains the essence of Keynes’ cause and effect insights, based on
the Marshallian paradigm, as to how the economic system actually works in
the real world. [Blackford (2016)]
mainstream economists have ignored the fact that since output and employment
are determine by effective demand, and since effective demand is ultimately
determined by expectations with regard to future consumption, economic
growth in the long run is enhanced only by increasing consumption, and is
inhibited by saving. As a result, the economic models created by
mainstream economists over the past fifty or sixty years have ignore the
long-run relationship between consumption and effective demand, output, and
employment and have been used to justify deregulating the domestic and
international financial systems, cutting corporate taxes and taxes on the
wealthy, increasing taxes on the not so wealthy, reducing public investment
in infrastructure and human capital, eliminating usury laws, destroying
labor unions, promoting the adoption of private retirement accounts,
converting Social Security from a pay-as-you-go to a partial-prepayment
system, neglecting the minimum wage, and many other supposedly economically
efficient policies that only make sense within models that ignore the
long-run relationship between consumption and effective demand and assume
that increasing saving enhances economic growth. [Blackford
(2014, Ch 1, and Ch 3)]
The end result
of these policies has been a dramatic increase in our current account
deficit along with an equally dramatic increase in the concentration of
income at the top of the income distribution. This, in turn, has led to a
situation in which saving in the foreign sector has increased dramatically
(by way of our increased current account deficit) and at the top of the
income distribution in the private sector (by way of the higher propensity
to save at the top of the income distribution than at the bottom). This
increase in saving in the foreign sector and at the top of the income
distribution in the private sector has been partially offset over the past
forty years by dissaving in the public sector and at the bottom of the
income distribution in the private sector. It has also been accompanied by
increases in investment as a result of speculative bubbles in the commercial
real estate markets in the 1980s, in the markets for tech stocks and the
dotcom and telecom industries in the 1990s, and in the housing market in the
(2014, Ch 1, and Ch 3)]
As a result,
these policies have transformed our economic system in such a way that,
given the resulting current account deficits and concentration of income at
the top of the income distribution, the mass markets for consumption goods
have been undermined to the point that it is no longer possible to achieve
potential output and full employment with the given state of mass-production
technology in the absence of a continual increase in debt relative to
(2014, Ch 3)] It is the unsustainability of a continual increase in
private-sector debt relative to income that eventually led to the Crash of
2008, and it is the inability to further increase debt relative to income
through dissaving at the bottom of the income distribution (or through
continually increasing debt relative to income in the public sector)
combined with the lack of speculative bubbles to stimulate investment that
has led to the diminished long-term expectation with regard to consumption
that is the primal cause of the economic stagnation we have experienced
since 2007. [Blackford
words, what we are facing today is the fallout from Keynes’ long-period
problem of saving.
long-period problem of saving stands at the very core of The General
Theory of Employment, Interest, and Money. In Keynes’ understanding of
this problem, consumption creates its own supply by stimulating
investment—it does not work the other way around. The logic of his
argument is this:
The accumulation of capital over time has a tendency to reduce the MEC
(i.e., investment demand schedule) by reducing the prospective yield
on additional units of various capital assets as those assets become
plentiful or even redundant.
The failure of the propensity to save to fall over time (that is, the
failure of the propensity to consume to increase) at a rate that will
offset the effects of the fall in the MEC as capital accumulates leads to
a situation in which a fall in the rate of interest is required in order
to maintain the investment needed to avoid unemployment.
Since the rate of interest is determined by the supply and demand for
money there are limits to the rate and the extent to which the rate of
interest can fall. To the extent the rate of interest lags behind the
fall in the MEC the failure of the propensity to save to fall (consumption
to increase) as rapidly as the MEC means that we can expect the economy to
hit the lower bound set by the rate of interest which will cause
investment to fall below the level needed to maintain full employment.
Even if interest rates were to adjust rapidly enough to avoid sporadic
unemployment as capital accumulates and the MEC falls in the short run, in
the long run interest rates must eventually be forced to zero (after
allowing for risk) and can fall no more. At that point the economy will
stagnate as the MEC and net saving and investment are forced to zero.
As a result, the only way the economic system can be kept
going in the short run is through a continual decrease in the propensity
to save (increase in the propensity to consume) and rate of interest, and,
even then, the MEC and net saving must eventually be forced to zero when
there is so much capital that additional increases will yield a negative
prospective yield even if the propensity to save is nil.
these ideas are not incorporated within the worldview of mainstream
economists because the effects of capital accumulation and consumption on
the prospective yield of increases in the stock of capital are not
incorporated into the Walrasian models through which mainstream economists
view the economic system. As a result, these models present a vision of the
economic system in which monetary policy can be used to maintain full
employment through stimulating investment indefinitely into the future.
This is a vision that presupposes monetary policy can be effective in
maintaining full employment even if the entire country were to become paved
over with concrete and every square inch of land were to sport a factory or
high-rise apartment building. It also presupposes that the less we consume
the sooner this end can be achieve. Keynes did not share this vision of the
long-period problem of saving. He saw clearly that monetary policy would
not be able to solve this problem in the long run.
Keynes analyzed the long-period problem of saving in excruciating detail throughout
The General Theory, one aspect of this problem that he did not examine
in detail is the vital role played by the flow of loanable funds in the
economic system. Even though the flow of loanable funds does not determine
the rate of interest and has very little to do with saving or investment,
as Keynes clearly understood, he did not seem to understand that this does
not mean the flow of loanable funds can or should be ignored. Just as the flow of
investment changes the stock of capital in the economy over time, the flow
of loanable funds changes the stock of debt in the economy over time. And
even though changes in neither the stock of capital nor the stock
of debt affect the system in a significant way in the short-run, both can
have dramatic effects on the system in the long run.
nowhere to be found in Keynes an analysis of the relationship between the
flow of loanable funds and the accumulation of debt comparable to that of
his analysis of the relationship between the flow of investment and the
accumulation of capital. Nor, as far as I know, is such an analysis to be
found anywhere in the writings of today’s mainstream economists (Fisher and
Minsky, yes; among today’s mainstream economists, I am not aware of any) in spite
of the fact that:
The creation of debt plays an essential role in achieving full employment
by providing a mechanism through which purchasing power can be transferred
from those who have it and are unwilling to spend to those who do not have
it and are willing to borrow in order to spend. [Blackford
(2014, Ch 3)]
At the same time the most serious depressions involve financial crises
that have at their root the inability to service debt. [Reinhart and
It is obvious, or at least it seems obvious to me, that if the
institutions of society are such that an increasing debt relative
to income is required to achieve full employment in the short run,
eventually debt service must overwhelm the system and cause a financial
crisis that will make it impossible to sustain full employment in the long
(2014, Ch 1,
Ch 3, and
It also seems
obvious to me that herein lies the cause of major financial crises and
depressions, and, yet, not only do mainstream economists seem to ignore the
dynamics of Keynes’ long-period problem of saving, they pay no attention to
the circumstances in which full employment can be achieved only through an
increase in debt relative to income in spite of the fact that this is
exactly the kind of situation that existed leading up to the Great
Depression and to the economic stagnation we see today. [Blackford
(2014, Ch 1, Ch 3, and
The failure of
mainstream economists to understand Keynes’ analysis of the long-period
problem of saving—combined with the failure to understand the role played by
increasing debt relative to income in creating financial crises—has resulted
in the adoption of economic policies over the past forty years that have
inhibited consumption and promoted saving and debt to the extent that we can
no longer achieve full employment in the absence of an increase in debt
relative to income. This is a path that, in the long run, inevitably leads
to financial and economic crises that result in the kinds of economic,
social, and political problems we faced in the 1930s, the last time we saw
the kind of economic stagnation we see developing throughout the world
As strange as
it may seem, few economists seem to realize that the US economy never
recovered from the Great Depression of the 1930s. What happened was the New
Deal came along, and the government completely took over the economic system
during World War II. It was the institutional changes that occurred as a
result of the New Deal and World War II that took us out of the Great
Depression, not a ‘recovery’ of the economy as such. The economic system
that emerged from the New Deal and World War II was no longer the laissez
faire system that led us into the Great Depression, and it was the
institutional changes that ended laissez faire that led to the
economic prosperity that followed the war—a prosperity that lasted until we
began to undo those changes in the 1970s as the long-period problem of
saving began to plague us again. [Blackford
(2014, Ch 1 and Ch 3)]
change as a result of war is hardly an optimal way to approach this
problem. It makes much more sense to affect those changes directly, but
this cannot be accomplished in the absence of a clear understanding of the
problem by mainstream economists. There can be little hope for the future
in this regard until mainstream economists are able to look beyond their
mathematical models, put aside their ideological blinders [Blackford
(2013)], and look at the
long-period problem of saving in a way that leads to an overwhelming
consensus within the discipline of economics to the effect that Keynes’
conclusion with regard to this problem—that consumption is the driving force
for economic growth, not saving—is right and that the failure of mainstream
economists, both Keynesians and anti-Keynesians alike, to address this
problem directly is a serious mistake. Only then will it be possible to
affect the institutional changes needed to solve the long-period problem of
saving directly in a way that, hopefully, will help to avoid yet another
world-wide conflagration that, in this nuclear age, is likely to be even
more devastating than the one that began on September 18, 1931 and reached
its climax on August 6th and 9th, 1945.
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See Blackford (2016) and Keynes:
The object of our analysis is, not to provide a machine, or method of
blind manipulation, which will furnish an infallible answer, but to
provide ourselves with an organized and orderly method of thinking out
particular problems; and, after we have reached a provisional conclusion
by isolating the complicating factors one by one, we then have to go
back on ourselves and allow, as well as we can, for the probable
interactions of the factors amongst themselves. This is the nature of
economic thinking. Any other way of applying our formal principles of
thought (without which, however, we shall be lost in the wood) will lead
us into error. It is a great fault of symbolic pseudo-mathematical
methods of formalizing a system of economic analysis . . . that they
expressly assume strict independence between the factors involved and
lose all their cogency and authority if this hypothesis is disallowed;
whereas, in ordinary discourse, where we are not blindly manipulating
but know all the time what we are doing and what the words mean, we can
keep ‘at the back of our heads’ the necessary reserves and
qualifications and the adjustments which we shall have to make later on,
in a way in which we cannot keep complicated partial differentials ‘at
the back’ of several pages of algebra which assume that they all
vanish. Too large a proportion of recent ‘mathematical’ economics are
merely concoctions, as imprecise as the initial assumptions they rest
on, which allow the author to lose sight of the complexities and
interdependencies of the real world in a maze of pretentious and
unhelpful symbols.” [Keynes (1936, p. 188)]
The typical Keynesian models of the 1960s and 1970s took the form of
various simultaneous equations, static equilibrium models spread
throughout the literature and found in one form or another in almost any
macroeconomic text book. These models have very little to do with Keynes
and are, for the most part, extensions of Walras. See Rose, Clower,
Leijonhufvud, and Davidson.
 While this paper is about the
long-period problem of saving, it is important to at least acknowledge
that what may be called “the long-period problem of capital formation”
is equally important. See Keynes:
It may be convenient at this point to say a word about the important
schools of thought which maintain, from various points of view, that the
chronic tendency of contemporary societies to under-employment is to be
traced to under-consumption;—that is to say, to social practices and to
a distribution of wealth which result in a propensity to consume which
is unduly low.
In existing conditions . . . where the volume of investment is unplanned
and uncontrolled, subject to the vagaries of the marginal efficiency of
capital as determined by the private judgment of individuals ignorant or
speculative, and a long-term rate of interest which seldom or never
falls below a conventional level, these schools of thought are, as
guides to practical policy, undoubtedly in the right. For in such
conditions there is no other means of raising the average level of
employment to a more satisfactory level. If it is impracticable
materially to increase investment, obviously there is no means of
securing a higher level of employment except by increasing consumption.
Practically I only differ from these schools of thought in thinking that
they may lay a little too much emphasis on increased consumption at a
time when there is still much social advantage to be obtained from
increased investment. . .
Moreover, I should readily concede that the wisest course is to advance
on both fronts at once. Whilst aiming at a socially controlled rate of
investment with a view to a progressive decline in the marginal
efficiency of capital, I should support at the same time all sorts of
policies for increasing the propensity to consume. For it is unlikely
that full employment can be maintained, whatever we may do about
investment, with the existing propensity to consume. There is room,
therefore, for both policies to operate together;—to promote investment
and, at the same time, to promote consumption, not merely to the level
which with the existing propensity to consume would correspond to the
increased investment, but to a higher level still. [Keynes (1936, p.
 Cf. Keynes:
If there is an increased investment in any given type of capital during
any period of time, the marginal efficiency of that type of capital will
diminish as the investment in it is increased, partly because the
prospective yield will fall as the supply of that type of capital is
increased [emphasis added], and partly because, as a rule, pressure on
the facilities for producing that type of capital will cause its supply
price to increase; the second of these factors being usually the more
important in producing equilibrium in the short run, but the longer the
period in view the more does the first factor take its place [emphasis
added]. [Keynes (1936, p. 88)]
We have seen that capital has to be kept scarce enough in the
long-period to have a marginal efficiency which is at least equal to the
rate of interest for a period equal to the life of the capital, as
determined by psychological and institutional conditions. What would
this involve for a society which finds itself so well equipped with
capital that its marginal efficiency is zero and would be negative with
any additional investment; yet possessing a monetary system, such that
money will 'keep' and involves negligible costs of storage and safe
custody, with the result that in practice interest cannot be negative;
and, in conditions of full employment, disposed to save?
If, in such circumstances, we start from a position of full employment,
entrepreneurs will necessarily make losses if they continue to offer
employment on a scale which will utilise the whole of the existing stock
of capital. Hence the stock of capital and the level of employment will
have to shrink until the community becomes so impoverished that the
aggregate of saving has become zero, the positive saving of some
individuals or groups being offset by the negative saving of others.
Thus for a society such as we have supposed, the position of
equilibrium, under conditions of laissez-faire, will be one in
which employment is low enough and the standard of life sufficiently
miserable to bring savings to zero. More probably there will be a
cyclical movement round this equilibrium position. For if there is
still room for uncertainty about the future, the marginal efficiency of
capital will occasionally rise above zero leading to a 'boom', and in
the succeeding 'slump' the stock of capital may fall for a time below
the level which will yield a marginal efficiency of zero in the long
run. Assuming correct foresight, the equilibrium stock of capital which
will have a marginal efficiency of precisely zero will, of course, be a
smaller stock than would correspond to full employment of the available
labor; for it will be the equipment which corresponds to that proportion
of unemployment which ensures zero saving. [Keynes (1936, p. 138)]
spite of the fact proponents of the loanable-funds theory seemed to
believe that the flow of loanable funds is dominated by saving and
investment, the reality is that a great deal of investment is financed
through stock issue and retained earnings and by home owners who save up
to make a down payment in order to get a mortgage and then gradually
invest their savings as they pay off their mortgages irrespective of
what the rate of interest may be. None of this investment shows up in
the flow of loanable funds except the repayment of mortgages. In
addition, a great deal of borrowing takes place to finance the purchase
of existing assets as opposed to newly created assets as well as to
finance dissaving as consumer debt increases. Thus, in principle, there
can be a huge flow of loanable funds from savers to dissavers and to
finance the purchase of existing assets with no saving or investing in
the economy at all, and a substantial amount of investment takes place
that is not financed by borrowing. Thus there is no reason to believe
that aggregate saving and investment play a special role in determining
the flow of loanable funds.