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George H. Blackford, Ph.D.

 Economist at Large

 Email: george(at)rwEconomics.com

 

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An Open Letter to Economists Throughout the World

http://www.rweconomics.com/_themes/sandston/astonrul.gif 

May 1, 2016

To those who are concerned,

 

Below is the conclusion of a paper, Liquidity-Preference/Loanable-Funds and The Long-Period Problem of Saving, along with an abstract of this paper and that of a note, A Note on Keynes’ General Theory of Employment, Interest, Money, and Prices.

 

These two papers reexamine the fundamental issues raised by Keynes in The General Theory of Employment, Interest, and, Money from the perspective of Marshall's methodology of supply and demand.  They provide, more or less, a summary of the research I did back in the 1980s.  I have brought this research up to date as best I can, but, unfortunately, I have had no academic affiliations for the past thirty years and am thirty years out of touch with the literature of economics.  In addition, I am too old with not enough time left to catch up.  Thus, I would like to turn the research summarized in these two papers over to a younger generation of economists to do with it what they will.

 

The analysis in these papers does not fit in well with the basic paradigm of mainstream economics that has been developed over the past seventy odd years and, in the spirit of Thomas Kuhn, is not likely to be welcomed by senior economists today anymore than it was back in the 1980s.  Nonetheless, I believe that given the kinds of problems we face today these papers may be of interest to graduate students who are better able than I to develop the ideas they contain in a way that may benefit the discipline at large. 

 

Thus, I would deeply appreciate your referring this letter to the attention of anyone you believe may be interested in the papers abstracted below.

 

Thanking you in advance,

 

Sincerely,

 

George H. Blackford, Ph.D.

www.rwEconomics.com

 

 

A Note on Keynes’ General Theory of
Employment, Interest, Money, and Prices

Abstract

The basic aggregate model summarized by Keynes in Chapter 18 of The General Theory of Employment, Interest, and Money is derived in this note from the implicit general equilibrium model that underlies Keynes’ general theory.  It is argued that when these models are viewed from the perspective of the simple dynamics of supply and demand it becomes clear that the methodology of Keynes is Marshallian rather than Walrasian and that this makes Keynes’ methodology causal and dynamic whereas the Walrasian methodology is, at best, descriptive and incapable of meaningful causal or dynamic analysis.

 

Liquidity-Preference/Loanable-Funds
and
The Long-Period Problem of Saving

Abstract

The purpose of this paper is to re-examine the central issue of the liquidity-preference/ loanable-funds controversy in an attempt to provide a definitive explanation of the way in which the rate of interest is determined.  The Marshallian roots of the controversy are established in section I, and in section II it is explained why the liquidity-preference theory is compatible with the Marshallian paradigm and the loanable-funds theory is not. The long-period problem of saving that lies at the center of Robertson’s objection to Keynes’ theory of interest is examined in section III, and in section IV it is explained why the failure to understand this problem within the context of the Marshallian paradigm, combined with the failure to understand the nature of the vital role played by loanable funds in the economic system, led mainstream economists to recommend economic policies over the past forty years that culminated in the Crash of 2008 and brought about the economic stagnation we are in the midst of today.

 

Liquidity-Preference/Loanable-Funds
and
The Long-Period Problem of Saving

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 [1953], 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. [1]  He spent his entire life examining the details in an attempt to discover the causal relationships that drive the economic system through time.   

 

In examining 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 unchanged.

 

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 (2016)]

 

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)]

 

Specifically, 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 2000s. [Blackford (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 income.  [Blackford (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 (2016b)]

 

In other words, what we are facing today is the fallout from Keynes’ long-period problem of saving. [2]

 

The 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:

 

  1. 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. 
     

  2. 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. 
     

  3. 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. 
     

  4. 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. 
     

  5. 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.[3]  
     

I believe 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. 

 

Even though 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,[4] 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

 

There is 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:

 

  1. 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)]
     

  2. At the same time the most serious depressions involve financial crises that have at their root the inability to service debt. [Reinhart and Rogoff]
     

  3. 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 run. [Blackford (2014, Ch 1, Ch 3, and Ch12)]  
     

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 Ch12)

 

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 today. 

 

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)]

 

Institutional 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.[5]

 

References

Blackford, G. H., 1975, “Money and Walras’ Law in the General Theory of Market Disequilibrium,” Eastern Economic Journal,” 2, 1-9.

            , 1976, “Money, Interest, and Prices in Market Disequilibrium: A Comment,” Journal of Political Economy, 84, No. 4, Part 1, pp. 893-894.

            , 1983, “Robertson versus Keynes: A Reevaluation,” unpublished paper, available on request.

            , 1986, “A Note on Tsiang’s Interpretation of Robertson’s Theory of Interest,” unpublished paper, available on request.

            , 1987, “A Note on Liquidity Preference, Loanable Funds, and Marshall,” unpublished paper, available on request.

            , 2013, “Ideology Versus Reality,” Real-World Economics, http://www.rweconomics.com/IVR.htm .

            , 2014, Where Did All The Money Go? How Lower Taxes, Less Government, and Deregulation Redistribute Income and Create Economic Instability, Amazon.com (Ch 1, Ch 3, and Ch 12 at Real-World Economics).

            , 2016, “A Note on Keynes’ General Theory of Employment, Interest, Money, and Prices,” Real-World Economics, http://www.rweconomics.com/htm/KGT.htm.

Clower, R. W., 1965, “The Keynesian Counter-Revolution: A Theoretical Appraisal,” in F. Hahn and F. Brechling, eds., The Theory of Interest Rates, New York: St. Martin's Press.

Davidson, P., 1972, “A Keynesian View of Friedman's Theoretical Framework for Monetary Analysis,” Journal of Political Economy, 80, 864-82.

Fisher, I., 1932, Booms and Depressions: Some First Principles, New York: Adelphi Company.

Friedman, M., 1957, A Theory of the Consumption Function, Princeton: Princeton University Press.

Haberler, G., 1941, Prosperity and Depression, Geneva: League of Nations.

Hansen, A. H., 1951, “Classical, Loanable-Fund, and Keynesian Interest Theories,” The Quarterly Journal of Economics, pp. 429-432.

            , 1953, A Guide to Keynes, New York: McGraw Hill.

Hawtrey, R. G., 1933, “Mr. Robertson on 'Saving and Boarding,” Economic Journal, 43, 701-08.

Hayek, F. A., 1931a, “Reflections on the Pure Theory of Money of Mr. J. M. Keynes,” Economica, Part I, II, 270-951, February 1932, Part 2, 12, 22-44.

            , 1931b,”A Rejoinder to Mr. Keynes,” Economica, 11, 398-403.

Hicks, J. R., 1937, “Mr. Keynes and the ‘Classics’; A Suggested Interpretation,” Econometrica, pp. 147-159.

Horwich, G., 1964, Money Capital and Prices, Homewood: Irwin.

Jaffe, W., 1967, “Walras' Theory of Tatonnement: A Critique of Recent Interpretations,” Journal of Political Economy, pp. 1-19.

Johnson, B. G., 1952, “Same Cambridge Controversies in Monetary Theory,” Review of Economic Studies,.19, 90-104.

Keynes, J. M., 1930, A Treatise on Money, Macmillan: London.

            , 1931a, “Mr. Keynes' Theory of Money: A Rejoinder,” Economic Journal, 41, 412-23.

            , 1931b, “The Pure Theory of Money: A Reply to Dr. Hayek,” Economica, 11, 387-97.

            , 1936, The General Theory of Employment, Interest, and Money, Rendered into HTML, 2003, by Steve Thomas, University of Adelaide Library.

            , 1937a, “The General Theory of Employment,” Quarterly Journal of Economics, 51, 209-23.

            , 1937b, “Alternate Theories of the Rate of Interest,” Economic Journal, 47, 241-52.

            , 1937c, "The 'ex-ante” Theory of the Rate of Interest," Economic Journal, 47, 663-69.

Klein, L. R., 1966, The Keynesian Revolution, New York: Macmillan.

Kohn, M., 1981, "A Loanable Funds Theory of Unemployment and Monetary Disequilibrium," American Economic Review, 71, 859-79.

Kuhn, T. S., 1962, The Structure of Scientific Revolutions, University of Chicago Press.

Leijonhufvud, A., 1968, On Keynesian Economics and the Economics of Keynes, London: Oxford University Press.

Marshall, A., 1961, Principles of Economics, 9th edition, New York: Macmillan.

Minsky, H., 1986, Stabilizing an Unstable Economy, New York: McGraw-Hill.

Modigliani, F., 1944, “Liquidity Preference and the Theory of Interest and Money,” Econometrica, XII, pp.45-88.

Ohlin, B. G., 1937a, “Some Notes on the Stockholm Theory of Savings and Investment,” Economic Journal; Part I, 47, 53-69, 47, 221-40.

             , 1937b, “Alternate Theories of the Rate of Interest: Three Rejoinders,” Economic Journal, 47, 423-27.

Patinkin, D., 1956, Money, Interest and Prices: An integration of monetary and value theory, Evanston, IL: Row, Peterson and Company.

Reinhart, C. M, and Kenneth S. Rogoff, 2009, This Time is Different: Eight Centuries of Financial Folly, Princeton University Press.

Robertson, D. H., 1931, “Mr. Keynes' Theory of Money,” Economic Journal, 41, 395-411.

             , 1933a, “Saving and Hoarding,” Economic Journal, 43, 399-413.

             , 1933b, “Mr. Robertson on 'Saving and Hoarding,“ Economic Journal, 43, 709-12.

             , 1936, “Some Notes on Mr. Keynes' General Theory of Employment,” Quarterly Journal of Economics, 51, 168-91.

             , 1937, “Alternate Theories of the Rate of Interest: Three Rejoinders,” Economic Journal, 47, 428-36.

             , 1940,“Mr.Keynes and the Rate of Interest,” Ch. I, Essays in Monetary Theory, P. S. King: London.

             , 1959, 'Lectures on Economic Principles III, Staples: London.

Robinson, J., 1951, “The Rate of Interest,” Econometrica, 19, 92-111.

Rose, H., 1957, “Liquidity Preference and Loanable Funds,” Review of Economic Studies, 24, 111-19.

Samuelson, P. A., 1947, Foundations of Economic Analysis, Harvard University Press.

Shackle, G.L.S., 1961, “Recent Theories Concerning the Nature and Role of Interest,” Economic Journal, 71, 209-54.

Tsiang, S. C., 1966, “Walras' Law, Say's Law and Liquidity Preference in General Equilibrium Analysis,” International Economic Review, 329-45.

 

Endnotes

[1] 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.

 

[2] 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. 202-3)]

 

Cf. Blackford (2014, Ch12).

 

[3] 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)]

 

And:

 

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)]

 

[4] In 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. 

 

[5] See Keynes (1936, Chapter 24) and cf. Blackford (2014 Ch12).

 

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