In graduate school, I became interested in stabilization theory and the relation of Keynesian macroeconomics to beautiful marginalist general-market-equilibrium microeconomics. Amelioration of the human cost of periodic episodes of more or less severe involuntary loss of jobs and income seemed to me the highest calling for an economist. So I did a smart thing and read Don Patinkin’s Money, Interest, and Prices (1956). It was a valuable experience. Graduate students today, whose interest in instability was piqued by the huge welfare loss incurred during the 2007-09 Great Recession and who are bewildered why Ben Bernanke paid no attention whatsoever to the mainstream market-centric DSGE model class with its clear-cut monetary theorems that they spend so much time and effort to learn, should read Patinkin.
If they are interested in the proper management of costly instability, they will of course be unimpressed by Pakinkin’s devotion to the real-balance effect, a valid principle without relevance to macro policymaking. It is too small and too slow to be an adequate response to broad market failure. But they should pay close attention to Chapters 13 and 14. That analysis may be a revelation in that it identifies what is essential in policy-relevant macroeconomics, a task that has most likely been simply ignored in their classroom instruction.
Money, Interest, and Prices (Chapters 13 and 14) assumes wage rigidity, explicitly pushing labor off its supply schedule, repealing Keynes’s Second Classical Postulate, and generating involuntary unemployment. In such circumstances, of course, total labor hours are easily demonstrated to be increasing in total spending. The requisite suppression of wage recontracting results from the imposition of an arbitrary, uncomplex class of wage inflexibility on Pakinkin’s carefully constructed general-equilibrium market system: (W/P)=(W/P)o.
The tacked-on labor-pricing restriction permits Patinkin’s “normal” state to be defined with respect to flexible wages and therefore feature full employment, a characteristic of the 1956 model that continues to be consistent with New Keynesian thinking more than a half-century later. By contrast, the GEM Project’s more complex meaningful wage rigidities (MWR), the specification for which has been derived from axiomatic primitives, generate a normal state for highly specialized economies in which a large share of all workers are pushed off their labor-supply schedule. LEV (large-establishment venue) employees typically prefer to work more hours on their jobs, while the remainder of the labor force is frustrated in their rational desire to obtain rent-paying, rationed jobs for which they are qualified. Continuous-equilibrium MWR critically provides the missing link between nominal-demand disturbances and involuntary job loss, fundamentally enriching monetary theory and imparting unique stabilization-policy relevancy to the generalized-exchange theory. That powerful class of microfoundations was beyond the reach of Patinkin. He, along with other great Early-Keynesian theorists, worked wholly within the restrictive market-centric general-equilibrium framework.
Patinkin provides analytic antecedents for the GEM Project’s crucial stabilization innovations, i.e., coherent meaningful wage rigidity and the consequent central role of aggregate demand in the determination of employment. Indeed, generalized-exchange modeling may be usefully understood as a lineal descendent of Patinkin’s masterful book. To reiterate, the principal difference, which shows up continually in the more than half century that follows, is that Patinkin works wholly within the confines of optimizing market exchange, while the Project generalizes rational exchange to the workplace. That is the big idea in macroeconomics that has been waiting in the wings since Keynes.
Looking at the Project’s relation to Patinkin the other way, incorporating the analytics of the eBook’s Chapter 2 into Patinkin’s Chapters 13 and 14, where he develops his ad hoc model of stationary demand disturbances that generate involuntary unemployment, grounds his Keynesian analysis in decision-rule general equilibrium. A fully microfounded Money, Interest, and Prices plays by the rules of, and should be welcomed into, the macro mainstream. Graduate students can read it without guilt.
Blog Type: New Keynesians San Miguel de Allende, Mexico