I have been reading Zachary Carter’s new biography of Maynard Keynes. The author’s take on the relative importance of various parts of Keynes’s rich professional life surprised me and seems, after some consideration, a bit ominous for the current state and future of macroeconomics. The index tells the tale. Only 29 pages of the 500-page book are devoted to the General Theory of Employment, Interest, and Money (1936). Ten of those pages are about the Cambridge Circus’s contributions to Keynes’s seminal book. On net, Carter’s attention to the General Theory is roughly the same as the space given to Keynes’s The Economic Consequences of the Peace (1919), a polemical, gossipy, and ultimately correct book that is not in the same league as his masterwork nearly two decades later. Even more curious is the 52 pages given to the interesting but much less significant contribution on John Kenneth Galbraith. (A future post in the Helping-Hand series will feature Galbraith.)
His Great Idea
Keynes’s central contribution is the reorientation of macro theory to accommodate the centricity of nominal demand in the stabilization of modern highly-specialized economies. The objective of the General Theory is to replace the neoclassical emphasis on general market equilibrium in aggregate analysis. Is Carter on to something? Has Keynes’s great idea become a lessor and receding part of his legacy? If so, how much of that erosion is the result of the decades-long replacement of the dominance of Early Keynesian (EK) demand-centric analysis with the New Keynesian (NK) revival of general-market-equilibrium (enhanced by rational market frictions) modeling.
Such a broad deterioration would be especially bad news given that NK theorists cannot explain the most important facts of modern instability. Most egregiously, GME macroeconomics does not, because it cannot, recognize the existence of involuntary job loss. Layoffs in recessions, including the Great Depression that centrally concerned Keynes, must somehow be voluntary. Of course, nobody really believes that, including the New Keynesians. Yet they continue to teach their foolish model to hapless graduate students and insist that the general-market-equilibrium approach be used in scholarly research and debate.
GEM Helping Hand
Keynes is vulnerable to being pushed aside largely because he tried to rationally model macro instability (in particular the 1930s Great Depression) absent meaningful wage rigidity (MWR). As readers of the GEM Blog understand, that absence makes his General Theory badly incomplete and at times nearly incomprehensible. The most powerful and useful helping hand that can be offered Keynes is the Project’s microfounded MWR. Given that fundamental innovation, Early Keynesianism would never been replaced by the New Keynesian insurgency reviving the dominance of general-market-equilibrium modeling.
Rejecting Keynes’ Rejection
Keynes was not able to microfound MWR. That core problem was greatly aggravated by his compensating decision to assert, but not prove, that MWR is not needed in stabilization-relevant macroeconomics. There are at least two counter-arguments to Keynes’ gambit that nominal wage rigidity may, in fact, significantly mitigate the real effects of recession by supporting total consumption spending. First, purchasing capacity gained from avoiding wage cuts is more than wholly offset by the decreased spending resulting from job loss. Moreover, EK macrodynamics, rooted in nominal wage rigidity, motivates weakening nominal demand in contracting investment, motivated by expectations of shrinking profits. Consumption plays a distant supporting role.
Second, no informed Keynesian can ignore that MWR is needed to rationally suppress wage contracting, making it a necessary condition for the micro-coherent existence of involuntary job loss resulting from adverse demand disturbances. Otherwise, rational employees must, in lieu of losing their jobs, accept any wage cut that does not violate their opportunity costs. Wage recontracting is a central pillar of market-centric neoclassical theory and its suppression provides necessary support for Keynes’s fundamental rejection of his Second Classical Postulate as well as for the centrality he assigned to discretionary demand management.
John McDonald (“Keynesian Theory and Policy”, 2009) insightfully assesses Keynes’ take on wage rigidity: “Keynes opposed a policy of wage cuts to restore full employment because they had not been effective and because they were painful.” If McDonald is correct, and the evidence is on his side, Keyes would have embraced the Project’s microfounded MWR if it had ben available to him. The GEM Project eliminates the feasibility of a wage-cut policy by demonstrating that sufficiently timely reductions are not rational. In information-challenged workplaces, the primary home of actual layoffs in response to adverse demand disturbances, such wage reductions cannot exist.
Moreover, Keynes and the GEM Project have more in common that his uncomfortably combined rejection and central use of wage rigidity in The General Theory would suggest. Once, when serving on the Macmillan Committee, the great economist was asked about imperfect labor pricing and economic laws. He replied: “I do not think there is any more economic law that wages should go down easily than they should not.” (Skidelski (2010), p.10) Keynes surely would have been pleased that the GEM Project has finally derived, for highly specialized establishments, the economic law that microfounds meaningful wage rigidity.
Is the Game Worth the Candle?
Endowing Keynes with microfounded MWR completes The General Theory, restoring that work to its previous centrality in modern macroeconomics. Macro theory becomes stabilization-relevant and macroeconomists are restored to their EK status as trusted advisors to policymakers. The cumulative score of the Helping-Hand game: Worth it: 12 (Lewis, Solow, Harris-Todaro, Bernanke, Lucas, Samuelson, Kerr et al, Okun, Hicks, Sraffa, Hayek, Keynes). Not worth it: 0.
As the game is played and the score builds, keep in mind the major objection of mainstream theorists to generalized-exchange macroeconomics: Adding a second (workplace) venue of rational exchange is too much work. Its benefits are not worth the effort. At some point as the GEM helping hand broadly reconstructs rational-behavior modeling to be stabilization-relevant, that argument surely becomes embarrassing.
Blog Type: New Keynesians Saint Joseph, Michigan