Today’s scripture is 1 Kings 17:16: “For the jar of flour was not used up and the cruse [jug] of oil did not run dry, in keeping with the word of the LORD spoken by Elijah.” The miraculous flour jar and olive-oil cruse belonged to the widow of Zarephath whom God had promised would not go hungry. Once translated by John Maynard Keynes (1930) into economist-speak, the “widow’s cruse” hypothesis took root, arguing that absent full employment macro profits (think business retained earnings) move in lockstep with increases in investment and consumption out of profits. That consumption fuels product-demand and profits of other businesses. From Keynes: “however much of their profits entrepreneurs spend on consumption, the increment of wealth belonging to entrepreneurs remains the same as before. Thus profits, as a source of capital increment for entrepreneurs, are a widow’s cruse which remains undepleted however much of them may be devoted to riotous living.”
While Keynes’s talent for colorful argument grabs the attention, the basic idea was taken very seriously. Richard Kahn later claimed the “widow’s cruse” phenomenon was the most substantive issue in the on-going discussions of the so-called Cambridge Circus, a group of young (eventually prominent) economists who met at the University to discuss Keynes’s theories. The context, of course, was the neoclassical one-way causality mandating that movement in saving generates a same-direction proportionate response in investment.
Somewhat later, Michal Kalecki (1942), a Circus participant, developed a more general version of the widow’s-cruse model. Kalecki restricted his model by assuming unchanged prices, confining the action to quantity (output and employment) adjustments. Whenever that model-building strategy occurred, it provided antecedents for the GEM Project. Like Keynes, Kalecki’s basic identity makes profits equal to investment plus consumption out of profit, given the assumption that all wages are all spent on consumption.
A bare-bones summary of his widow-cruse macrodynamics begins with a total-spending equation (Y=C+Į) in circumstances of under-utilized capacity. Model mechanics are rooted in a simple income-distribution model. Wage (W) and capital (П) incomes are separated. All of the former is assumed to be spent on consumption goods, while only a portion out of the latter is consumed and the remainder of profits are invested:
Y=W+bП+Į, such 1<b<0;
Within a framework of product-price rigidity, the multiplier (I/(1−b)) propagates nominal disturbances. Investment and consumption decisions determine profits, not vice-versa. (A catchy, albeit crude, version of Kalecki’s conclusion is: Capitalists earn what they spend, and workers spend what they earn.) The “widow-cruse” outcome disappears at full-capacity utilization.
Kalecki’s effective-demand theory employs three assumptions to construct a context for the necessary price rigidity. First, perfect competition does not exist. Second, average variable costs of production are constant up to full employment. Third, firms set product prices in relation to their average variable costs and their industry’s prevailing price. Providing additional GEM antecedents, his core idea is rooted in the size distribution of enterprises and is compatible with Alfred Chandler’s new corporate forms mandated by the Second Industrial Revolution. Kalecki interpreted modern large firms as characterized by industrial concentration, vertical integration, product diversification and oligopolistic market coordination that combine to endow individual firms with discretionary market power with which they fix prices. (Note that the absence of meaningful wage rigidities in his analysis implies that his analysis, like Keynes’s The General Theory, cannot rationally generate involuntary job loss.)
In Kalecki’s model, explaining the swings in unemployment is reduced to explaining movements in investment spending. Both cyclical recessions and nonstationary stagnations are the outcome of inadequate spending out of retained earnings. Looked at another way, a decrease in the propensity to save leads to higher rates of output growth and higher rates of profit. The widow’s cruse is the fixed-price equivalent of the better-known paradox of thrift. The short-run version of the paradox of thrift equivalently asserts that individual efforts to increase saving will be frustrated by unintended consequences. In particular, output will fall, as outlined by Keynes in 1936.
The point of this sermon is familiar, as many sermons tend to be. Microfounding MWR enables the most efficient, insightful approach to constructing stabilization-relevant rational-behavior macroeconomics and to establishing the centrality of the discretionary management of effective demand.
Blog Type: Wonkish Saint Joseph, Michigan