From: Robert.Vienneau@launchpad.unc.edu (Robert Vienneau)
Newsgroups: sci.econ
Subject: Re: Inflation
Summary: Discusses developments in Keynes' thought
Date: 6 Jan 93 23:46:01 GMT
Organization: University of North Carolina Extended Bulletin Board Service

In article <1993Jan6.134027.29788@hemlock.cray.com> rja@mahogany126.cray.com (Russ Anderson) writes:
>In article <1id49fINNsok@darkstar.UCSC.EDU>, david@cats.ucsc.edu (David Wright) writes:
>> In article <1993Jan5.152354.16686@hemlock.cray.com> rja@mahogany126.cray.com (Russ Anderson) writes:
>> |From "Free to Choose" by Milton & Rose Friedman, p257:
>> |  You can see why John Maynard Keynes, in discussing the inflations after
>> |  World War I, wrote: "There is no subtler, no surer means of overturning 
>> |  the existing basis of society than to debauch the currency.  The process
>> |  engages all the hidden forces of economic law on the side of destruction,
>> |  and does it in a manner which not one man in a million is able to diagnose."
>> |  (John Maynard Keynes, "The Economic Consequences of the Peace",(1920) p 236)
>> |   ...
>2) While there are certainly many distortions of Keynes views (by both
>   those that agree and disagree with "Keynesianism"), I hope that in
>   this forum we deal with Keynes actual beliefs instead of perpetuating 
>   the distortions of his beliefs.
>Russ Anderson    |  Disclaimer: Any statements are my own and do not reflect
>------------------              upon my employer or anyone else.  (c) 1992
>EX-Twins' Jack Morris, 10 innings pitched, 0 runs (World Series MVP!)

Ah, at last perhaps somebody worth talking to. Russ, I hope you agree
with the following summary of how Keynes changed his mind.

The Friedmans could just as easily have quoted _A_Tract_on_Monetary_
_Reform_. There Keynes accepted the traditional view that the economy
was headed towards a long-run equilibrium position where money does not
matter and all markets clear. His claim was that policy has to worry
about short-run disequilibrium positions, and he tried to offer some
suggestions. It is in this context he made his famous crack, "In the
long run we are all dead." This book comes from the same general point
of view that Friedman later adopted.

The _General_Theory_ (GT) adopts an entirely different theoretical
position, so radical that it is still today hardly known. The GT
analysis is based on equilibrium models set in historical time. Keynes
argues that competitive equilibrium, whether short run or long run, is
perfectly compatible with effects previously assigned to frictions and
disequilibrium. Among these are the failure of labor markets to clear
and the nonneutrality of money. His vision did not change, but it is
only by adopting a new theoretical position that he began to frame tools
to articulate it. For those interested in inflation, the GT is more
appropriate, not less, than traditional theory.

Academic economists, for the most part, have been blind and deaf to the
GT. They created an equilibrium IS-LM model that ignores both the labor
market and prices. They said that Keynes was arguing policy and had no
theoretical innovations. They assigned Keynes' results to traditional
frictions: monopolistic forces in the labor market or disequilbrium
effects. They admitted that Neoclassical equilibrium might take a long
while to reach and that there were coordination problems in the mean
while, but once the labor market and other markets cleared, the economy
would remain in equilibrium. Of course, the GT denies that supply and
demand in the labor market determine wages and employment (Harrod talked
Keynes into toning down this bit).

If none of this is the GT, what is? The key point is that it is about a
"monetary production economy" in which the future is uncertain and the
particpants know this. If you do not what Keynes meant by "uncertainty,"
you do not understand the GT. The key texts are the
_Treatise_on_Probability_ (which I have not read), chapter 12 of the GT,
and his 1937 response to reviewers, especially the second half. in
Keynes sense, uncertainty cannot be modelled by a single probability
distribution or by models that generate ergodic stochastic processes.
And the difference is not captured by the distinction between Bayesian
and classical probability. For example, new classicals models are not
about agents reacting to Keynesian uncertainty. Robert Lucas is totally
cognizant of this fact.

Once one understands Keynes, the policies that have been adopted in his
name or assigned to him seem to be anything but "Keynesian." The "dark
forces" of ignorance and uncertainty are not minimized in a regime of
continuously varying inflation. Nor can politicians be expected to be
able to trade off inflation and unemployment along a stable
relationship, the Phillips curve. (By the early 60s, Keynes' followers
at Cambridge UK had developed models of stagflation.) What Keynesian
policy should be about is modifying institutions and policy rules so as
to ensure the optimal performance the market cannot spontaneously
provide, not ad-hoc "fine-tuning."
                                  Robert Vienneau


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