Hicks’ misrepresentation of Keynes — the Wicksellian connection6 September, 2016 at 12:56 | Posted in Economics | 1 Comment
Having read my post on Krugman and Hicks’ IS-LM misrepresentation of Keynes’ theory, professor Jan Kregel kindly sent an unpublished article he wrote back in 1984 — The Importance of Choosing a Model: Hicks vs. Keynes on Money, Interest and Prices — in which it is argued that Hicks’ particular presentation of Keynes’ theory and choice of model was “crucial to its destruction”:
Hicks’ choice of model led to a presentation of Keynes’s theory which implicitly required either 1) the operation of the liquidity trap, or 2) the assumption of unchanging prices, for a horizontal LM curve represented stable prices in conditions of perfectly elastic supply of consumption goods. As already noted, the IS-LM framework makes no reference to any supply conditions, except the supply of savings. Although neither of these positions represented Keynes’s model, nor were they ever accepted by Keynes, despite Hicks’s suggestions to the contrary, they have become the standard representation … Indeed, both Friedman and Tobin accept a positive slope for the LM curve, rejecting a vertical or horizontal curve. But, as Hicks’s article pointed out, in this case there is no difference between Keynes’s method and the “ordinary method of economic theory” …
Indeed, having, shown that Keynes does not differ significantly from the Classics, Hicks proceeds:
“Mathematical elegance would suggest that we ought to have Y and i in all three equations, if the theory is to be really General. Why not have them there like this:
M = L (Y, i) Ix = f (Y, i) Ix = S(Y, i)?”
While Hicks was eager to add the i for the money rate of interest to all three relations, his eagerness led him to overlook the fact that his “generalised” General Theory used two rates of interest, the money rate, I, and the investment rate, or the “natural rate”, call it r, which determines the slope of the IS curve!
It is interesting to note that this was precisely the distinction that Keynes called attention to when he suggested his own view of the difference between his theory and the Classics. Keynes identifies the classical theory as considering the rate of interest as a non monetary phenomenon: the r given by the horizontal IS curve. But in Wicksell’s theory this would lead to either cumulative inflation or deflation, depending on whether the IS curve lay above or below the horizontal LM curve. Hicks’s innovation may then be seen as making Wicksell’s explosive system into a determinate equilibrium by means of his assumption of a given supply of money which assures a slope to the LM curve.
But, in such a scheme it is the money rate, i, which must adjust in equilibrium to the natural, real or investment rate of interest. This is just the opposite of Keynes’s expression of his own position! (as well as contradicting Keynes’s belief in the endogeneity of the money supply).
Added to the arguments put forward in my own blog post, this certainly reaffirms the view that Hicks’ IS-LM model(s) gave very little insights to Keynes’ theory.