Keynes on ‘money neutrality’ and the ‘classical dichotomy’

22 April, 2017 at 19:06 | Posted in Economics | 2 Comments

Paul Krugman has repeatedly over the years argued that we should continue to use neoclassical hobby horses like IS-LM and AS-AD models. Here’s one example:

So why do AS-AD? … We do want, somewhere along the way, to get across the notion of the self-correcting economy, the notion that in the long run, we may all be dead, but that we also have a tendency to return to full employment via price flexibility. Or to put it differently, you do want somehow to make clear the notion (which even fairly Keynesian guys like me share) that money is neutral in the long run.

I seriously doubt that Keynes would have been impressed by having his theory being characterized with catchwords like “tendency to return to full employment” and “money is neutral in the long run.”

alfa

One of Keynes’s central tenets — in clear contradistinction to the beliefs of mainstream neoclassical economists — is that there is no strong automatic tendency for economies to move toward full employment levels in monetary economies.

Money doesn’t matter in mainstream neoclassical macroeconomic models. That’s true. According to the ‘classical dichotomy,’ real variables — output and employment — are independent of monetary variables, and so enables mainstream economics to depict the economy as basically a barter system.

But in the real world in which we happen to live, money certainly does matter. Money is not neutral and money matters in both the short run and the long run:

The theory which I desiderate would deal … with an economy in which money plays a part of its own and affects motives and decisions, and is, in short, one of the operative factors in the situation, so that the course of events cannot be predicted in either the long period or in the short, without a knowledge of the behaviour of money between the first state and the last. And it is this which we ought to mean when we speak of a monetary economy.

J. M. Keynes A monetary theory of production (1933)

Advertisements

2 Comments

  1. Didn’t Keynes also point out that in the long run we are all dead?

  2. Really, anyone propagating AS-AD has completely lost the thread and should probably stop pretending to be an economist. The idea that there can be a supply or demand curve for a single product is questionable; the idea of aggregate supply or demand, let alone equilibration, not by price (of a single product) but by a price level!! requires a suspension of critical thinking such as might be accomplished only by a frontal lobotomy.
    .
    It is not that I object to the idea of a self-correcting economy — though I do. The economy distributes decision-making in a loosely coupled fashion — it isn’t an inanimate machine lurching into motion only when the policymaker kicks it. Money is a key means to facilitating that loosely coupled distributed decision-making. Money enables calculating, hedging, deal-making, money creates a fictional bridge to the future. Krugman, as the OP surmised, wants to dismiss money. Economists have no more important role as experts in the economy that as the experts managing a fiat money and Krugman wants to teach them money does not matter. That will work out well.


Sorry, the comment form is closed at this time.

Create a free website or blog at WordPress.com.
Entries and comments feeds.