Is the economic system self-adjusting?

12 July, 2017 at 13:15 | 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.”


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 towards full employment levels.

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)



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  1. One of the problems that I have with the economic mainstream is that it often conflates many different issues, so that discussions with some mainstreamers seem to me to end in their stubborn insistence on non-sequiturs.

    My own view is that through 2005-2010 the global economy was largely self-adjusting, with Gordon Brown’s intervention at the nexus of the crisis being a possible exception. On the other hand, the UK’s railway boom seemed (like all booms) to be driven by a form of money-madness, and it still has a huge impact on our economy today.

    More sensible mainstreamers merely claim that most of the time we may as well reason ‘as if’ their dogmas were actually true. I don’t particularly dissemble from that, just so long as we recognise when the occasion demands a different view.

    For example, any argument that concludes that current inequalities cannot be corrected is, for me, time to critique the mainstream assumptions. Keep it up.

  2. AS-AD is such a lazy and uncritical notion that it is difficult to be other than dumbfounded to see Krugman speak of it approvingly. AS-AD tells us nothing true about the actual economy, but it is proof of the intellectual bankruptcy of neoclassical economics. It is the triumph of convention over thought.

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