Download History of Economic Thought Pre-Keynesian business

History of Economic Thought
Pre-Keynesian business-cycle theory
January 5, 2010
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
1
Oct.
26/27
Nov.2Nov. 24
Nov. 11Jan. 4
Jan. 5Jan. 19
Jan. 25Febr. 1
Introduction
Classical Political Economy
The emergence of the science of the market
Markets vs. aggregation
Conclusions
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
2
Markets vs. aggregation
• Pre-Keynesian business cycle theory
• Two short essay presentations
• Niko Steinhoff: Neoclassical Theories of the Business
Cylce
• Johanna Stolze: Is reducing costs the driving force for
innovation?
• Wicksell´s distinction between natural and market rate
• Over-investment theories
• Keynes´s critique
• The Economics of Keynes – a first glance
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
3
Pre-Keynesian business cycle theory and Keynes´s
General Theory
„stylized facts“: during the business cycle
- fluctuations of M*V
- output fluctuations in production goods industries
are more violent than in consumption goods
industries
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
4
Pre-Keynesian business cycle theory and Keynes´s
General Theory
• Over-investment theories („Monetary theories“,
Austrian business cycle theory)
• Under-consumption theories
(GB: John A. Hobson, D: Emil Lederer, CH: Fritz Marbach)
– intertemporal analysis
– proto-Keynesian economic policy conclusions
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
5
Over-investment Theories
• Austrian capital theory
– Temporal production function: productivity of roundabout methods of production
– Production processes are inflexible
– i 1 < i 0 : time preference ↓= lengthening of production
processes
• Wicksell´s distinction between natural and market
rate (of interest)
Knut Wicksell (1851-1926)
Geldzins und Güterpreise (1898)
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
6
Wicksell´s distinction between natural and market rate
r
S
S: supply of (real) savings
I: demand for (real)
investment funds
r: real rate of interest
(productivity / time preference)
r0
I1
I0
S, I
Natural rate:
Market rate:
Prof. Dr. Elisabeth Allgoewer
investment demand = supply of savings
demand for credit = supply of credit
Pre-Keynesian business cycle theory
7
r
S
If:
natural rate = market rate
- goods market equilibrium
- monetary equilibrium
(price stability)
r0
I0
S, I
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
8
r
S
If:
natural rate r1 > market rate r0
- excess demand in goods
markets
- inflationary pressure
r1
r0
I1
→ „real“ effects
„cumulative process“
I0
S, I
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
9
Over-investment theories:
Friedrich August v. Hayek (1931) Prices and Production
Expansion
market rate < natural rate, credit expansion
More round about / capital-intensive production processes
Rising investment goods prices, delayed increases in wages and
consumer goods prices
Upper turning point
Reserves of the banking system are exhausted: market rate ↑
Recession
Bankrupcies, lay-offs, credit contraction
Falling investment goods prices, falling wages and consumer goods prices
Market interest rate declines in the course of the recession
Lower turning point
When market rate < natural rate
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
10
Crisis
- production processes are designed to be more
round-about / capital intensive than real time
preferences in the economy allow to finance
- therefore: „too little is saved“ (in relation to
investment projects under way)
→ crisis is characterized by:
over-investment = under-saving = over-consumption
→ economic policy conclusion
increase savings, reduce consumption
(deficit financed government spending compounds
the crisis)
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
11
Over-investment theories
• Benchmark: intertemporal equilibrium
• Disrupted by credit expansion (information and
coordination failures in credit markets)
• The expansion is a deviation from intertemporal
equilibrium
• The crisis is necessary to „purge“ the economy of
the „excesses“ of the expansion and boom
• Market forces bring the economy back into
intertemporal equlibrium
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
12
Pre-Keynesian business cycle theory
• Pre-Keynesian business cycle theory
• Wicksell´s distinction between natural and market rate
• Over-investment theories
• Keynes´s critique
• The Economics of Keynes – a first glance
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
13
Pre-Keynesian business cycle theory and
Keynes´s General
Theory
• Analysis of effective (macroeconomic) demand
(rather than disaggregated individual markets)
• Short-term macroeconomic equilibrium
(instead of intertemporal equilibrium)
• Employment / Output: focus is on quantities
(rather than prices)
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
14
Back to Wicksell:
r
S
If:
natural rate r1 > market rate r0
- excess demand in goods
markets
- inflationary pressure
r1
r0
I1
→ „real“ effects
„cumulative process“
I0
S, I
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
15
Underlying assumptions:
• Goods market equilibrium (determined by
investment demand and savings supply): shortterm deviations from equilibrium positions do not
change long-term equilibria
• frictions in the market mechanism (information and
coordination failures) lead to short-term monetary
and real effects
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
16
Keynes critique:
Short-term deviations from the goods market
equilibrium change the equilibrium positions
(especially: changes in income lead to changes in savings)
→ analysis of short-term effective demand
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
17
Keynes, J.M. (1936) The General Theory of Employment, Interest and Money, p. 180
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
18
The Keynesian Cross
(graphical analysis developed by Paul Samuelson)
• Changes in investment demand
• Multiplier effects lead to quantity (rather than price)
adjustments
• Short-term equilibrium: output and employment
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
19
Conclusions
Economic policy:
The market economy (based on private property and
competive markets) is not inherently stable.
Economic theory:
The interest rate can not be determined from I = S.
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
20
Pre-Keynesian business cycle theory – and
Keynes´s General Theory
• Pre-Keynesian business cycle theory
• Wicksell´s distinction between natural and market rate
• Over-investment theories
• Keynes´s critique
• The Economics of Keynes – at the first glance
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
21
• Interest rate determination in the GT
– liquidity preference and the portfolio decision
– uncertainty
• the investment decision
– marginal efficiency of capital and uncertainty concerning
the returns on real investment
– (monetary) interest rate as opportunity cost
• (volatile) investment demand determines
aggregate demand
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
22
Economic policy conclusions (again)
Fiscal policy (increase in government expenditure)
vs. monetary policy
(vs. downward wage flexibility)
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
23
The Economics of Keynes
• „macro-economics“
• short-term analysis („In the long run we are all dead.“)
• monetary and real factors determine employment
and output
• S = I (ex post)
• monetary interest rate explanation
(Denis Robertson: boot strap theory)
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
24
Next session:
Prof. Dr. Elisabeth Allgoewer
Keynes and Keynesianism
20th century developments
Pre-Keynesian business cycle theory
25
John Maynard Keynes
1884
Marshall becomes
Professor of Political
Economy at Cambridge
University
1901
First wireless transatlantic
telegraph connection
1885
Indian National
Congress
1890
1880
June 5, 1883
John Maynard
Keynes is born
in Cambridge,
England
1914 - 1918
First World War
1899
Bloomsbury Group
comes into being
1910
1900
1902 - 1906
Studies in philosophy,
mathematics and history,
King’s College, Cambridge
1906-1908
Employment
at the India Office
(British administration)
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
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1931
Britain abandons
gold standard
1926
Britain returns
to gold standard
1917
Breakdown of
Russian monarchy,
October Revolution
1929
Stock market crash
in the USA,
beginning of
Great Depression
1919/20
Versailles
Peace Treaty
Germany:
1923
Hyperinflation
1920
1910
1939
Beginning
of the Second
World War
1930
Comments of Keynes’
Cambridge “Circus”
on Treatise
1930
1940
1908
Becomes lecturer in economics
at King’s College, Cambridge
1944
1925
1929
Keynes heads the
Marriage to
Acquaintance with
British delegation
ballerina
Ludwig Wittgenstein
at the Bretton Woods
Lydia Lopokova
1936
conference
1919
1911 - 1945
“The General
“The Economic
Editor of the
Theory of
Consequences
“Economic
Employment,
of
the
Peace”
Journal”
Interest and Money”
published
1915
published
1930
April 21, 1946
Adviser to the
“Treatise
on
Keynes dies in
British finance
Money”
Tilton, Sussex
department
Prof. Dr. Elisabeth Allgoewer
Pre-Keynesian business cycle theory
27
John Richard Hicks
1936
Keynes publishes
“The General
Theory of
Employment,
Interest and Money”
1906
Vilfredo Pareto
“Manual of Political Economy ”
1922
Dennis
Robertson
publishes
“Money”
1929
Lionel Robbins becomes
the head of the economics
department at LSE
1920
1910
April 8, 1904
John Richard Hicks
is born in Warwick, England
1930
1917-22
Studies at Clifton College
in Bristol
1922-26
Studies mathematics
at Balliol College in Oxford
1923
Hicks reads "Philosophy,
Politics and Economics“
1939
Eric Lindahl
“Studies in the
Theory of Money
and Capital“
1940
1932
“The Theory of Wages”
1939
1935
“Value and Capital”
Marriage with
Ursula Webb 1937
“Mr. Keynes and the
classics” published
1935-38
Lecturer at Cambridge Uni.,
work on “Value and Capital”
1926-35
Hicks teaches at the
London School of Economics
Prof. Dr. Elisabeth Allgoewer
1939-45
World War II
1929
Beginning of the
Great Depression
Pre-Keynesian business cycle theory
1938-46
Professor at
Manchester University
28
1947
Marshall Plan
established
1943
Maurice Allais
“A la recherche
d'une discipline
economique“
1944
Abba Lerner
“Economics
of Control“
1957
Treaty of Rome
1968
Prague Spring,
student protests
1959-75
in Europe
Vietnam War
1973
1st oil crisis
1980
1st Gulf War
1979
2nd oil crisis
1954
Kenneth Arrow, Gerard Debreu
"Existence of an Equilibrium
for a Competitive Economy“
1947
Paul Samuelson
“Foundations
of Economic Analysis“
1950
1946-65
Research fellow
at Nuffield College,
Oxford
1952-65
Drummond Professor of
Political Economy at All
Souls College, Oxford
1950
Member of the Revenue
Allocation Commission
in Nigeria
Prof. Dr. Elisabeth Allgoewer
1971
Kenneth Arrow, Richard Kahn
“General Competitive Analysis”
1960
1980
1970
1965-71
Research fellow at
All Souls College,
Oxford
May 20, 1989
Hicks dies
in New York
1964
Hicks is knighted
1960-62
President of the Royal
Economic Society
1972
Nobel Prize
together with
Kenneth Arrow
Pre-Keynesian business cycle theory
29
Milton Friedman
1919-46
Jacob Viner is professor
at the Chicago University
1929
Beginning of the
Great Depression
1929-30
Federal Reserve system
allows the quantity of
money to decline
1945
World Bank
established
1936
John Maynard Keynes
“The General
Theory of Employment,
Interest and Money”
1921
Frank Knight
“Risk, Uncertainty
and Profit“
1910
1920
July 31, 1912
Milton Friedman is born
in New York
1930
1928
Rutgers University
Mathematics and
Economics
1933–34
Fellowship at
Columbia
University
1932
Studies at the
University of
Chicago
1944
Bretton Woods Conference
1950
1940
1937
Work at the
National Bureau of
Economic Research
1934–35
Research assistant
to Henry Schultz,
lifelong friendships
with George Stigler
and Wilson Allen Wallis
1938
Marriage with
Rose Director
Prof. Dr. Elisabeth Allgoewer
1944
IMF established
Pre-Keynesian business cycle theory
1946
Lecturer at the
University of
Chicago
1943
Joins the Division of
War Research
at the Columbia
University
1947
Founding member
of the Mont
Pèlerin Society
30
1965-75
Vietnam War
1976
1981-82
Lucas publishes
Monetary crisis in the US
“Econometric Policy
Evaluation: A Critique”
1973
Military coup in Chile,
beginning of the
1st Miracle
1968
Prague Spring,
Student protests
in Europe
1970
1953
“The Methodology
of Positive Economics ”
1973
1st oil crisis
1962
“Capitalism and
Freedom” published
1979-90
Thatcher Prime
Minister of
Great Britain,
“Thatcherism”
1979
2nd oil crisis
1966-84
Weekly columns for
Newsweek magazine
Prof. Dr. Elisabeth Allgoewer
1981-89
Ronald Reagan
President of the US,
“Reaganomics”
1980
1975
Visit to Chile,
Lecture on principles
of economic freedom
1963 with Anna Schwarz
“A Monetary History
of the United States –
1867-1960”
1998
Foundation
of ATTAC
in France
1989
Berlin Wall
falls
1996
Catherine Caufield
publishes „Masters
of Illusion: The World
Bank and the Poverty
of Nations“
2000
1990
1981
Member of the
Council of
Economic
Advisors
to the President
1988
Receives the
Presidential Medal of
Freedom and the
National Medal of Science
1976
Nobel Prize
1980
Television program
“Free to Choose”
aired on PBS
Pre-Keynesian business cycle theory
November 16, 2006
Friedman dies
in San Francisco
31