Download Short period and long period in macroeconomics: an awkward

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PKSG SEMINAR
JUNE, 5TH 2012
SHORT PERIOD AND LONG PERIOD IN
MACROECONOMICS: AN AWKWARD
DISTINCTION
ELEONORA SANFILIPPO
(UNIVERSITY OF CASSINO, ITALY)
Robinson College, Cambridge
Introduction
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I was kindly invited here by Dr. Hayes to present my
paper on the use of the notions of Short Period and
Long Period in Macroeconomics – a paper which has
recently been published in the Review of Political
Economy (Vol. 23, n. 3, pp. 371-388, July 2011).
This publication represents a further development of a
research that I started many years ago, at the time
when I wrote my PhD thesis (in 2000) on the notion of
equilibrium in Keynes’s General Theory.
The aim of the paper
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The aim of the paper is to show that the meaning of the
concepts of short period and long period is often
unclear and may be seriously misleading when applied
to macroeconomic analysis.
What seems particularly difficult to grasp is the exact
content to be given to them, as well as the analytical
assumptions underlying them.
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One of the main problems seems to lie in the
fact that the meanings attributed to these
methodological tools change accordingly to the
different macroeconomic models and
approaches, making comparison between them
very difficult.
Short and long period in microeconomics:
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As is well-known, in microeconomic analysis both concepts
refer to the equilibrium position of a firm or industry. To
put it in a very simple manner, the short period is defined
as a context in which the productive capacity is given and
what can vary with the fluctuations in demand is the
intensity of the use of this given capacity;
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while the long period is a framework in which
the productive capacity can change to adjust
to variations in the level of demand. This
distinction (as originally conceived by Marshall)
was essentially linked to the ‘length’ of time
necessary for the adjustment of supply to
demand conditions in each specific market.
No confusion arises in microeconomic
analysis
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In microeconomics the meaning of short period and
long period is clearly identified and any scholar
can refer to these concepts with enough
confidence that no misunderstandings can arise.
My fundamental point is that these definitions
become much less clear and more controversial
when we move to macroeconomics.
The confusion in macroeconomics: two evidences
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To show the ambiguities arising when the concepts of short
period and long period are employed in an aggregate
framework, I provide two main evidences:
(i) one is given by the interpretative debate (which took
place in the 1980s and 1990s) aiming at establishing
whether Keynes’s General Theory should be considered as
a short- or long-period analysis of the aggregate level of
output;
(ii) the other by the different uses (or misuses) of these
concepts that are currently made in macroeconomics
textbooks (see for example Stiglitz 1997, Krugman-Wells
2005, Lipsey-Crystal 2006, Blanchard 2009).
The 1980s and 1990s debate
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Let me start with a brief recollection of the debate.
Although Keynes’s General Theory has been widely
considered as a ‘short-period’ analysis, it is easy to
detect in the literature two different types of shortperiod interpretations, which refer to two different
contents (or definitions) of ‘short period’:
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(1) The ‘Neoclassical’ interpretations of Keynes’s model which are, by far, the best known (e.g. Modigliani 1944,
Klein 1947, Meade 1978). They impinge on what has
been called by Leijhonhufvud (1968) the ‘imperfectionist
view’, which is based on the assumption that, once given
enough time to change variables, like the wage level, kept
‘in the pound’ in the short period, the economic system
necessarily tends in historical time towards an optimal
long-period equilibrium, by means of automatic
mechanisms.
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From the perspective of the present paper we include
under this group the New Keynesian interpretations of
Keynes’s model (Lindbeck and Snower, 1986, Shapiro
and Stiglitz 1984) but also those interpretations that
define Keynes’s unemployment equilibrium as a
‘disequilibrium’ position (Clower 1965, Barro and
Grossman 1976, Malinvaud 1977).
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Indeed all these contributions share the idea that
unemployment emerges as a short-period
phenomenon due to the existence of various
rigidities in the economic system and they also share
the implicit or explicit assumption that in the long
period these rigidities will disappear and the
economy will naturally tend to a full employment
level of output.
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(2) The Post-Keynesian interpretations which, referring to
Marshall’s original framework, consider the General
Theory as an application, or extension, of the Marshallian
‘short-period’ to an aggregate framework (see for
example Davidson 1978, Asimakopoulous 1989, Lim
1990). Differently from the Neoclassical ones, these
interpretations do not adhere to the view that
unemployment will be necessarily re-absorbed in the long
period. On the whole, the Post-Keynesians do not attribute
so much importance to the concept of long period.
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Beside the short period interpretations of Keynes’s model
we find in the debate also a different interpretative
approach (taken by Eatwell and Milgate 1983), which
associates Keynes’s equilibrium with ‘a long-period
position of classical type’ (contra see Garegnani,
1983).
And finally we should also mention other interpretations
(for example by Nell 1983, Bhattacharjea 1987,
Carvalho 1990, Amadeo 1992, Park 1994), which
extend the relevance of Keynes’s theory to the long
period, all grounding on textual and/or analytical
elements that are present in the General Theory.
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The debate just recalled is, according to me, a
particularly telling example (and proof) of the
ambiguous meanings attributed to short and long
period in macroeconomics and of the difficulties of
communication among different theoretical
approaches in macroeconomics, due to the lack of a
common ground even at a purely semantic level.
Short period in macroeconomics
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Looking also at the macroeconomics textbooks, it emerges that:
The short period is usually associated to a given quantity of
capital (as in microeconomic analysis) and/or to a rigidity of
prices and wages.
Very often it is also identified with a situation in which a
differential exists between actual and potential output (the
latter being understood as a full employment and stable
position).
Sometimes but not always the short period is also meant to
describe simply a situation of short duration in calendar
time.
Long period in macroeconomics
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The long period is sometimes associated with the full
flexibility of prices and wages but – strangely enough
– also with the assumption of an unchanging capital
(differently from the definition of the long period in
microeconomics), and refers to a context in which there
is equality between the actual output and a given
potential output (Think for example to the AS-AD
model).
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Sometimes it refers to a context of growth of
potential GDP and changes in productive capacity
(growth models).
Very often but not always the long period is
identified with the achievement of a full
employment position (in which change is ruled out),
provided that a ‘sufficient’ – but not univocally
specified - length of time is given to the selfadjusting mechanisms to operate.
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The list is not complete because we can also consider
the Neoricardian models of growth, wherein the
long period positions are not conceived as full
employment positions but simply as situations in
which the productive capacity is adjusted to the
level and composition of demand.
It is possible, in my view, to reduce this variety of
meanings basically to two different ways of
conceiving the long period:
Two different ways of conceiving the
long period
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(i) one as a dynamic context characterized by
changing capital, where some fundamental forces
are at work and some fundamental tendencies can
be detected;
(ii) the other as a final position, possessing some
specific characteristics, where there are no
incentives to change or where opposite forces
counterbalance.
The problem of a ‘given capital’
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It seems quite evident, therefore, that one possible source
of ambiguity derives from the use of the same wording
to refer to two different things: the gravitation process
towards a final position and the final position itself.
Obviously in the former, the capital cannot be conceived
as given neither in quantity nor in form during the
gravitation process, while in the latter it is possible to
assume a condition of given capital stock, since all
changes have already happened.
The main source of ambiguity
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My opinion is that, beside what can be considered as a
terminological confusion, there is also a conceptual
ambiguity which relates to the distinction itself.
Two uses of these concepts in fact seem to me to be
juxtaposed:
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(i) One in which the distinction is purely logical and some
analytical characteristics are supposed to distinguish the
short from the long period, without necessarily referring
to a particular duration in historical time.
(ii) The other in which the distinction is, instead,
chronological in the sense that a specific length in terms
of calendar time is attributed respectively to the short
and long period and that it is with the mere passing of
time that the system goes from the former to the latter.
Possibles explanations
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The paper also suggests two possible explanations for the
ambiguities arising when the distinction between short run
and long run is employed in macroeconomics:
one has to do with the fact that these tools were originally
introduced by Marshall at a micro level and cannot easily be
extended to a macroeconomic context of the analysis
another seems to derive from the habit – which Keynes firstly
criticized (Collected Writings of JMK, vol. XXIX: 54-55) – of
identifying the long period with an ‘optimal’ position.
Difficulties in adapting the Marshallian
distinction at a macro level
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Let me examine first the difficulties arising in the
application to aggregate models of methodological
tools ‘invented’ for the partial equilibrium analysis.
In the case of a single firm or industry the assumption
of a given productive capacity takes on a definite
and concrete meaning, and the short period as a
logical device can also have a definite
chronological duration.
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On the aggregate level instead you can still apply a
logical short period but it is far more difficult to
give it a content in terms of historical time. One
year can be a ‘short period’ for some industries and
a ‘very long period’ for some others, in which the
physical capital can be far more easily adjusted
over a span of the year.
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As far as the second explanation is concerned, it was
Keynes himself who, in the preparatory works of the
GT, criticized – as a source of confusion - the
erroneous identification between the long period
and optimal positions:
‘…there is no reason to suppose that positions of
long-period equilibrium have an inherent tendency
or likelihood to be positions of optimum output’
(CWK, vol. XXIX: 55).
Keynes’s ‘ceteris paribus’ method
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Let me now clarify Keynes’s method by recalling this
fundamental and well-known passage of the GT:
“We take as given the existing skill and quantity of available
labour, the existing quality and quantity of available
equipment, the existing technique, the degree of competition,
the tastes and habits of the consumer, the disutility of different
intensities of labour and of the activities of supervision and
organisation, as well as the social structure including the forces,
other than our variables set forth below, which determine the
distribution of the national income” (GT: 245).
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It is fundamentally on the basis of this passage
that the General Theory has been interpreted
as a short-period model.
My claim is that applying the distinction between
short and long period to the interpretation of
Keynes’s method of analysis proves not
particularly useful and, on the contrary, a
source of misunderstanding.
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I do not deny that the hypothesis of a given productive
capacity is used by Keynes, nor that the General
Theory is mostly built on this assumption. The idea
suggested here is that this assumption should not be
linked to the traditional distinction between short- and
long-period analysis at a disaggregate level but
should be considered simply as an application of the
ceteris paribus method, as a logical device to cope
with continuous changes taking place in economic
reality.
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This is why in Keynes’s model the assumption of fixed
plants does not seem linked in any significant way
to the length in historical time of the period
considered in the analysis. The lack of this link can
be attributed to the awareness by Keynes of the
crucial role played by ‘fundamental uncertainty’ in
the economy, and to the need to take this element
into account at both the analytical and
methodological levels.
An awkward distinction in macroeconomics
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The difficulties related to the existence of several
meanings attributed to the long period (and to its
distinction from the short period) are still there in modern
macroeconomics literature.
In the Neoclassical interpretations of Keynes’s model the
long period is simply a context in which the rigidities are
relaxed, and unemployment absorbed, while the level of
capital is still given in the economic system.
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In the neoclassical theory of growth, on the other
hand, the long period is a position of full
equilibrium both of labor and capital, towards
which the system tends, if enough time is given
to the adjustment mechanisms to operate.
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In the Post-Keynesian approach the traditional
concept of long-period intended as a
gravitation centre is rejected in favor of an
analysis of structural dynamics, in which the
effects of changes in the level of capital are
fully considered but the introduction of the
uncertainty à la Keynes makes indeterminate
‘the final point’ the system will reach in its
evolution through time.
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In the Sraffian or Neo-Ricardian approach the long-period
position is derived from the classical theory and considered
as a point of attraction for the system in real time, even
though full employment is not guaranteed.
Finally, we can just mention the ‘rational expectations’
approach à la Lucas, where the short period is simply
identified with a context in which people do not revise their
expectations, while the long period is a context in which,
thanks to the revision process, economic agents are able to
capture the underlying structure of the economy, which
basically coincides with the walrasian equilibrium framework.
Conclusions
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My provocative suggestion is:
do not apply this distinction in macroeconomics – where it is
a source of confusion and misunderstanding – but use the
‘ceteris paribus method’, where the given factors,
independent and dependent variables are made explicit in
each model in use, according to the specific quaesitum of
the analysis.
This is exactly what Keynes did in his General Theory (Ch.
18), where he never made reference to the distinction
‘invented’ by his Master, we may guess because he was
fully aware of the difficulties arising when it is applied to
models and contexts other than those assumed by Marshall
himself.
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In his biographical essay on Marshall, Keynes
referring to short and long period concepts wrote:
‘All these are path breaking ideas which no one who
wants to think clearly can do without. Nevertheless
this is the quarter in which, in my opinion, the
Marshall analysis is least complete and satisfactory,
and where there remains most to do’ (Keynes 1924:
351).
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I hope that my discussion reveals just how
well-founded this observation by Keynes
eventually proved to be.
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THANKS