Download Antal Mátyás: The Harmony of Real Economy and Financial

A N TA L M ÁT Y Á S : T H E H A R M O N Y O F R E A L E C O N O M Y. . . 2 0 0 5 / 3 ( 7 6 – 7 9 )
ANTAL MÁTYÁS
The Harmony of Real Economy
and Financial Equilibrium
Remarks on the Article by György Szakolczai
György Szakolczai wrote an erudite article on the nesian model reduced to 3 equations each, and in
system of IS–LM curves in 2005/1 issue of De- the equations representing Keynesian thoughts
velopment and Finance. In the article he gives a he depicts investment as being almost unambigreview of the fundamental work by Hicks writ- uously reliant on the interest rate. Expectations
ten in 1937, then goes on to give an account of as to the potential yield of capital are missing
modern versions of the system of curves. He from the equations in their entirety.
On the other hand, Hicks only puts down the
proves that though the intention behind the system of curves is to depict the pioneering thoughts equation between actual saving and investment,
of Keynes, his revolutionary ideas go unnoticed. he makes no distinction between ex ante and ex
Hicks was convinced that by establishing the post saving and investment. One possible excuse
system of IS-LM curves, he had created the might be that Keynes applied the same method,
mathematical basis for the integration of Key- making no explicit but only implicit reference to
nes’s General Theory and the Walras model, that the aforementioned factors.
For this reason, this differentiation is also abis for neo-classical synthesis.
Szakolczai points out that in the article on IS- sent from the Keynes-interpretation of Farkas
LM curves written by Hicks in 1937, the LM Heller, who therefore drew false conclusions recurve will most probably be nearly horizontal on garding the explanation given by Keynes for the
the left and nearly vertical on the right. Therefore, grave problems of capitalism he had discovered.1
if the IS curve is rather positioned on the right,
Then, Szakolczai says, Hicks rewrites the three
the point of intersection will be found on the as- equations describing the theory of Keynes. Nacending part of the curve, which gives a good ap- tional income and the interest rate also feature in
proximation of the classical theory; by contrast, if the rewritten versions of all three equations. Acthe intersection is on the left-hand side of the cording to the justification given by Hicks, this
curve, the special shape of Keynes’s theory will be change, the inclusion of i and Y in the three equavalid. Accordingly, the increased demand on the tions, was necessitated by mathematic elegance,
latter section encourages production, while on the to make the theory really general. However, acother section it increases prices. All this boils cording to Szakolczai this alteration is a huge step
down to the conclusion that in the
back towards neoclassical theory,
abstract world of IS-LM curves,
since Keynes does not depict savAntal Mátyás,
depending on their shape and poings (and consumption) as a funcordinary member of the
sition, we either come to a neoclastion
of the interest rate. It was not
Hungarian Academy
by
accident
that Robinson, a faithsical or Keynesian result.
of Sciences, professor
Szakolczai sensibly shows that
ful
follower
of Keynes, called the
emeritus (Corvinus
Hicks in his article of 1937 deHicks-system of IS-LM curves as
University of Budapest)
‘bastard Keynesianism’.2
scribes the neoclassical and Key-
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In the discussion of the modern use and problems of IS–LM curves, and in the model described by Szakolczai the concept of target income appears, and the model elucidates the impacts of fiscal and monetary policy. According to
Szakolczai this very simple way of demonstration
is the reason for the widespread application of
IS–LM analysis. However, I do not understand
the statement that the popularity of the IS-LM
system was enhanced by the fact that Keynesian
instruments proved to be insufficient to depict
stagflation triggered by repeated oil price explosions, the permanent deficit of public finances,
growing indebtedness and the increasing interrelation between national economies. How could
this be done by applying the IS-LM curve today?
It is still a valid claim that in these models the
central role is played by interest rates. This, according to Szakolczai, is neither Keynesian, nor
realistic. The author rightly concludes that similarly to the Hicks model of 1937, the discussed
new models are also erroneous in making ex ante
and ex post investment and savings equal in the
case of IS curves, i.e. these models assume that
the mechanisms function, without drawing a distinction between ex ante and ex post volumes.
Further criticism regards only the more recent
form of the system of curves. The interrelation expressed in the IS-LM system is not symmetrical in
Hicks’ article (1937). It displays different characteristics under and around the level of full employment. The modern analysis by comparison is
symmetrical, and demonstrates IS-LM curves
with straight lines, as in nearly every textbook today. The idea behind this is that the economy automatically stabilises at around full employment.
Szakolczai is right in concluding that this makes
the entire Keynesian problem area fall outside the
scope of the analysis. Nevertheless, the European
economy and all developing economies have long
been performing under the level of full employment. On the other hand, I do not understand the
statement that this consideration limits the applicability of the IS-LM model to present-day American economies. As if the phenomenon of longterm unemployment was unknown there.
Szakolczai correctly raises the need for the
most important economic policy variables to ap-
pear as independent variables in the analysis, since
it is untenable to identify the rate of interest as the
only economic policy variable on which national
income depends. This requires a functional and at
least theoretically quantifiable relation in the
model between the most important economic
policy variables and result variables. In the IS-LM
analysis economic policy variables do not impact
functionally but through the shifting of curves.
Szakolczai finally concludes critically that due
to the listed shortcomings, macroeconomic correlations cannot be simplified and demonstrated
by a Marshall-cross, as opposed to microeconomic correlations. The IS curve does not have such
a tangible and quantifiable content. The same applies to the LM curve as well. Consequently, the
analysis is a smart theoretical instrument suitable
for demonstration purposes, but obviously it is
not applicable in order to conduct quantitative
investigations or lay the foundations for economic policy decisions.
In the last chapter Szakolczai provides basic
principles for future work: return to the detailed,
taxonomic Keynesian analysis; stick to concrete
and quantifiable correlations, he mentions the
Samuleson-Nordhaus transmission mechanism as
an example; return to Keynes; instead of starting
out from the idea of automatic return to equilibrium he suggests using imbalances, the disturbances of economic equilibrium and their tendency to
become permanent as a point of departure. I wish
to add some further comments on this issue.
Samuelson and Nordhaus represent the neoclassical-Keynesian synthesis. According to this
school of thought, in the long run, which might
be extremely long, the equilibrium will set in under the conditions of full employment. I do not
know whether or not the transmission mechanism
they introduce is suitable for a genuine Keynesian
analysis. The fact that they discuss the system of
IS-LM curves in the Appendix of their book does
not mean that they underestimate its relevance.
Let me prove this with two quotations: in the
chapter on Fiscal and Monetary Policy Mix and
Government Deficit they write: ‘the instruments
applied in the main body of the text demonstrate
in certain respects how monetary and fiscal policy
influence the economy. However, to gain a more
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This might a s well be ca lled t he Hick sia n
approach…’ 7
In relation to IS-LM curves Tobin also emphasises that Hicks calculates only with flow variables and does not take into account that these variables in time will become stocks, when the position of individual curves changes. When investment matures, the capital stock increases, which
undermines the prospects of profits while the investment function and the IS curve shift to the
left. Saving part of the income increases wealth.
The wealthier consumer saves a lower proportion
of his income and spends more on consumption.
This makes the investment curve and the IS curve
shift to the right, although in the absence of external factors the stability of the curves is a precondition for the model to be valid.
Let us select a few Keynesian thoughts of the
surplus that is missing from the system of IS-LM
curves and that Hicks also mentioned.
The Keynesian division of economics into Euclidean and non-Euclidean economics is one of
the absent elements. ‘The followers of classical
theory act as Euclidean mathematicians would
do in a non-Euclidean world, who – realising
that even parallel lines intersect – would blame
those lines for not being straight enough. In reality, however, there is no choice but to drop the
axiom of parallel lines and elaborate a non-Euclidean geometry. We need something similar in
economics today as well.’8
In the equations Hicks established to express
Keynesian thoughts, investment depends solely
on the rate of interest; the expectations regarding
the return on capital investments are not included. The high degree of uncertainty that nowadays embraces entrepreneurs’ investment decisions, the Keynesian vigour, the ‘animal spirit’,
often referred to in literature as Smith’s ‘invisible
hand’, are completely missing. When in a world
of uncertainties ‘… we decide to act positively
which may induce long-term consequences, we
follow our animal spirit which prefers action to
inaction, rather than basing our decision on the
weighted average of quantitative advantages multiplied by quantitative probabilities.’9
In the world of Keynes, however, the degree of
people’s distrust in the uncertain future is ex-
in-depth understanding of the topic, we need to
make use of the IS-LM analysis, an important instrument, which is a succinct summary of the
main features of the dominant school of thought
in modern macroeconomics. It shows the interrelation between output, money and interest rates,
and sheds light upon the major points of macroeconomic debates.’3 Or: ‘Nowadays Say law has
been replaced by IS-LM analysis, which … facilitates a more detailed formulation of the impacts of
fiscal and monetary policy than was previously
possible by means of the most simple tools.’4
The appearance of the system of IS–LM curves
in the Appendix only expresses the authors’ preference for the aggregate demand and supply
function, but they do not underestimate the importance of the curves either.
As time passed, Hicks grew more and more
dissatisfied with the conclusions he drew in his
paper in 1937. His dissatisfaction might have been
aggravated by the failure of neoclassical synthesis
to provide any efficient economic policy solutions
for the grave economic problems of the 1970s.
In his speech at the Nobel-prize award ceremony in 1977 Hicks said that the system of ISLM curves had become part of neoclassical economics discussions in standard literature. ‘But a
long time has passed since then, and I have mixed
feelings now that I have been given an award for
this work that I think I have grown out of. ... It
was the formal model of Keynes that I summed
up in the IS-LM diagram. Actually, his General
Theory contains much more than this formal
model, and even more can be found in his other
writings to illustrate his work.’5
In the article published in 1980-1981 by a journal established by post-Keynesian economists,
Keynes’s true followers, Hicks writes that the article of 1937 was written for the session of the Society of Econometrics held in September 1936, 8
months after Keynes’s General Theory was published. ‘I have to admit though, that my dissatisfaction has grown with the passage of time.’6
Tobin challenges the Keynesian nature of neoclassical synthesis based on the system of IS-LM
curves. ‘In all probability the theoretical synthesis of the past 25 years contains several elements
which were not included in the General Theory.
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is not governed from above so that private and
public interests should always overlap... It would
be a mistake to conclude from economic principles that enlightened self-interest always acts for
the benefit of the public.’13
In his General Theory he writes: ‘The major
fault of the economic system we live in is that it
cannot provide full employment and distributes
wealth and income in an unfair and arbitrary
manner.’14 There is no justification for ‘… the disproportionate distribution of wealth we experience today’15
What does Keynes suggest? ‘… a degree of
central governance is vital in processes which
nowadays are usually governed by individual initiatives …’16 The responsibility of central governance is to ‘… harmonise propensity to consume
and reasons for investment.’17
As the above quotations indicate, Keynes was
far from saying that economics should be void of
value judgements or that the positive and normative can be clearly demarcated. According to Joan
Robinson this meant that ‘The ideology at the
end of ideologies has been shattered. Economics
is increasingly becoming political economics.’18
pressed by their wish to possess money, the storage
of wealth. If an economic player has a pessimistic
view of the future, he will not invest his savings into securities or real capital goods but keep them in
the form of money/cash. Keynes finds the intention of keeping savings in the form of money harmful, because it is aimed at an item that cannot be
produced freely, and prevents aggregate demand
from growing together with aggregate supply.
Joan Robinson in her book entitled Economic
Philosophy mentions that seeing the discrepancies inherent in the mechanisms of capitalist
economy, Keynes’ writings typically ‘...reintroduced the moral problem the laissez-faire theory
had already eliminated...’10 It is an exceptional assumption that ‘… people acting in their own interests do something good for the benefit of the
community.’11 By this ‘… he completely destroys
the possibility of harmonising the desire for profit and acting for the benefit of the public.’12
Though Keynes never thought that there was
any better motivation in the economy than profit, he has reservations as to whether this driving
force, the profit, ensures the best possible allocation of resources. As he himself put it: ‘Our world
NOTES
1. Mátyás, A. (2003): The Keynesian revolution in
Hungarian economic literature. In: Studies to pay
tribute to Tamás Szentes, academic, on the occasion of his 70 th birthday. BK ÁE Világgazdasági
Tanszék, edited by: Blahó, A., Budapest, pp. 249259.
2. J. Robinson (1962): Rewiev of H. G. Johnson,
Money, Trade and Economic Growth, Economic
Journal, 72. September, pp. 690-692.
3. Samuelson–Nordhaus (1987): Közgazdaságtan,
(Economics), Budapest, K.J.K. p. 521.
4. Samuelson–Nordhaus: op. cit. p. 128.
5. Hicks, J. R. (1977): Economic Perspectives,
Oxford, University Press, V–VI.
6. Hicks, J. R.: ISLM – An Explanation, Journal of
Post Keynesian Economics, 3, p. 139.
7. Tobin, J. (1984): Friedman elméletének körvona la i, megjelent J. Tobin: Pénz és ga zda sá gi
növekedés c. kötetben, K.J.K., (The Outlines of
Friedman’s Theory, in: J. Tobin: Money and Economic Growth) p. 285.
8. Keynes, J. M. (1965): The General Theory of
Employment, Interest and Money, K.J.K. Budapest, p. 35.
9. Keynes, J. M.: op. cit. p. 183.
10. Robinson, J. (1964): Economic Philosophy,
Anchor book, New York, p. 76.
11. Robinson, J.: op. cit. p. 77.
12. Robinson, J.: l.c.
13. Keynes, J. M. (1972): Essays in Persuasion,
reprint in: The Collected Writings of John Maynard Keynes, vol. IX. MacmillianColn, p. 312.
14. Keynes, J. M.: op. cit. p. 396.
15. Keynes, J. M.: op. cit. p. 397.
16. Keynes, J. M.: op. cit. p. 401.
17. Keynes, J. M.: op. cit. p. 403.
18. Robinson, J. (1964): Economic Philosophy, p.
77.
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