Happy Reading to the London Reading Group on Keynes's General Theory!
I bought my first copy of this great book (trading off 21 meals) in 1972 in
Dhaka. Bangladesh had just emerged from a genocidal liberation war and we
were in a hero-worship mood, and Keynes seemed to us like the great warrior
who battled the genocide-like problem of mass unemployment. But we soon
found what Samuelson described: this book was hard to read. We learned what
Keynes said from Alvin Hansen and Kenneth Kurihara and others. As I lost my
books when I moved from Dhaka to New York to Boston to Washington to Atlanta
to Toronto, I kept buying copies of the book, and with the same frustration:
how do you read what Keynes wrote? I Bbught the same book five times over,
but could never finish reading it. Can the London group finish reading it?
I guess somebody should prepare a readable version of the book. Here are
some suggestions for the reading group.
1. What is GT about? Suppose that it is about market-clearing, namely, how
can the economy reach a state of full employment such as when the supply of
labor is matched by demand? To find what may determine full employment, we
may also discover what may deter full employment: what could prevent the
market from clearing?
2. Unsaying Says Law? The new generation of readers may approach the issue
of market clearing with a two dimensional concept of market equilibrium. The
first dimension is the quantitative matching: the quantity supplied must
match the quantity demanded. Classical theory had two ingredients to deal
with this, but the two were not modeled compactly, leaving much looseness
that ultimately assailed it. The quantitative matching relies on the price
flexibility mechanism, and also involves an equality of value of equivalence
to achieve balance of payment or balance of incomes. The price flexibility
mechanism says that if the demand is not equal to supply, the price must
change such that demands and supplies will change until they become equal.
The other part is Says Law that ought to have said that the value of what
one sells must be equal to the value of what one gets in exchange. But Says
Law was unclear and that doomed the theory of market clearing through price
and output adjustments. The assault on Says Law was bound to invite a
backlash.
But why was Keynes talking about money then? Was he groping to find an
articulation for the second dimension of market clearing? The second
dimension is that in equilibrium, the kinds of goods must match too. After
being sabotaged by Jevons, the idea of double coincidence as an equilibrium
condition lost its legitimate place and gave rise to groping. One could not
see why money was in the picture without grasping the second dimension
(matching of kinds). Had this been clear, Keynes would be understood most
easily. Here is how I would reread Keynes.
First, let us bust Says Law by showing that even when demand is equal to
supply for every good at the equilibrium price (so that income is equal to
expenditure for every agent), the market may still not clear. Suppose that
John has 1 dollar of x to sell and wants to buy 1 dollar of y from Paul.
However, Paul does not want to buy 1 dollar of x, from John but wants to buy
1 dollar of z from Tim. And Tim wants to buy 1 dollar of x against the sale
of 1 dollar of z. Now, there is a set of prices at which the values of x, y
and z reach equilibrium; and the income for each agent is exactly equal to
the expenditure. Yet there is no trade, because barter is not possible. John
cannot sell x and buy y directly, because Paul refuses to buy x against y.
Paul cannot sell y to buy z, because Tim refuses to buy y against z. And Tim
cannot buy x for z, because John does not want to buy z.
The solution is the use of external money as a device to transfer claims. An
outside senior must issue money such that John will deliver x to Tim and get
money instead of z. He will then buy y with money instead of with x. Paul
will get money for y, and then get z for money but not for y. The real goods
are of the wrong kind to serve as means of payment, so that everybody here
must pay with money instead of with the real good, even though money is just
a device to allow the owner to claim the right kind of good.
The second dimension is the matching of kinds. This is achieved by creating
double coincidence between money and the real good, and this double
coincidence is artificial. Thus John really does not demand money, but
demands y, and yet he pretends to demand money when he sells x to Tim for
money. The double coincidence between x and money is a necessary condition
for the sale of x. There is no market clearing except with money here. Even
though z really pays for x, z cannot pay for x directly: it must be
converted into y to properly compensate the seller of x. This conversion is
done by the use of money as a device to transfer value, and not a device to
store value.
If one sees this example, one can relate it to Keyness idea of multiplier.
If one dollar changes hands 3 times over, then the failure to issue 1 dollar
will disable trade worth 3 dollars.
3. Price theory of monetary theory? The monetarist counter-revolution and
the rise of real business cycle there would not occur had Keynes steered
clear of price theory (first dimension) and instead embarked on monetary
theory to uncover the second dimension of market equilibrium. I have
decided to forgive myself for feeling utterly confused: what is Keynes
doing? Is he studying price theory or is he doing monetary theory? What have
the wage rate or the interest rate to do with market clearing other than the
way classical theory described price-quantity adjustments? In short, why
bring money in the discussion? Wage rigidity, money illusion, and liquidity
trap are all matters of price theory, oops, are they matters of monetary
theory?
The key is to distinguish between ability to buy as given by equivalence
(Says Law) from ability to pay as given by money. The term effective demand
seems to be groping for this distinction.
For example, John has 1 dollar of x and wants to buy 1 dollar of y, he has
the ability to buy y, that is, he has adequate real income to buy y.
Classical theorists could not understand how there could be lack of demand
for y. Well, there is no lack of demand. But there is lack of means of
payment. John cannot pay for y with x, he must pay for y with z, but he does
not have z. So he must get money and with it, empower Paul to get z with
money. That is, paying with money is a ploy to pay with goods belonging to
other people. It has nothing to do with price.
So when Keynes says effective demand, he seems to refer to demand coupled
with ability to pay in addition to ability to buy. In the example, John
must convert x into money before he can purchase y. Thus owning x is not
effective as demand, but it is demand in the classical sense.
3. Animal spirits of outside animals? The savings-investment equilibrium of
course must be present to clear the market in the first dimension, but it
has no relevance in the second dimension. The new reader may notice the
existence of banks as issuers of (fiat) external money, without being either
the producer or the consumer of real goods. The big bad animal with a
wayward spit lives in Lombard Street of good old London. May be the readers
group should visit the financial city to see how the bankers are able to
increase or decrease the supply of money without any consideration of the
volume of actual output or productivity or real profitability prospects. If
the bankers are lending money to stock market speculators, they may be
pumping in too much money compared to the stock of real goods. But with a
few spectacular failures of borrowers, they bankers may also cut down the
supply of money even if no decline has occurred in real output or
productivity or profitability.
This animal spirit is wholly different from the spirit of the investors in
real output and the savers who save out of real output. The marginal
propensity to consume and the marginal propensity to save should give fair
warning that the real people are not as wily the animals as business cycle
would require them to be. Are business cycles adequately explained by wild
fluctuations in marginal propensity to consume or to save?
The wily ones are in the City. And they are increasing or decreasing the
supply of fiat money according to their wily animal spirits.
In short, the failure of the market to clear in the second dimension lies
outside the real sector: it is not in the factory floors or in the farm
lands; it is in the banks. This money does not grow out like crops of
savings (or savings of real crops?), and surely does not fall from Friedmans
endogenous helicopter (or like weeds growing spontaneously or as spontaneous
classical veils like on the faces of Afghan women under the Taliban?). This
money is created out of thin air and it vanishes into thin air. Yes, there
is that animal, not unlike the Alice in Wonderland capacity of the Cheshire
Cat: he may vanish, but his smile or grin may not. He is not real, and yet
he has effect, like the ghost. May be it is a spirit behaving like an
animal: the spirit of Wall Street?
May you read Keynes ever so happily.
Mohammad Gani
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