OK, this is weird considering that this is an austrian forum but since I don’t know much about this and you seem to know a lot about it I was wondering if you could help me out.
What were the differences between the keynesians and the monetarists because their theories are often just presented as “macroeconomics” without any differentiation. I know there were differences over the neutrality of money, the effectiveness of fiscal/monetary policy, and the natural rate of unemployment but I fail to see why these differences would make one more pro-free markets or less?
Did keynes say that if one market was out of equilibrium then another market could also be out of equilibrium and yet still produce an economy where demand was equal to supply? And if so, this means that he didn’t really refute say’s law but found a situation where disequilibrium didn’t contradict it?
I’m not Student, but let me see if I can answer some of your questions.
Monetarists believed that the money supply should be targeted in order to keep inflation at or near the natural rate of growth. As you mentioned, they believed that the price level should be “stable” (in the literal sense) in order to prevent a depression in business activity. I can’t help but think that they’ve never gotten over Marx, and the belief that falling prices must necessarily lead to a contraction in business activity and unemployment. Nevertheless, that’s just speculation. Monetarists have always believed that inflation is worse than deflation, and that monetary policy is much more effective than fiscal policy. Their attack on “fiscal fine-tuning” has lead to their label as the champions of capitalism. But, they do believe that monetary central planning is essential, and that recessions are caused by deflation. They brought back the quantity theory (monetary aggregates) with a constant velocity (the reciprocal of the demand for money, denoted as k), but integrated Keynes’ precautionary and speculative demand for money (during the second wave of monetarism). The Monetarists were quick to attack the long-run Philips curve, but believed that it held in the short run. Furthermore, Monetarists supported anti-trust, attacked the gold standard, and pushed for monetary nationalism and freely floating international exchange rates.
The Keyensians, on the other hand, held onto the belief that deflation is much more dangerous than inflation. Keynes, who abandoned the Wicksellian framework, still held onto the “Wicksellian rot” (a deflationary spiral where actors wait to purchase and increase their sales, putting perpetual downward pressure on prices and therefore profits). Their monetary policy focus on targeting the interest rate, which is the price of money (Mercantilism), according to them. Savings and investment are never equal ex ante, and lowering short-term interest rates stimulate the “animal spirits.” Of course, if the “precautionary demand for money” takes over, then monetary policy must fail, because the newly created funds never enter the economy. This is why, according to Keynes, fiscal policy is absolutely essential (0% interests rates may be too high). Thus, the government has to run deficits and pump money into the system directly–and the “income multiplier” (1/marginal propensity to save) assures that every dollar put into the system, is magically increased, further stimulating business activities (also assumes that purchasing behaviors remain constant).
So the Monetarists want to intervene with expansionary monetary policy, while the Keynesians believe we need both expansionary monetary and fiscal policy (with an emphasis on the latter). Also, the Monetarists believe in a natural rate of interest, but claim that the market rate never really deviates from it. Again, for the Keynesian’s, it’s a purely monetary phenomena (not tied to anything real).
I think you’re talking about Keynes’ “under employment equilibrium.” This situation occurs when investment and savings are equalized ex-post through inventory adjustments (I never understood this). Firms cut their investments by slashing inventories and have “fire sales.” Entrepreneurs will save themselves when they cut costs enough, which somehow leads to equilibrium (savings = investment). In the Keynesian world, it is possible to be at equilibrium with 35% unemployment (represented by the Keynesian Cross–Samuelson).
Keynes not only never refuted Say’s law, but he never even addressed it. Say’s law destroys Keynes’ entire nonsensical framework.
Huh, thanks esuric, but why did the monetarists not care about inflation. I thought they believed it would lead to post-war german-style problems and cause depressions too?
And why were the keynesians believers in the division between real and nominal economies? I thought one of the main points about keynes was that money could affect output?
Oh and one more question. Is it true that most monetarists tend to be supply-siders?
Ah, the problem, and this is quite common, is that you’re confusing Keynes’ with the Neo Keynesian’s, and New Keynesians. Keynes didn’t make the nominal and real distinction; in fact, that was the entire point of his theories (in this sense, he may sound like an Austrian, but Austrians understand that manipulating the money supply can only misdirect real resources, and not actually increase its supply)! But the neo Keynesians (Samuelson, Hicks, et al.), for whatever reason, brought it back. The New Keynesians are the synthesis of Keynes, Lucas (rational expectations), Friedman (monetarism), and Laffer (supply-sider). There are many anti-Keynes Keynesians around today. Their (new Keynesians) basic gist is that the economy is in equilibrium in the long-run, and that exogenous shocks bring the economy out of equilibrium in the short-run. Monetary policy (some still support fiscal policy) can bring the economy back into equilibrium. This school is extremely heterogeneous, but they all share the same method (positivism), and use aggregation/mathematical models.
Well, I would agree with Roger Garrison that in a broad sense monetarists were “keynesians” in the sense that monetarists used the same analytical frame work as Neo-Keynesians like Tobin and they both tried to explain recessions as being the result of fluctuations in aggregate demand. However, you’re right that there were differences. I have seen some authors boil down the policy differences between Keynesians and Monetarists to the empirical question of whether or not money demand is interest elastic. For example, like you mention, monetarists believed that money demand was interest inelastic and relatively stable, so fiscal policy was largely useless and the central bank could keep the economy running smoothly by simply following some policy rule for adjusting the money supply. I think many people would consider these policy perscriptions more free-market because they largely eliminate the need for discretionary government policy (at least as it related to economic stablization).
However, let me stress that these are just policy implications of monetarism. Milton Friedman and his followers made significant theoretical contributions to economics that have fundamentally changed the way economics is studied and many of the contributions have been carried on by New Keynesians.
Well, I guess it all depends on how you define Say’s Law. It sounds like the definition you’re using is similar to what mainstream economists consider to be Walras’ Law, which is that “if all markets but one are in equilibrium, then it must also be in equilibrium.” In other words, that to have a disequilibrium in one market you must have a disequilibrium in another market (or more precisely, excess demands must sum to zero). If that is how you define Say’s Law, then I agree that Keynes did not contradict it (and no logically coherent theory could).
However, Keynes himself defined Say’s Law differently. Here is Keynes: “From the time of Say and Ricardo the classical economists have taught that supply creates its own demand; meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product.” http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch02.htm
This definition essentially amounts to saying that the money market must always be in equilibrium and essentially writes money “hoarding” out of the equation (or at least that’s one way of reading Keynes here, there are others). And there are problems with taking this approach, as described here: http://homepage.newschool.edu/het/essays/keynes/keyneslogic.htm#say
So who’s definition is correct? Tyler Cowen actually has an excellent article on this where he lays out several possible definitions of Say’s Law (based on the pre-Keynesian literature and of course Say himself) and evaluates whether Keynesian economics can be said to have refuted them. If I remember correctly, Cowen concludes that Keynes was using a straw-man definition of Say’s Law that no one really believed. So by refuting that straw man he proved nothing special other economists did not already appreciate. I found Cowen’s argument very convincing.
I can’t find a version of this article on the web, but it was called “Say’s Law and Keynesian Economics” and it was reprinted in “Supply Side Economics: A Critical Evaluation”. I know there is a copy at my univ’s library, so if you can’t find it let me know. I would be willing to making you a copy and upload it, because now that you mention this I want to go back and re-read it.
On money demand: Is the elasticity really a matter of empirical (I’m thinking contingent) or theoretical (here I’m thinking tautological) thought? Because if the differences are largely empirical, then monetarism really is just keynesianism.
Well, I think it is an empirical issue because the question is how sensitive people’s money holdings are to changes in the interest rate and I can’t think of a strictly theoretical way to answer that question.
That is one reason why I said in my previous post that monetarism could be considered a branch of keynesiansim, if you define “keynesianism” to mean those theories that attempt to explain economic fluctuations as the result of changes in aggregate demand.
But I would stress that there are differences between Monetarism and Neo-Keynesian Economics as it existed in the 1950s and 1960s (ala Tobin and Patinkin). The Delong article is a good breakdown, but so is this essay from the New School’s website on economic intellectual history.
I know there is a copy at my univ’s library, so if you can’t find it let me know. I would be willing to making you a copy and upload it, because now that you mention this I want to go back and re-read it.