Post Keynesian Macroeconomics

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Post Keynesian Macroeconomics Powered By Docstoc
Macroeconomic methodology
   Cambridge, 26. January 2010

        Jesper Jespersen
        Roskilde University
1. Post-Keynesian methodology: a Critical
   Realist perspective

2. Post-Keynesian macroeconomic theory:
   making ‘uncertainty’ epistemological
   a. the Principle of Effective Demand
   b. liquidity preference theory
       What is Post-Keynesian
• A broad ranging approach on how to
   understand the dynamics of the real-world
   economy - considered as a whole:
1. Methodology – the (re)search for a
   relevant method to establish
2. Real-world related Theories and Models +
3. Empirical Tests of our Findings +
4. Reasonable judgements
(with inspiration from Keynes and many
 Inspiration from Keynes’s view on
       real-world economics:
…’[E]conomics is essentially a moral
  science and not a natural science... [I]t
  deals with introspection and values... and
• Motives (incentives),
• expectations,
• psychological uncertainties.’
 Microeconomic foundation
Keynes’s Methodology:
• Economics is a science of thinking in terms of
  models joined to the art of choosing models
  which are relevant to the contemporary world.
• It is compelled to be this, because, unlike the
  typical natural science, the material to which it is
  applied is, in too many respects, not
  homogeneous through time (CWK, XIV: 296)
• It seems to me … that you [Roy Harrod, jj] do not
  repel sufficiently firmly attempts ... to turn
  [economics] into a pseudo-Natural-science.....’
Two fundamentally different methods in
• On the one side are those who believe that the
  existing economic system is, in the long run, a
  self-adjusting system, (CWK, XIII: 486)
• On the other side of the gulf are those that reject
  the idea that the existing economic system is, in
  any significant sense, self-adjusting (Ibid.: 487)
• The gulf between these two schools of thought is
  deeper, I believe, than most of those on either
  side of it are aware of.
• On which side does the essential truth lie? That is
  the vital question for us to solve. (Ibid.: 488)
Said by Keynes in 1934
 Method has implication for theory!
• The strength of the self-adjusting school
  depends on it having behind it almost the whole
  body of organised economic thinking of the last
  hundred years (CWK, XIII: 488)
• There is, I am convinced, a fatal flaw in that part
  of orthodox reasoning which deals with the
  theory of what determines the level of effective
  demand and the volume of aggregate
  employment (Ibid.: 488)
Methodology (continued):
• I shall argue that the postulates of classical
  theory are only applicable to a special case only
  and not to the general case, the situation which it
  assumes being a limiting point of the possible
  positions of equilibrium.
• Moreover, the characteristics of the special case
  assumed by the classical theory happen not to
  be those of the economic society in which we
  actually live, with the result that its teaching is
  misleading and disastrous if we attempt to apply
  it to the fact of experience. (Keynes, 1936: 3,
  my highlighting).
 Hence, Post-Keynesian economics
  have to deal with methodology:
• How to model the consequences of
• Does macroeconomics need a specific
  microeconomic foundation?
• How to avoid the fallacy of composition?
  (the outcome is different from the sum of the
  parts) – the economy as a whole
• Trend and cycles cannot be separated in an
  open and path-dependent system
• Context matters

 Methodology is a major dividing line when
  these questions are answered
• Post-Keynesian economics is when
  uncertainty and money are taken seriously
• It penetrates economic decision making
  and behaviour at all levels – micro/macro
  and short or long run.
• Hence, uncertainty and money are
  inescapable phenomena in
• We know this from e.g.
Liquidity preference theory
The theory of effective demand
The post-Keynesian economists
   have to be conscious about

Methodological requires thinking about:
1. Ontology - object
2. Epistemology - method
3. Outcome - results
      Three worlds of Popper
• World 1 – Reality: ontology
• World 2 – the analytical level, where
  method matters: epistemology
• World 3 – the strategic level, where
  analytical results are used for politics:
                        Figure 2.1: Critical Realism methodology (Retroduction)

The real level:                 Ontology                 History                  Tendencies

                                           Mappi                                     WORLD 3
The cognitive veil                         ng                      Tests             The operational level:


The analytical level:           Landscape              Theory/Model               Results
Figure 2.2: Stratified reality grounded in Critical Realism

 Reality divided into three strata

                               Empirical stratum
                        Data – Imprecise measurements

                                Factual stratum
                             Events and tendencies

                             The deep stratum
        Causal mechanisms, power structures and institutional relations
Figure 3.1: Macroeconomics is a sub-disciplin of social sciences

       Frame of nature

         Macroeconomics     Law          Sociology   Political science

                          Society as a whole
  Jesper’s methodological

             World 1


        World 2
 clock-work                                                    reflexive
                             agents          actors            organism

                         Market                  Power,
                         System                  culture
World 3:         Predicting the                  Understand
                 marketsystem                    reality
Inspiration: Martin Hollis
Figure 2.3: Two different methodologies

                    Post-Keynesian methodology –
                     Critical Realism/retroduction
              Reality                 Analysis             Policy-recommendations
              (World 1)              (World 2)            (World 3)

          General equilibrium methodology –
          Hypothetical deduction
              Axioms                  Analysis       Results =
              (World 2)              (World 2)       policy-recommendations
                                                           (World 2)
     Why Critical Realism(I)?

• There is an emerging consensus that the Post
  Keynesian approach is consistent with much of
  critical realism, with open-system theorizing
  applied to an economy understood as an
  organic, open system. Different forms of
  abstraction are relevant to different questions,
  and different economies; and indeed the study
  of actual economies required before abstraction
  can occur involves the application of different
  disciplines (Dow, 1996:79).
    Why Critical Realism(II)?
• Finally, since Post Keynesian theory starts
  with observation, the position on empirical
  matters must be discussed. First, rejecting
  the subjective/objective dual…. 'Facts' can
  be observed with some degree of
  objectivity… Since the group of theories
  includes formal models which are
  susceptible to empirical application, Post
  Keynesians do not reject econometrics
  (ibid.: 80)
   Why Critical Realisme (III)?
1. Understanding Reality
2. Unescapable uncertainty, the future is
3. Individuels are context dependent and
   interrelated because of uncertainty
4. Hidden structures and powers matter
5. Actual performance is path-dependent
6. Hence, open system analysis without a
   predetermined outcome is needed.
    Open System Ceteris Paribus-
• The object of our analysis is, not to provide a
  machine, or method of blind manipulation, which
  will furnish an infallible answer, but to provide
  ourselves with an organised and orderly method
  of thinking out particular problems;
• and, after we have reached a provisional
  conclusion by isolating the complicating factors
  one by one, we then go back on ourselves and
  allow, as well as we can, for the probable
  interactions of the factors among themselves.
  This is the nature of economic thinking (Keynes,
  1936: 297).
  Post-Keynesian economics is a
         social science :
As Keynes remarked:
…’[E]conomics is essentially a moral
  science and not a natural science... [I]t
  deals with introspection and values... and
• Motives (incentives),
• expectations,
• psychological uncertainties.’
• Keynes’s perception was that economies
  did not behave in the way economists said
  they did, that something vital had been left
  out of their accounts, and it was this
  missing element which explained their

• Keynes accused economists of his day of
  abstracting from the existence of
  uncertainty – human beings take decisions
  in ignorance of the future. (Skidelsky,
  1992: 538-9)
  Macroeconomic implications of
   taking uncertainty seriously
• Here uncertainty makes a crucial
  difference, because any microeconomic
  decision or activity is characterized by lack
  of knowledge, but you have to act – so
  what do you do?
Look at Figure 1 – The structure of
Figure 1: The anatomy of uncertain individual knowledge

                                                           (un) known
                                                           (un) likely
                       Expectations       Future


                                                          (un) known
                        Actions                            (un) likely
• Uncertainty makes macro-behaviour
  different from (n * individual micro),
• Households and firms don’t behave
• They follow conventions
• Or they act intuitively on new information
  (animal spirit)
• Or they learn from past experiences
Hence, there is no such thing as an
  atomistic market (theory)
    I will now concentrate on
Macroeconomic: Effective Demand
      & Liquidity Preference

• There is, I am convinced, a fatal flaw in
  that part of orthodox reasoning which
  deals with the theory of what determines
  the level of effective demand and the
  volume of aggregate employment
Where has ‘macro-demand’ gone?
because ‘You will not find it [effective demand]
  mentioned even once in the whole works of
  Marshall, Edgeworth and Professor Pigou, from
  whose hands the classical theory has received
  its most mature embodiment’. (Keynes, 1936:

This really is a puzzle, because neoclassical micro
  theory is, if anything, about supply and demand,
Until you realize, that at the macro level there was
  no room for macro-demand, when uncertainty is
  squeezed out of the analysis.
Figure 2: Uncertainty explains the complexity of ’effective demand’

Z-curve: Expected Aggregate costs                             D-curve: Expected proceeds from
(incl. Profit): imperfect competition,                        aggregate (macro)demand

                                     Effective Demand
                                     Macrobehaviour of business

  Aggregate credit facilities: the                                Expected availability of supply factors:
  working of the banking system                                   labour, capital, technology
                                                                  environmental conditions
Instead we are looking for:
 An open, integrated market system ruled by
  aggregate - macroeconomic behaviour:
Liquidity preference:
There is, however, a necessary condition
  failing which the existence of a liquidity
  preference for money as a means of
  holding Wealth could not exist.
This necessary condition is the existence of
  uncertainty as to the future of the rate of
  interest (Keynes,1936: 168)
    So, what to do in practice?
• We make a macroeconomic landscape
• We have to make semi-closures,
  provisional stability (fixed expectations)
• Using the Open System Ceteris Paribus
  method developed by Mark Setterfield
Figure 3.2: The macroeconomic landscape

                                                                                                                                                                  Foreign sector:
                                                                                                                                                                  Balance of payments:
                                                                              Market for goods and services               Exports                                 Current account
                                                                              (GDP)                                                                               Capital account
                        Goods and services                                                                                                                        Exchange rates


                                                                                                                      Gross profit

                                                                                                                                                                                    capital flows

                                                                                                                                     Real investments

                                                                    Labour market:                                                                         Financial markets:                       marke
                                                                    Employment                                                                             Money, bonds and shares                  t
          Public sector                                             ---------------------------------
               Income transfers


                                                                                                                                                        Excessive                   Rate of

                                                                                                                                                        profits                     interest

                                                                                                                                                                                     Central Bank


                                                                                  Housing- market

                                                                                        Financial savings