In a short presentation at a seminar at Cambridge England last week Pontus Rendahl responded to a presentation by Steve Keen outlining his theories (or rather a subset of them in time constraints).
This is interesting as it is the first serious (as opposed to a sly remark in a blog Krugman style) review of Keen’s ideas by a noted neoclassical economist.
Pontus’s remarks in part result from not knowing the full corpus of Keen’s work (such as on bank’s power to lend) and as Keen acknowledges ‘talking past each other’ on occasion. But what is interesting is that Pontus’s main thrust is not utterly dismissive of Keen but are implied in general equilibrium models dating back 30 or 40 years. Of course the mainstream reaction to any heterodox idea is at first dismiss it and then to acknowledge we have known this all along.
Keen’s analysis starts from a very neoclassical observation … In the macroeconomy everything comes from somewhere and goes somewhere …The rest of us call this General equilibrium”
No the sectoral balances approach – though implicit in and predating Keynes – was neglected by neoclassical economics and only taken up interdependently by Wyne Godley and Hyman Minsky. An economy modeled as ‘everything comes from somewhere and goes somewhere’ is the classical circular flow paradigm, not the neoclassical snapshot of an instantaneous equilibrium of prices with no retention of ‘stocks’ such as capital accumulation through time. Note the key driver of the Classical adjustment process was switches in equity funding, this is not yet modelelled though by Keen.
Keen is of course not modelling a snapshot of equilibrium but the process of change between one set of prices and another and how and why that changes. The Walrasian approach has nothing to say about how and why economic actors move prices towards or away from equilibrium. The simultaneous equation approach is simply one (like the neo-ricardian project) a modelling of possible sets of prices not of price formation, profits and loss. Keen’s systems dynamics approach can models dynamics of prices moving towards equilibrium – but also potentially overshooting it and building up pressures which can result in disequilibrium and breakdown – financial crisis. The GE approach cannot do that.
Also of course GE not a stock – flow consistent approach, Pontus rather puzzlingly claims
All GE models (including DSGE) are stock flow consistent
Well only if SFC is redefined to include abolishing stocks and cash accumulation, we only have flow (period 1) flow (period 2) consistency in DGSE.
Pontus also says Says Law holds in Keen model. Keen of course claims that monetary injections (credit) invalidate Says Law. There is an important insight here though – that the law of markets (Says Law) does hold if you add two qualifiers:
1) You include credit advanced for investment; and
2) The prices planned at the point of investment are realised (markets clear and their is no inventory remaining)
Of course the view of the business cycle as a credit cycle – which Keen has revived – shows circumstances where entrepreneurship overestimate sale prices, because they have speculated on goods prices, and / or by the time the consumption good is ready demand is depressed by debt repayments and deliveraging forcing sale of inventory at market clearing prices of a new (lower price point) equilibrium. Perhaps one way of looking at the Circuitist tradition to which Keen belongs is explaining when and when not the ‘law of markets’ works and why (and why not).
I should note though that although Keens models currently include modelling of ‘inventory’ in labour markets it is not yet modeled in goods markets. However of course if these is insufficient demand in one market Walras’s law dictates there must be excess demand in another so it is no great fault, it is implied.
Pontus claims Keen’s model lacks any ‘forward looking’ behavior Code for rational expectations and microfoundations. Keen’s approach though is based on Keynes’s insight on radical uncertainty in fluctuating markets – economic actors carrying on doing what they have been doing. His aggregative approach assume firms invest if their are profits and hire workers as a result these incomes and profits being reinvestment etc. There is as yet no sophisticated modelling of investment functions (even in Kaleckian form). or modelling of portfolio preferences. Though there are others modelling in the Stock Flow Consistent tradition that do include portfolio – optimising behavior (such as for example the NEF model). The key point where is whether an approach founded on Keens approach can be modified to include these. It shows important results without them suggesting that the Keynes insight that the key driver of the economy is demand is correct and the claims for microfoundations somewhat overblown, macrofoundations are more important than microfoundations.
Pontus states that Keen’s insight that effective (aggregate) demand must exceed (exante) income is – ‘nice but not novel’ and is implied in Lucas’s cash in advance model from 1982. Keen claims the concept of ‘cash in advance comes from a Minsky paper in 1963 (claims about priority seem to go nowhere as Clower, Simonsen and Minsky all seem to have discovered the concept in 1963 in response to the Patinken controversy).
Note The ‘Cash in Advance’ concept seems to me weak as the decision to spend against a liquidity constraint is always made simultaneous with a decision to not spend to maintain liquidity for future spending – which also undermines the pure Keynsian concept of ‘liquidity preference’ as idle balances can accumulate or without concious decision to vary them, automatically running up with wages and investment returns, running down faster than anticipated as interest rates and prices rise etc. The Randall Wray’s concept of a demand for money depending on current balance sheet levels and investment plans (which can translate into a demand for credit) seems much superior.
But the Lucas approach, though endlessly cited (my theory is that papers that use hard but not excessively difficult in obfusicating, dry, none real world way are cited so much to make the author look clever to their PHD and Journal referees) is based on a world with no debt or cash /capital accumulation. However the insight that even with a single ‘Representative consumer’ that they require an injection of money is important. Of course in Lucas’s world that injection is from exogenous money from a monetary authority that mysitcially anticipates the investment and monetary requirements of banks. One might ask that if Lucas had seen this why he did not map out the dynamic implications for business cycles it implies and predict the GFC, when instead in his address to the AEF in the mid 1990s he suggested an eternity of stability.
Pontus accuses Keen of implying that
banks [mindlessly and recklessly] extend credit
But this is a caricature as Keen (though not in the Cambridge Presentation) – has modelled explicitly the balance sheet constraints on the creation of endogenous money – such as in his INET paper of earlier this year for example. If Keen is to be criticsed is that this modelled does not yet (at least in published form) include the sources of investment to create this lending power – such as from equity or retained profits (Keyne’s revolving fund of credit) and how this lending power transmits through and across banks through excess reserves – which my own modelling has attempted to fill.
Pontus also states that Keens graph of discontinuous demand from an injection of credit was generated in a drawing prtogramme and not a maths one, im sure this is right but very quickly im sure the Fields Institute will send one generated in Mathematica slam dunking the point. His point about infinate integrals is not relevent to Lebesgue integration used by Keen where integrals are calculated horizontally as follows where the top is conventional Reimann integration and the bottom is Lebesgue integration.
Also if Pontus doubts this how does he square this with the assertion that discountinous injections are implied in the Lucas Cash in Advance model – either Keen is right or the Lucas Model is mathematically flawed, which is it to be?