Critical Approaches to Economics - Post Keynesianism - Essay Example

? Beyond Markets: Critical Approaches to Economics Post Keynesianism Introduction There has been a mass scale transformation in the global economyin the 21st century. With the collapse in the former Soviet Union and decline in the communist governments in the Eastern Europe, the global economic scenario took a topsy turvy turn. Realms of capitalism authorized its supremacy over the notions of socialism and communism leading to the reduction in the role of government in the years of 1990s with greater emphasis on free market mechanism within the economic system of the world. Economics have also seen a significant transformation especially within the macroeconomic forefront (Holt & Pressman, 2001, pp.2-3). John Maynard Keynes, the famous British economist in his book General Theory of Employment, Interest and Money exhibited rigorous manifestation of macroeconomics. He explained the factors that are determinants of the level of output and employment in a particular economy and also explains the causes for which the economies experience lower levels of outputs and escalated levels of unemployment for extended period of time. Keynes believed that aggregate demand in the economy is affected by several important variables like “income distribution, uncertainty, the psychological habits of the consumers, the “animal spirits” of the entrepreneurs as well as the government policies” (Holt & Pressman, 2001, p.3) and mainly based on strong theoretical foundations. The Post Keynesian economics is an extension of Keynesian economics but they stress more on realistic interpretations rather than abstract theories. They state that behavior of the individual agents within the economy is determined by following several rules, developing habits and actions of others and so on. The business executives follow “animal spirit” according to Keynes detaching itself away from rationality. Decisions are crucial parameters in business and they vary from individual to individuals. Post Keynesian economics stresses more on the microeconomic foundations of macroeconomics and applies several techniques depending on various real life situations and circumstances. 2. Theme of the paper The above discussion is just an abstract prelude to post Keynesianism. The paper is fragmented in two main areas. The first section will focus on the understanding of the core of post Keynesianism from Keynesian perspectives. The second part will be discussing a post Keynesian theory which is Milton Friedman’s quantity theory of money demand and the target will be to analyze its connection with Keynesian thought and its deviation from the same. This will help us to understand a facet of post Keynesianism (as scope of discussion is limited). Now, before entering into hardcore mechanics of theory (the second part) a brief discussion regarding the distinction between Keynesianism and post Keynesianism (the first part) is necessary. The subsequent section will be highlighting the same. 3. Dimension of Keynesian economics 3.1 Deviation from laissez-faire The root of Keynesianism originates from the book, “The General Theory of Employment, Interest and Money” published as a potential rejoinder to the great depression of the 1930s (Nunzio, 2011, p.70). The main agenda of Keynesian economics directs towards the establishment of a mixed economy wherein the government (public sector) as well as the private sector play a predominant part. The Keynesian economics deviates from the concept of laissez-faire economics, which states that the private and market dynamics operate in an efficient way devoid of state intervention. From the perspectives of Keynes, the trends of macro level analysis surpass the micro level of the individual behavior and focuses on the aggregate demand for goods in the economy as the prime driving force in escalating the growth of the economy in period of economic crisis. Keynes stated that the policies of the government are highly useful for the promotion of demand at the macro level for fighting social menaces and deflation encountered during the great depression as in 1930s (Keynesian economics, n.d.). 3.2 Staggered adjustments One of the core arguments of the Keynesian economics is that there is there is no automatic tendency of the forces in the economy, which would bring output and employment to the full employment levels. Keynes deviates from the tenets of supply side economics like the Austrian school of economics, which argues that there is a general tendency of equilibrium attainment within a reserved money creating economy. Keynes proposed that in the economy, resource utilization is subjected to severe fluctuations and deviated himself from the earlier economists who pointed towards full utilization of resources (Keynesian economics, n.d.). 3.3 Non neutrality of money Neutrality of money signifies that money volume in the economy does not affect the real economy and the money does not really play a role in determining the relative prices, employment, real interest rates, intensity of capital and the output. Keynesians argue that the money may be neutral in the long run but in the short run (i.e. within a span of 3 to 10 years), money is not neutral (Bhole, 2004, p.1.14). In this case, the classical dichotomy also comes in the forefront, which states that the output of individual industry is depended on the supply and demand as well as the aggregate price level and the quantity of money. Keynes stated that through “interest rates, money affected relative prices, output and the aggregate price level, and the money, banking and asset markets had profound effects on the demand and employment” (Congdon, 2007, p.131). The neutrality and non neutrality from Keynesian perspective can be depicted in a diagram as follows: Fig 1. Short run (Bhole, 2004, p.1.14). Fig 2. Long run (Bhole, 2004, p.1.14). In the above diagram it can be stated in the short run money is non neutral and affects the real variables of the economy in a direct or indirect manner. The D and I curve state direct and indirect relationship between the volume of money and the real variables, which is depicted in figure 1. Now in figure 2, the neutrality of money is depicted, which shows that with change in the volume of money the real variables do not change. 4. Post Keynesianism building up from Keynesian perspectives 4.1 Keynes solution invalidated Keynes also stated that spending of one person basically enters into the income portfolio of another person, which on turn supports earnings of other and this cycle continues to go on for supporting the normal functioning of the economy (MacDonald, 1999, p.85). When Great Depression hit the world economy, then the common people were basically guided by the principle of saving money (Wroble, 1999, p.10). Within the theory of Keynes, this stalled the circular flow of money making the economy stagnant. As solution Keynes stated that there should be robust government intervention through either increasing the money supply or through purchase of things. But this was not regarded as a potential solution. On the contrary it could be said that huge defense spending executed by the then president of United States of America helped the economy of the country in reviving (Yilmazkuday, n.d., pp. 3-4). 4.2 Stress on microeconomic foundation In 1970s world saw another great economic crisis. Later in the 1970s, owing to the economic crisis and based upon the works of economists S. Fisher, John Taylor and some other economists, the post Keynesian economics arose in the era of 1980s especially against the theoretical crisis of 1970s. More emphasis was given on the real world in post Keynesianism. At that time development of microeconomic foundations of macroeconomics started to develop in a frantic manner. Wages, prices rigidities are the central core of Keynesian economics and a rigorous effort have been employed in order to explain the ways in, which the rigidities evolve from the microeconomic foundations of wage and price settings. The post Keynesian economics was basically guided by two main features. Firstly, it violated the classical dichotomy unlike the Keynesian economics and secondly it assumes there are market imperfections within the economy, which is highly important in grasping the reasons for economic fluctuations. In the post Keynesian economy, the central theme is that of imperfect information as well as rigidity in the relative prices (Yilmazkuday, n.d., pp. 3-4). 4.3 Non believers of active government intervention The post Keynesian economics does not concentrate strictly on the notion that active government policies are strictly desirable for delivering efficient economic outcomes. As they concentrate mainly on the agendas of market imperfections they state that the free market leads to inefficient equilibria ( Yilmazkuday, n.d., pp. 3-4). 4.4 More stress on the real world One of the basic differences between the Keynesian economics with that of post Keynesian is that of stress on the real world. One of the primary goals of this branch of economics is directed towards understanding the crux of the capitalist system and simultaneously develops a rational platform which will generate solution in dealing with the economic problems in today’s modern world. These notions have been vehemently reflected in the studies of post Keynesian economists like “Hyman Minsky, Paul Davidson, Ed Nell, Jan Kregel, Joan Robinson, Vicky Chick, Alfred Eichner, Malcolm Sawyer, Marc Lavoie, Sidney, Weintraub and so on” (Holt, 2012). Post Keynesian economists always focus on the development of a logical explanation. In this regard, the statement of Nell in 1980 can be stated as who views Post Keynesianism as “account of the working and misworking of the capitalist system." (Nell, 1984, p.xi). From the dimension of traditional economics have been always applied in two approaches and they are partial equilibrium and general equilibrium analyses. In the partial equilibrium framework, only a part of the society is subjected to experimentation assuming the concept of cetaris paribus (all other things remaining constant) (Chauhan, 2009, p. 224). The general equilibrium framework stresses more on the application of various mathematical tools and explores the whole economy with the determination of prices and quantities within the economic system. The post Keynesian economists stresses on the dynamic nature of the economy which stresses on the utilization of money and are subjected to uncertainty. Time is a crucial variable and clearing of market depends on time. Generally, individuals leave out relevant variables, relationship changes over time and ignore functional specifications of the relationships that exist in the real world (Holt & Pressman, 2006, p.23). More emphasis is entailed by these economists on the institutional settings as well as the social relationships embedded within them. The post Keynesian economics realize that the markets are in state of jeopardy and uncertainty prevails in rampant manner. Thus they target in understanding these fluctuations and uncertainties in the economy instead of just relying on model development as the Keynesian economics did. But it is a fact that the post Keynesian economics attaches itself strongly to the efforts of Keynes who tried to develop a general theory for analyzing the working of the capitalist system during his time. In this respect the statement of Asimakopulos can be mentioned which states that, “Keynes tried to develop a theory that would be relevant to the capitalist economies of his day, economies that existed in historical time. The basic framework for his theory was thus conditioned by his vision of the operation of such economies” (Holt, 2012). Thus the discussion so far highlights on the first part of the paper. Thus understanding the facets of post Keynesian economics in the above section, the second part of the paper will be now discussed. Quantity theory of money will be discussed in a short manner and then Milton Friedmain’s quantity theory of money demand will be discussed in contrast with liquidity preference theory by Keynes. 5. Quantity theory of money Within the classical school of thought, economist Irving Fisher developed a theory known as the quantity theory of money which is commonly known as the equation of exchange. The equation of exchange can be depicted by the equation given below as: MV = PQ…….. (1) In the above equation, M is total money supply in the economy, V is the velocity of money which can be thought of as number of times in each year one dollar of money is utilized in buying final goods or service. The equation of exchange is basically an identity which states that quantity of money times it is used in purchasing goods that will be equal to the amount of goods times their price (Kennedy, 2000, p. 146). Fisher stated that velocity of money is constant in the short run as because he thought the velocity of money is affected by institutional and technological changes over time in a slow manner. Fisher believed that the flexibility in wages and prices guarantees the output in the economy to its full employment level and it is constant in the short run. Thus if the velocity and Y remains unchanged then change in the money supply results in an equi-proportionate change in the price level P. Now, if equation is divided by V on both sides then the equation boils down to: M= (1/V) PQ…………….(2) 1/V can be treated as a constant suppose k (say) and with constant when k remain constant and the money market is in equilibrium i.e money demand is equal to the money supply, then equation (2) can be written as MD= kPQ………………………… (3) Thus it can be stated that under the notion of Fisher’s quantity theory of money demand is depended on income and is independent of interest rates (The Demand for Money, 2012). 6. Liquidity Preference theory of Keynes In Keynes book, The General Theory of Employment, Interest Rates, and Money, he developed a theory of money demand on the basis of liquidity preference theory (Keynes, 1971, p.142). He has stated that money bears a positive relationship with income and when transaction increases then people will be also holding more money. He also stated that people usually hold that money for emergency purposes and this is captured within the precautionary motive of the individuals. Another important assumption which Keynes stated is that of the speculative motive which directs that money serves as a medium for the people for storing wealth. Keynes stated that individuals usually store wealth in the form of money or in the form of bond. In times when the rate of interests are high, then bond prices are also expected to rise as bond are positively related with interest rates and this makes the bonds more attractive than money at times when there is escalated interest rates. In times of low interest rates the demand for money is low. And thus there lies a negative relationship between money supply and interest rates. Keynes also included money demand for the real quantity of money in terms of money balances i.e, M/P. Keynes state that this M/P is a function of interest rate (r ) and income (Y) i.e, M/P=f(r, Y). Now clubbing this value in equation (1) we get the following equation as, V= Y/ f(r, Y)…………………………… (4) Thus Keynes state that velocity of money changes with the interest rates. And he also stated that velocity and interest rate are pro cyclical i.e. it rises with expansionary regime and falls during recession. 7. Milton Friedman’s Quantity theory of money demand Post Keynesian economist Milton Friedman formulated a theory of money demand within his famous article, “The Quantity Theory of Money: A Restatement” in 1956. Friedman stated that demand for money is influenced by the factors that influence demand for any other assets. The money demand function in Friedman’s model can be depicted as follows: MD/ P = f ( YP, rb-rm, re- rm, - rm, w, u)…………………(5) Where, MD/ P = Real money demand YP= Permanent Income, rm= expected return on money, rb= expected return on bonds, re= expected return on equity, = expected rate of inflation, w= human and non human wealth and u=other factors . Friedman states that the demand for a particular asset has a positive relation with wealth and money demand is positively associated with permanent income. The permanent income has much smaller fluctuations in the short run as several movements of income are basically transitory. Permanent income in Friedman’s model acts as a determinant of money demand which states that the demand for money will not be affected by the movements in business cycles. Three categories of assets were mainly devised by Friedman namely bonds, equity and goods. Individuals find incentives in holding the assets as compared to money. The expected return on money is influenced by the service provision of the banks on deposits and the interest payment on the money balances. rb-rm and re- rm are the expected return on bonds and equity as compared to money. When these variables rise then there occurs a fall in expected return on money and as a result there will be a fall in demand. - rm signifies to the expected return on goods as compared to money. When it rises, the expected returns of goods compared to the money rises and money demand falls (Xueping, n.d., p.4). 8. Friedman and Keynes Although the model bears similarity with Keynes yet there are several differences that occur between the ideas proposed by these two stalwarts. Friedman has considered multiple return rates and considered relative return to be of high importance. Freidman also considered the permanent income of the individuals to be more significant than the current income in the determination of the demand for money. The theory developed by Friedman is more stable than that developed by Keynes because permanent income is very stable and the spread between the returns will be also stable as the returns would fluctuate with the spread remaining the same. In Freidman’s model the changes in interest rates will be affecting very less or independently to the money demand which is not the case in case of the model developed by Keynes. If the terms that affect the money demand are stable then there will be also stability in the money demand. The significant differences between Keynes and Friedman lies within the sensitivity of money demand to that of the rate of interest and that of the stability of money demand in a dynamic manner. Tobin further researched the relationship between interest rates and money demand and found that the relationship did not change over time (The Demand for Money, 2012). 9. Conclusion The brief study of the paper gives us a clear idea about post Keynesian economics extending from the realms of Keynesian economics and also a departure from it. Keynesian theories have been based on a more theoretical basis with less emphasis on the real world and failed to provide potential solution to the economic crises taking place in the economy. Post Keynesian economists rely heavily on the real world uncertainties for developing the theories. Quantity theory of money demand as proposed by Keynes interest rates and velocity of money move in the same direction. Milton Friedman incorporates the asset market in a more rigorous manner showing the stability of money demand in a dynamic approach. References 1. Bhole, L M, (2004), Fin Inst & Mkts, 4E, Tata McGraw-Hill Education 2. Congdon, T, (2007), Keynes, the Keynesians and Monetarism, Edward Elgar Publishing 3. Chauhan, (2009) Microeconomics: Theory And Applications Part 2, PHI Learning Pvt. Ltd. 4. Holt, R. P. F & Pressman, S, (2001), New Guide to Post-Keynesian Economics, Routledge 5. Holt, R. P. F & Pressman, S, (2006), Empirical Post Keynesian Economics:  6. 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