David Colander’s original posting on the Macro Follies thread on the SHOE website along with my reply. My reply comes first.

I am really grateful for David Colander’s intervention. I am too well aware that such discussion threads can be a time of sabre cuts and bloodletting. And I am particularly grateful where he wrote:

What became known as Say’s Law was simply an argument that some people’s argument against too little demand being the cause of recessions was too simple–that real demand is tied to real supply.

That is so far from “supply creates its own demand” as to be almost unrecognisable as a statement of what the majority of the profession now believes Say’s Law to mean. We could refine the words but in the end what David has written is near enough identical to the classical statement “demand is constituted by supply”. It may even be somewhat of an improvement since it adds the word “real” on both the demand side and the supply side which was always understood when these issues were discussed.

But it is policy that matters which is why The General Theory was written. And here David writes:

[Keynes] devised a new framework–it said that sometimes economies could get out of kilter so much so that even if the long run classical model is correct, that is irrelevant because the adjustment is too slow for the political structure.

In this interpretation, Keynes accepts that real demand is constituted by real supply but the process is too slow so needs a bit of help. If that is what he had said, then The General Theory would have been entirely within the classical tradition. But unfortunately it’s not what Keynes meant or even what he said. But irrespective of what Keynes did or did not actually mean, Keynesian economics is now embodied in the expression Y=C+I+G.

If Keynes had accepted the constraints imposed by Say’s Law and the classical theory of the cycle, then he would have argued that public spending should be on productive value adding forms of output and budget deficits should be avoided at all costs. But that was not the message of The General Theory. Here is one of Keynes’s most famous passages which has been taught to students for generations and which is highlighted because it underscores how wrong-headed classical economists supposedly were. Notice that it is “loan expenditure” that Keynes is advocating which implies spending in excess of tax receipts:

The above reasoning shows how ‘wasteful’ loan expenditure may nevertheless enrich the community on balance. Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better. . . .

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing. (p. 129)

If one understood Say’s Law as it was understood by the classics, rather than such valueless expenditure being “better than nothing” it would have been seen as disastrous, shifting resources away from self-sustaining productive activities and into cul-de-sacs that would make recovery even more difficult to achieve because even more of the nation’s resources were being used in unproductive non-value-adding activities.

Say’s Law – the Law of Markets – is not, in my view, a long-run principle. It applies at every moment and in every economy. You cannot make an economy grow through wasteful expenditure. Where activities that do not return enough to cover costs take place economic forces are set in motion to restructure activity, unless the activity is being pushed by governments.

The idea that anyone even thinks it’s possible to increase economic growth and employment through wasteful expenditure, never mind it being the majority of the economics profession who hold this belief, would have seemed fantastic to those classical economists who were brought up on Say’s Law. But there we have it. Because of Keynes, this is where we now are. How we will ever get out of this intellectual dead end I have no idea but that is what needs to happen if the advice economists provide during recessions is to be of any use at all.

This was David Colander’s original posting to which the above was a reply.

to SHOE

I have stayed out of this, but I decided to throw in my two cents.

I think both Classical and Keynesian views of the depression make sense. It is all in the nuance of how one interprets them. Classicals, such as Mill and Marshall (who I see as following a classical methodogy) and Keynes, who as a follower of Marshall also followed a classical methodology, connected theory and policy together in a different way than did later economists who adopted a Walrasian methodology.

Laws to them were principles that were used to provide insight and to correct arguments. They were not everywhere and always true, and weren’t meant to be.

What became known as Say’s Law was simply an argument that some people’s argument against too little demand being the cause of recessions was too simple–that real demand is tied to real supply. It was part of their broader separation of the monetary and real sector that was part of the quantity theory (which also was not a hard a fast theory, but rather general tendencies.) Keynes was part of that Classical tradition and in the Treatise attempted to shoehorn the depression into it.

He soon came to believe that it didn’t fit well enough, so he devised a new framework–it said that sometimes economies could get out of kilter so much so that even if the long run classical model is correct, that is irrelevant because the adjustment is too slow for the political structure. He never developed his theory–he was pulled into policy and then died–but the outlines of theory were there–today it would be explained as a problem of complex systems dynamical adjustment, where there are lots of temporary basins of attraction that an economy can get stuck in, making it impossible to reach a more desirable basin.

Keynesian policy, which was not seen as permanent, was designed to push the economy to a preferable equilibria. The theoretical issues surrounding Keynesian policy all concern dynamical adjustment systems of complex systems, they do not concern equilibrium issues, although there are issues of multiple equilibria that can also be models. Keynesian policy as affecting dynamical adjustment makes sense in the Classical framework, which is why Keynes thought he had corrected a theoretical flaw in Classical theory–the flaw was that it did not sufficiently consider dynamical adjustment properties of the aggregate economy. But Keynesian theory can be seen as an (important) adjustment to Classical theory, not a whole new theory.

That was not the way Keynesian theory was developed–as it moved to neoKeynesian, Keynesian theory was shoehorned into a unique equilibrium Walrasian model that was not even closely up to the task of providing a solid foundation for Keynes’s ideas. That is the insight of Post Keynesians and fundamentalist Keynesians. Today, in my view, the interesting theoretical work in macro is being done in the study of dynamical complex systems, and little of that has filtered down to the texts or the general discussion, which is why there is so little ability to talk.

Dave Colander