April 6, 2017

Keynes saw the problems but did not solve them

Comment on Lars Syll on ‘Sticky wages is not the problem!’


Laypersons cling to the naive belief that economists know how the price and profit mechanism works. The fact is that the major approaches ― Walrasianism, Keynesianism, Marxianism, Austrianism ― are mutually contradictory, axiomatically false, and materially/ formally inconsistent.

Keynes was right, of course, in “heaping scorn on what he called the ‘classical’ doctrine that cyclical … unemployment could be attributed to the failure of nominal wages to fall in response to a reduction in aggregate demand.” (David Glasner)

Thereof, though, does not follow that Keynes’ employment theory was correct: “Keynes never stopped insisting that the key defining characteristic of ‘involuntary’ unemployment is that a nominal-wage reduction would not reduce ‘involuntary’ unemployment. The very definition of involuntary unemployment is that it can only be eliminated by an increase in the price level, but not by a reduction in nominal wages.” (David Glasner)

There is not much use to reenact one more time the farce titled ‘Mr. Keynes and the Classics’ so, here is the elementary version of the correct (objective, systemic, macrofounded) Employment Law on Wikimedia AXEC62#1

From this equation follows that employment L depends (i) on aggregate demand, which is here given with the expenditure ratio ρE and investment expenditures I, and (ii), on the price mechanism, which is formally embodied in the macro-ratio ρF≡W/PR with W = average wage rate, P = average price, and R = average productivity.

Let ρE and I be fixed and the rate of change of productivity R for simplicity be zero, i.e. r=0, then there are three logical cases:
(i) The rate of change of the wage rate W is equal to the rate of change of the price P, i.e. w=p, then employment does NOT change NO MATTER how big or small the rates of change are.
(ii) The rate of change of the wage rate is greater than the rate of change of the price then employment INCREASES.
(iii) The rate of change of the wage rate is smaller than the rate of change of the price, then employment DECREASES.

So, it is DIFFERENCES in the rates of change of wage rate and price and NOT the absolute magnitude of change. Every PERFECTLY SYNCHRONOUS inflation/deflation is employment-neutral, that is, employment sticks indefinitely where it actually is.

In general terms, the neutrality condition reads w=p+r+pr. Therefore, it is a matter of indifference whether the wage rate falls or rises or whether wages are sticky or not. ALL depends on relative changes. Employment increases if w is greater than p+r+pr and decreases in the opposite case.

So, Keynes’s assertion that involuntary unemployment “can only be eliminated by an increase in the price level” is false. An increase of the price level with w=0, r=0 REDUCES employment. From this follow that Keynes, too, had NO idea, how the price mechanism works or, as Allais put it: “... son insuffisance logique ne lui a pas permis de résoudre les problèmes que son intuition lui avait fait entrevoir.”

Keynes’ logical insufficiency is alive and kicking as After-Keynesians demonstrate until this very day.

Egmont Kakarot-Handtke

#1 For details of the big picture see cross-references Employment and cross-references Keynesianism and cross-references Scientific Incompetence.