Monday, May 16, 2011

Keynes - The General Theory - Chapter XXI

Section I: Keynes proposes to give us his theory of prices. He points out the problem with economists who divorce their theory of money from the rest of their teachings, noting, quite correctly, that a theory must be able to make sense of money, an integral aspect of the modern economy. For "as soon as we pass to the problem of what determines output and employment as a whole, we require the complete theory of a Monetary Economy."

Moreover, this problem cannot be avoided: "We cannot get rid of money even by abolishing gold and silver and legal tender instruments. So long as there exists any durable asset, it is capable of possessing monetary attributes and, therefore, of giving rise to the characteristic problems of a monetary economy." This is well said.

In this section, he also notes, and in italics: "For the importance of money essentially flows from its being a link between the present and the future." Actually, the essential importance of money is that it serves as a medium of exchange. True, people expect money to be valued in the future, but this is true of a variety of other things, whereas non-monetary goods are seldom used as a medium of exchange.

Section II: This is comprised of a single paragraph, with little value.

Sections III-IV: Keynes wishes us to grant him two assumptions for him to illustrate what will happen to employment if the money supply is increased. To wit: "(1) that all unemployed resources are homogeneous and interchangeable in their efficiency to produce what is wanted, and (2) that the factors of production entering into marginal cost are content with the same money-wage so long as there is a surplus of them unemployed."

The first assumption is preposterous. Workers cannot be treated homogeneously so long as they differ drastically--in training, ability, physical or metal prowess, etc. As written, the second is tautological, though if what he means is that workers do not demand raises while others are unemployed, he is making an erroneous assumption.

Nevertheless: "So long as there is unemployment, employment will change in the same proportion as the quantity of money; and when there is full employment, prices will change in the same proportion as the quantity of money." (Italics his.)

At the moment, the first half of this supposition is faring rather badly. Inflation, even according to the deliberately under-stated government criteria, is far outpacing employment, which is stagnant. The second half of his statement is not correct, either, though it is less obviously flawed. As we have discusses previously, inflated money does not enter the economy all at once, but through those who have access to the money first. So when Bernanke gives money to his pals at Goldman-Sachs, they can spend that money on fine cigars; the cigar store owner and the manufacturer of the cigar then spend this money, which is in turn spent, and so on. Overall, prices do increase, but they increase more for some goods than for others.

Keynes then mentions five possible complications. He enumerates them here, and then offers a defense of his earlier supposition in the following section of this chapter. I shall list each reason, followed by brief commentary.

(1) Effective demand will not change in exact proportion to the quantity of money.

We have discussed this above. Inflation redistributes wealth, taking from the poor and giving to richer, more well-connected people. But also, and more fundamentally, it distorts the price structure.

(2) Since resources are not homogeneous, there will be diminishing, and not constant, returns as employment gradually increases.

An excellent point. Actually, entrepreneurs are well aware of this fact. The unemployed are those who cannot be expected to produce enough to make hiring them worthwhile; they can only be hired at a lower rate Of course, judgments of entrepreneurs are not infallible; nonetheless, this holds for every good in the economy.

(3) Since resources are not interchangeable, some commodities will reach a condition of inelastic supply whilst there are still unemployed resources available for the production of other commodities.

Again, well said Keynes. During a bust, employment decreases, but it does so unevenly. Realtors are probably still hurting, but other professions are doing comparatively better. Similarly, just because housing prices in Miami, FL continue to fall, does not mean International Falls, MN experienced much of a housing bubble.

(4) The wage-unit will tend to rise, before full employment has been reached.

This strikes me as plausible. When unemployment begins to fall--and I mean substantially, more so than the insignificant changes we've experienced during the last few years--people who were happy enough to be employed, may start to look for better jobs elsewhere. Employers are not required to hire only those who are unemployed; just because a person changes jobs does not mean that an unemployed person will necessarily be able to fill the vacated position.

(5) The remunerations of the factors entering into marginal cost will not all change in the same proportion.

This is true, and I have said as much above.

Keynes also introduces the term "cost-unit," which he calls "the essential standard of value." I am not terribly sure what he means by this.

Section V: With all the increases in the supply of money, we come to inflation: "When a further increase in the quantity of effective demand produces no further increase in output and entirely spends itself on an increase in the cost-unit fully proportionate to the increase in effective demand, we have reached a condition which might be appropriately designated as one of true inflation."

This is a curious way of putting it. Keynes speaks as if the money which is used to increase employment is somehow exhausted. Yet the whole point of printing money was to increase employment, thereby increasing the propensity to consume, which would redound to the benefit of everyone in the economy.

Inflation is a monetary phenomenon. When the supply of money is increased, more dollars--or whatever the unit of currency may be--are available to compete with the same supply of goods. The effect of this is to drive up prices. Generally rising prices, then, are an effect of inflation; but prices may rise for other reasons--an increase in demand or a decrease in the supply of a particular good. The effects of inflation may be obscured by improvements in the productive process; so while computers are still falling in price, they are falling less than they would be if helicopter Ben had kept his fingers off the printing press.

Sensible thinking about inflation would have led Keynes to be more cautious about the supposedly salutary connection between an increase in the money supply and unemployment.

Section VI: Again, we have some more algebra which does not merit our time. Lest the reader think I glance over a subject which I do not possess the training to understand, I merely note that, as an engineer, and one who took courses in mathematics as electives, I am sufficiently qualified to simplify equations.

Section VII: Our economist notes that in "the very long-run course of prices has almost always been upward. For when money is relatively abundant, the wage-unit rises; and when money is relatively scarce, some means is found to increase the effective quantity of money."

Yet this is only true because the authorities are so often trying to debase the currency. Absent that, prices tend to fall, as we see, not only in certain sectors, such as the aforementioned computer industry, but more ubiquitously in those infrequent periods of history in which the money supply was kept stable, such as after the American Civil War. Keynes would have been better served trying to determine why governments are so intent on impoverishing the citizenry through debasement of the currency rather than rationalizing that such theft is actually good for those being robbed.

Despite his assurance that his theory is a general one, Keynes finds himself commenting on particular problems that plagued those of his time: "The acuteness and the peculiarity of our contemporary problem arises, therefore, out of the possibility that the average rate of interest which will allow a reasonable average level of employment is one so unacceptable to wealth-owners that it cannot be readily established merely by manipulating the quantity of money."

Hence the authorities will have to step in and massage the rate of interest. Yet the rate of interest, like everything else, is determined by market forces; it is coordinated between borrowers and lenders. I can see no reason to offer judgment as to whatever agreements are reached between said groups.

No comments: