Micro-foundations for Keynesian Economics
from Asad Zaman
Lecture 8A of Advanced Macroeconomics — Outline below covers the first 17m of the lecture linked below at bottom of post.
1. EXCESS Savings reduce Effective Demand, Normal Savings Do Not
It seems clear that shortfalls in aggregate demand can lead to recessions, but only in presence of fixed prices. Furthermore, normal levels of savings cannot create such shortfalls – an abnormally high level of savings is required. This is because of factors discussed in “ The Subtleties of Effective Demand ”. Basically, if a normal level of savings is reduced from Aggregate Demand, this money is saved and goes on to period T+1. Similarly, the savings of last period T-1, is going to come into the present period T. This will exactly offset the shortfall in Aggregate Demand created by the savings. However, this will not happen if for some reason there is EXCESS savings, over and above normal levels. This excess S(T) > S* will be not be compensated fully by S(T-1)=S*, where S* is the normal level of savings.
What could lead to abnormally high savings? It appears that debt can force people to earn money to pay off debt, reducing aggregate demand. Thus it appears that the Keynesian mechanism for creating unemployment as an equilibrium phenomenon relies on debt – without explicit mention. Once the role of debt is highlighted as the source of shortfall in aggregate demand, we examine in detail Fisher’s theory of Debt-Deflation, which never received the prominence that Keynes did. In the recent times, this theory has been resurrected, and is solidly backed by empirical evidence. See: Fisher-Minsky-Koo theory of debt-deflation.
2. Empirical Evidence favors Keynes Conjectures read more
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Real-World Economics Review Blog 
Bravo, Zaman! You have the braveness to tell the truth. Although I have several points of reservation on details of his arguments, his conclusion that “demand for Micro-Foundations for Keynesian Economics is legitimate” is totally welcome and right. Zaman speaks simply of Keynesian Economics but this is in reality the question of Post Keynesian Economics. Most of the post Keynesians believe that microfoundations are dispensable and even toxic. Their claim may be right if the microfoundations mean general equilibrium theory. This was the solution taken by New Keynesians. Post Keynesians have reason to reject the New Keynesian solution. However, as Zaman made it clear, there are many ambiguities in Keynes and Keynesians reasoning if we examine it in detail and in depth. Post Keynesian Economics needs its foundations.
See also my question in ResearchGate: Does Post Keynesian Economics need no theoretical foundations?
https://www.researchgate.net/post/Does_Post_Keynesian_Economics_need_no_theoretical_foundations
In the arguments presented, a Cobb-Douglas production function is invoked, as if it was a meaningful theoretically valid argument. Such an argument is FALSE. The Cobb-Douglas function is a concrete representation of specific data. It can NEVER be a theoretical relationship. It contravenes the requirements of the quality calculus. ALL production functions do! By introducing such specious arguments, trails of false logic confound economic analysis.
Such simple errors undermine any valid analysis which might be present. It behoves authors to ensure that what they say is true and when such errors are demonstrated, they do NOT continue with the failed arguments. They achieve nothing by so doing and even confound valid argument by giving a superficial air of respectability to that what they are arguing against.
If real scientific standards were applied, then economic analysis would be relieved of the plethora of misunderstanding which currently abound.
Your comment on Cob-Douglas production function is extremely important. Cob-Douglas and CES (constant-elasticity of substitution) production function are first things to be excluded from good macroeconomics.
While I can applaud any brave effort, here I think Asad (like most economists) is mixing his metaphors when thinking of micro differences in the structure as differences in the macro foundations on which differing structures have been built. Does one underpin a structure after it has been built, or having laid the foundations, monitor any structures built on them to see if they are stable? Only when (as now again in economics) none of the structures seem stable does one question the foundations.
Keynes was into macro-foundations for micro-economics, not what Yoshinori keeps advocating, micro-foundations for the unstable static structures still being built by so-called Keynesians. This is due not so much to Keynesian ambiguity as their failure to understand the macro difference between a state of equilibrium and the cybernetic (dynamic) pursuit of one: in Asad’s gestalt illustration, still seeing the old woman’s face and not even looking for the young one. Keynes saw this clearly, even if he couldn’t describe it clearly in words. I applaud him as a brave pioneer, who pointed us in the right direction, but whose architectural designs were fatally modified at Bretton Woods and made to appear counter-productive when self-serving monetarists replaced progressive taxation with progressive rents.
Let me take the phases of life as a paradigm of the difference between macro and micro theory. There are four such ‘macro’ phases: unicellular organisms, linear plants, physically mobile animals and mentally mobile humans. Within us there are still blood cells, linear structures and reactive neurological subsystems, but also a continued evolution in behaviour like having to change gear when one’s navigation brings one to a hill, hence the genetically ‘micro’ but behaviourally vast differences between, say, cold-blooded and warm-blooded species of animals.
In economics, then, I’m seeing the four phases (figuratively) as the kids consuming, dad’s producing, mothers distributing and old folk developing – which already takes account of a lot which has been left out or underplayed in conventional economic theory. One of the things which has been developed is a monetary control theory, again with four phases: barter with “one for you and two for me”; Adam Smith’s price control; Keynes’s price and unemployment control; and what has always been there but ambiguously: profit control by switching markets when they become unprofitable, or Keynes’s way of keeping profiteering within safe limits by progressive taxation. The paradigm Keynes is feeling for is thus the PID control servo having electricity for money and information feedback rather than naked market forces for control..
I have carefully formulated my question: Does Post Keynesian Economics need no theoretical foundations?
Many Post Keynesians refuse to consider “theoretical foundations”. If “microfoundations” have some problem, it must not be a pretext that PK people always argue based on their intuition rather than theory.
Micro and macro-economics are like quantum and temporal reality…seemingly unresolvable…until one cognites on the single concept capable of uniting the two into a separate third reality of its own while simultaneously respecting the realities of each/all three. A concept of Twoness/Duality within THIRDNESS/Greater ONENESS. The scientistic will never countenance this even though its staring them in the face all over nature and the cosmos. It’s the problem of the experience of consciousness itself as opposed to mere computation, of mental figure-figure-figure versus beingness.
This is where economic theory is.
That is, it’s stuck in Duality.
Seeking micro foundations for macro economics is insurmountable, or perhaps better said a dead end, because the economy is inherently an accounted-for social structure. Only when linear self-production is the norm, instead of the non-linear reciprocal process of providing hopefully-demanded output for others, would micro foundations be applicable. Hardly worthy of a pursuit by progressives isn’t it?
Furthermore, what are “normal” savings? What part of the expended income, i.e. disbursed costs by employers, can safely be “saved” so as not to cause a shortfall in aggregate demand? A badly needed theory of money is missing here. Is money an independently existing wealth or not?
Not a new theory of money…a new monetary paradigm that resolves the problems of systemic austerity and individual scarcity. Why do we allow the most important and potent factor in a monetary economy (money, and its creation and distribution) to be monopolized by a single self interested business model? JUST HOW GD STUPID IS THAT?????
To say that there is an “insurmountable” problem is postulated upon unstated assumptions. I have demonstrated that transient analysis, from first principles, provides a complete description of manufacturing projects and industries which is fully in accord with the empirical data. With manufacturing being the major component of industrialised economies, it comes close to being a description of these economies.
The fact that conventional approaches continue to fail to explain macroeconomic reality merely confirms that conventional analysis is inherently wrong. It does NOT indicate that quantitative relationships are impossible.
Unfortunately, economic education provides a totally inadequate basis for valid economic understanding. It has failed to grasp the realities of the scientific method. If it had, so much misunderstanding would already have been eliminated.
Your first principles and “scientific method” leads you to an “economy” that doesn’t possess a theory of demand, nor of distribution. You fake dynamism by calling it transient. It’s about as useless and as far away from the real world as it’s possible to get. Your hubris is breathtaking. Besides, close only counts in horseshoes (and hand grenades).
John Vertegaal (November 18, 2018 at 4:40 pm) is clearly a man of strong views. It would be advantageous if he were also to be better informed.
Why does he assume that there is a real theory of demand? Simple counterexamples demonstrate there is unlikely to be such a simplistic theory; outbreak of war, unemployment, economic cycles, all change the nature of demand.
What is his dynamism? I use transient in the same way as thousands of other papers in the physical sciences. Papers which are accepted as describing the real world. This is one of the strengths of the physical sciences. Mathematics is used as a descriptive tool. The physical sciences do not depend on rhetoric.
To claim that my analysis is “as far away from the real world as it’s possible to get” demonstrates either wilful ignorance or deliberate deception. The mathematical relationships developed in “Transient Development” are shown to describe manufacturing projects and industries as they exist in the real world. I do NOT claim nor need to claim more than this. If stating the truth is hubris then you and I have very different understandings of the word.
I have no idea what his final sentence means.
I’m well enough informed to be able to spot a crank theory when I see one. Salter’s theory, based on physics, doesn’t have the remotest possibility of developing any demand whatsoever from its set of first principles, never mind documenting a change. Neither can he deduce from them the concept of monetary savings. As this obviously isn’t applicable to pure physical objects, its impact on human beings has to also fall by the wayside.
Human beings live in a dynamic world that, given the right conditions, renews itself. Transient conditions of the physical world are just that, fleeting or passing through without the development of a life force behind it all.
Salter has no pertinent knowledge to contribute about an economy constructed by and for the benefit of humans. His utterances are just as useless as his revered “manufacturing projects”, but endlessly involved in cranking out non-demanded goods.
Vertegaal continues to set up a row of straw men and knock them down — bravo! Unfortunately, his straw men are totally irrelevant to actual reality.
He introduces demand but fails to mention the nature of the market — so much for Adam Smith. If someone produces a new product, it will either sell or it will not. If it sells and demand is seen, production will be increased. It is does not sell, they will move on to something else. Does Vertegaal expect to be able to predict this. If so, I imagine he will be a very rich man.
His next straw man is money. No I do not deal with money. I deal with capital. I show that the formulation of the neoclassical production function requires capital to be labour time, which I do deal with. This is the classical labour theory of the value of production.
His next straw man is some irrelevant philosophical point about life force. This does not deserve a response.
His final claim is that I have “no pertinent knowledge to contribute about … revered “manufacturing projects””. Here he demonstrates what I described above as “either wilful ignorance or deliberate deception”. I will restate that yet again.
My analysis predicts the nature of manufacturing industries. The predictions are fully in accord with the empirical facts. As such they pass Popper’s falsification test. They predict previously unrecognised relationships. Therefore, they satisfy their being an example of a progressive research programme as required by Lakatos.
The possibility of wilful ignorance: He has either NOT read or has NOT understood my paper but pontificates nevertheless.
The possibility of deliberate deception; I would interpret this as self-deception because he does not understood the lessons of the scientific method, Popper and Lakatos.
Funny how Salter digs himself ever deeper into a hole he cannot get out of. For outside of mentioning competition amongst manufacturers, nowhere in his “thesis” does the market as an exchange and clearing of output make an appearance. So apparently there is no need for it in his logic.
He doesn’t deal with money, or so he says. Then how does the output of a unit of labour time exchange in the market that I supposedly forgot?
He shows just how desperate he must be when he deliberately pulls words out of context as to me having said: “no pertinent knowledge to contribute about … revered “manufacturing projects””. Yet I am the one who is deliberately deceptive.
And finally we’re supposed to take his word for it that a manufacturing process, without apparent buyers for its output, operates in accordance with empirical facts.
That theory of his is a joke and I’ve wasted more than enough time on it. I’ll let whomever has been following this decide as to whether my arguments are strawmen or not.
My analysis makes specific predictions and they are in accordance with the empirical facts. Read the paper and examine the cited papers in which the empirical data was published.
Vertegaal shouts you can’t be serious but never demonstrates that any of of my analysis fails to correspond to the empirical data. All of his spurious claims always come down to his mind is made up so don’t confuse him with the facts — the very definition of mumpsimus.
I do not want to get involved in this slugfest. But John Vertegaal has made an important point in the last sentence about the manufacture of non-demanded goods. If you want to sell goods (theories), you have to understand the needs/desires of your audience. If they have a problem – or they think they have a problem — and you show them that your theory can provide a solution – then they will take interest in your theory. But to accomplish this, you have to have greater interest in and understanding of what your audience thinks it needs, then most people who want to sell their theories do. Most sellers of theories take the view that their theory is so perfect and excellent and golden and shiny that anyone with any sense will automatically take interest in it. If someone does not take an interest, then he/she must be blind – it cannot be due to any defects of the theory (ie failing to address needs).
I would agree with much of what you say, However, The majority of economic analysis fails the tests of Popper and Lakatos.
Your final argument is one of argument by analogy. To do this in a valid manner requires you to prove the analogy first. If you do not demonstrate the theory to be defective, then this argument fails a priori.
So your argument is that if anyone comes up with a theory which he/she claims to be correct, the burden of proof is on the OTHERS to demonstrate that the theory is defective. So have you looked at all the theories so ardently advocated by their own respective coteries and demonstrated that they are all defective?
Here you are identifying the basic failings of economics discourse. Scientific understanding states that it is impossible to prove the correctness of theories. Economists talk about such proof. Scientists use the word laws to refer to well established understanding, but accept the possibility of their being invalidated at some time. Lakatos (1970) sets out how the problem should be considered. For examples Newtons theory of gravitation is a member of a progressive research programme. So is Einstein’s theory of relativity. Both are still only partial descriptions of reality. Both are successfully used in the appropriate context. Valid theories do NOT need to be universal in scope and be the theory of everything!
It is possible to invalidate vast swathes of economic hypothesising. Any paper claiming theoretical validity for any production function is actually invalid. Quality calculus requires this to be so. Production functions can only be concrete descriptions of some data. Cobb and Douglas clearly understood this. Why do so many economists fail to do the same? It can only be a failing of their understanding. Equilibrium analysis and all its offshoots is falsified by empirical facts. The mere presence of economic cycles proves this conclusively. Those two facts alone falsify the majority of economic theorising.
I do not wish to demonstrate all individual failings of economic analysis. That would be a Herculean task or possibly Sisyphus’. My only claim, so far, is that my analysis is NOT invalidated by falsification and is a member of a progressive research programme as defined by Lakatos. I know of no other piece of economic analysis which can claim the same!
Reference
Lakatos, I. (1970). “Falsification and the Methodology of Scientific Research Programmes”.
In: Criticism and the Growth of Knowledge. Ed. by I. Lakatos and A. Musgrave, pp. 190–196.
Correction to reference: pp. 170–196.