Brad DeLong highlights a particular portion of Krugman's piece on Keynes:
"What did Keynes really intend to be the key message of the General Theory?... [I]t’s surely not the most important thing.... What matters is what we make of Keynes, not what he really meant.
I’d divide Keynes readers into two types: Chapter 12ers and Book 1ers. Chapter 12 is, of course, the wonderful, brilliant chapter on long-term expectations, with its acute observations on investor psychology, its analogies to beauty contests, and more. Its essential message is that investment decisions must be made in the face of radical uncertainty to which there is no rational answer, and that the conventions men use to pretend that they know what they are doing are subject to occasional drastic revisions, giving rise to economic instability.... Part 1ers, by contrast, see Keynesian economics as being essentially about the refutation of Say’s Law, about the possibility of a general shortfall in demand. And they generally find it easiest to think about demand failures in terms of quasi-equilibrium models in which some things, including wages and the state of long-term expectations in Keynes’s sense, are held fixed....
So who’s right about how to read the General Theory? Keynes himself weighed in, in his 1937 QJE article, and in effect declared himself a Chapter12er. But so what? Keynes was a great man, but only a man, and our goal now is not to be faithful to his original intentions, but rather to enlist his help in dealing with the world as best we can..."
A lot of people claim that there's this massive contrast between the early Keynes and the late Keynes. I think that's vastly overblown. Yes, there are a few ideas that the late Keynes provides us that the early Keynes hadn't thought of yet. But as early as the early 1920s you could see the germ of all the later arguments - all of them. And nothing was especially contradictory, so much as immature.
Now Krugman is suggesting there's some divide in the General Theory itself!
I really don't think there's any reason to choose here.
Why can the economy operate below full employment? Because investment demand isn't guaranteed to adjust to full employment. Why doesn't investment demand always adjust? Because investment demand is limited by the interest rate which - rather than being determined in the loanable funds market - is determined entirely by the demand for money or liquidity. The low expectations that Krugman refers to from Chapter 12 lower the expected stream of benefits from an investment. When those expectations are reduced, the marginal efficiency of capital - the discount rate at which an investment breaks even - is also reduced. Financial panics that reduce expectations also increase money demand. So the MEC consistent with full employment is getting lower at the same time that the demand for money is getting higher, and there is no guarantee that the interest rate provides a level of investment that is consistent with full employment.
We have a new equilibrium. It is not a unique equilibrium. There are many, including many that are below full employment.
Chapter 12 and Book 1 don't conflict. You need Chapter 12 to explain why Book 1 says that we're not guaranteed to sit at full employment. And furthermore, you need a liquidity preference theory of the interest rate to understand any of this or to make sense of the behavior of interest rates and employment over the last two years.
Procrastinating on January 23, 2017
6 hours ago