Transcript Classical – Neoclassical Economics

Classical – Neoclassical Economics: An Aside
Neoclassical Economics
Classical Economics
Smith – Ricardo/Malthus – Mill
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Labor theory of value
Malthusian population
Say’s law
Quantity theory of money
• Marshallian economics
• Gossen/Jevons/Edgeworth
• Microeconomics
Physiocrats – Marx
• Balanced growth/imbalance
Concern: consequences of
capitalist accumulation
First Principles:
• Price independent of demand
» Labor theory of value
• Natural (long-run) prices
equalize rates of profit
• Real wage = “subsistence”
» Wage fund – Iron Law
Concern: allocation of scarce
resources
First Principles:
• Decision at margin
• Prices determined by
interaction of supply (costs)
and demand (utilities)
• Distribution accords with
marginal productivities
Irving Fisher
1867 – 1947
Rags – Riches – Rags (not quite)
•Top Yale graduate (math) and Professor
•Married rich  Europe tour – networking/New Haven house
•Illness  Health fetish (corn flakes!)
•Inventor (card index system) – merged into Remington Rand  $$$$
•Stock market speculation  Crash  $
•Crusader: stable money, League of Nations, calendar reform, spelling
reform, Esperanto, environmental protection, prohibition
•Leading US economist/Public advocate/Government advisor
•First President of Econometric Society, 1930
• Contributions to price theory
• Consumption indifference curves/”utils” + Production possibilities frontier
• Market equilibrium: MRT = dy/dx = px / py = MUx / MUy = MRS
• Contributions to monetary economics
• Ideal index numbers: geometric mean of Paasche and Laspeyres
• Fisher effect: Nominal interest rate = Real rate + expected inflation (e)
• Quantity Theory of Money: MV = PT
» Velocity and Transactions independent of Money
» If M up, P up, ceteris paribus
» expectations lag  sticky nominal interest rate (stickier than Price)
M up  P up  Real rate down  Investment spend up  EXPANSION
Fisher’s Debt Deflation Theory of Depression
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Easy money  over-indebtedness/speculation/boom – bubble
Bubble bursts  Debt liquidation  distressed sale of assets
Contraction of bank balance sheets  M down
M down  P down
P down  Profits down  Business net worth down
• Liquidation does not liquidate but rather aggravates debt
“The debtors pay the more they owe.”
• Output down / Employment down / Income down
• Depression
• Hoarding / reduced velocity of money / P down
• Vicious spiral of deflation
Institutionalist Aside
• Thorstein Veblen (1857 – 1929)
– Conspicuous consumption – Conspicuous leisure
• Rick Tilman – Veblen Incarnate
• Wesley Clair Mitchell (1874 – 1948)
— NBER / New School
• Simon Kuznets—National Income Accounting
• Arthur F. (Fluctuations) Burns
Eisenhower Advisor—Nixon Fed Chair
• John Kenneth Galbraith (1908 – 2006)
• Office of Price Administration (OPA) / Miracle of the Deutschemark
Galbraith: A “Policy Entrepreneur” (Paul Krugman)
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American Capitalism: The Concept of Countervailing Power (1952)
The Great Crash, 1929 (1954)
The Affluent Society (1958)
New Industrial State (1967)
Ambassador’s Journal (1969)
Monetary Theory
• David Hume – specie flow, prices, and trade balance
• David Ricardo – The High Price of Corn
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• Alfred Marshall – Cambridge oral tradition: M = k PY
Professor Irving Fisher has been the first, in several instances, to publish in book form
ideas analogous to those which had been worked out by Marshall at much earlier dates.
J.M. Keynes, Alfred Marshall, 1842 – 1924, p. 336 fn.
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Irving Fisher – Quantity Theory and Real Interest Rate
Knut Wicksell – Natural rate of interest/cumulative process
Gustav Cassel – Quantity Theory  Purchasing Power Parity
Gunnar Myrdal – Monetary Equilibrium: Ex ante – ex post
John Maynard Keynes
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Tract on Monetary Reform (1924)
Treatise on Money (1930)
The General Theory of Employment, Interest and Money (1936)
The General Theory of Employment, QJE, 1937.
•Professional student – first job as economist at age 48
•Career at University of Lund
•Social radical serving conservative (neoclassical) science
•Champion of birth control, women’s rights, free love
•Military nihilist (Sweden can’t defend self  disband army)
•Jailed for sacrilege
•Established marginal productivity theory of distribution
• Competition: Linear homogeneous (Cobb-Douglas) production function
Knut Wicksell
1851 – 1926
•Proposed Pareto optimal log-rolling before Pareto
Fiscal packages where everyone gains
•Level the playing field: inheritance tax; public education!
• Interest and Prices, 1924: Cumulative process in full-employment
economy using bank money … Say’s Law holds  real GDP steady
i = market rate of interest set by banks…credit and Ms adjust to Md at market rate i
r = “normal” rate of interest—keeps P steady = “natural rate” = return on capital
I/Y = Investment/Real GDP = F(i – r) demand for credit (remember, Y is fixed)
$Y = $C + $I = PY
Steady-state equilibrium ($I = 0): $Y = $C = $Yt-1
Disequilibrium (r rises; i steady): $Y = $C + $I = $Yt-1+ $I  $I = Δ$Y = ΔPY = $S
 Investment is financed out of forced saving owing to inflation (real C down)
$I = PI = ΔPY  ΔP/P = I/Y = F(i – r)
If i<r, firms demand credit to finance investment, banks create money to meet
demand for credit
Prices (and wages) rise Profit expectations  Demand for Credit Up
Monetary equilibrium requires i = r.
 Role for Central Bank to manage i.
Wicksell’s interest rate rule for monetary equilibrium:
Precursor of inflation targeting
So long as prices remain unaltered the (central) bank’s
rate of interest is to remain unaltered. If prices rise, the
rate of interest is to be raised; and if prices fall, the rate of
interest is to be lowered; and the rate interest is
henceforth to be maintained at its new level until a further
movement of prices calls for a further change in one
direction or another.
Wicksell, Interest and Prices, p. 189
quoted in Michael Woodford, Interest and Prices:
Foundations of a Theory of Monetary Policy, p. 38
The Stockholm School
Gustav Cassel
1866 – 1945
Purchasing Power Parity
General equilibrium … extension of Walras
A writer less generous than Cassel would be hard to find.
Marx at least paid tribute to Quesnay and Ricardo. Cassel
paid tribute to nobody. Walras had written the first system of
simultaneous equations of general equilibrium. Pareto had
purged it of any measure of sensations. Cassel followed both
but mentioned neither…
Eli Heckscher
1879 – 1952
Economic
historian at
University of
Stockholm
“Classical” theory of interest: rate that equates saving & investment
Foil for Keynes in General Theory
Ohlin-Hecksher
Trade Theory
Teacher of Myrdal, Ohlin
(Factor Endowments)
The Stockholm School, 1927 – 1937
Extending Wicksell’s Cumulative Process
Eric Lindahl, 1891 – 1960 General equilibrium theory
Dag Hammarskjöld
1905 – 1961
UN Secretary General
Gunnar Myrdal
1898 – 1987
• Myrdal, Monetary Equilibrium, 1933
• Ex ante intentions drive macro-performance.
• Ex post results are basis for next period’s
intentions.
• S = I ex post, but not necessarily ex ante.
Bertil Ohlin
1899 – 1979
•Autonomous changes in consumption
Extension of Wicksell model.
The Stockholm School
Beyond Macrodynamics
• Dag Hammarskjold – Secretary General of UN
• Gunnar Myrdal … extensions of cumulative process
• Cumulative causation – vicious circles
» An American Dilemma, 1944  Brown v. Board of Education
» Rich Lands and Poor, 1957
» Asian Drama, 1968
• Wife, Nobel Laureate Alva Myrdal
» Director of UNESCO
» Swedish Ambassador to India
• Bertil Ohlin
• Transfer problem (1929): income adjustment
» Keynesian analysis vs. pre – General Theory Keynes
• Head of opposition social – liberal People’s Party
Sweden’s Commission on Unemployment
• 1924: Return to gold standard at overvalued rate
• 1927: Recession … formation of Commission
• Ohlin (1934) Monetary Policy, Public Works, Subsidies
and Tariffs as Means for Reducing Unemployment
• Focus on Aggregate Demand, not wage reduction to get out of
depression
• Deficit finance of Public Works + Easy Money for Investment
+ Price Supports for Farmers
Spending Multiplier and Investment Accelerator
• Myrdal (1934) The Effects of Fiscal Policy
• Countercyclical policies … balance budget over cycle
» Build infrastructure in depression
… not US “leaf-raking”
» Easy money in recession … tight money in expansion
• 1936: Swedish depression ended
Vicious Spirals of Note
• Fisher – Minsky: Debt Deflation Spiral
• Foreclosure “Death Spiral”
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Wicksell: Loan rate < Real rate  hyperinflation
J.H. Williams: Depreciation – Inflation Spiral
Myrdal: Discrimination – Poverty Spiral
Debtor “Death Spiral”
• Budget “Death Spiral”
• Insurance “Death Spiral”