Post Keynesian Macroeconomic Theory: A Foundation for Successful Economic Policies in the Twenty-First Century.

This book by Paul Davidson, co-founder and editor of the Journal of Post Keynesian Economics, presents a careful reading of Keynes and a sharp critique of mainstream macroeconomics as it has developed in the years since Keynes. In The General Theory and his subsequent QJE and Economic Journal articles, Davidson explains, Keynes depicts capitalism as unstable and prone to stagnation in the absence of government direction. The future is uncertain and people lack confidence in their own best opinions of what might happen. This inhibits spending, particularly on long-lived capital assets, and leads people to hold onto money instead. Demand then generally falls short of the economy's full output potential; growth is slowed while business is buffetted by waves of optimism and pessimism.

Keynes's ideas about how people react to uncertainty are hard to model, however, and they are not stressed in the familiar IS-LM framework, originally developed to explain The General Theory but soon used to refute it. Classically flexible wages and prices can restore an IS-LM economy to full employment from the depths of a depression when the effects of deflation on financial conditions and on confidence are ignored. Seen in the light of this Keynes/Classical synthesis, Keynes's theory explains no more than a special case of underemployment disequilibrium maintained in the short-run by wage and price rigidities. It offers Mainstream Keynesians, whom Davidson also labels Old Keynesians and Bastard Keynesians, no more than some hints on how to relieve temporary economic distress. Davidson views the evolution of macroeconomics as we know it as an aberration, starting with the IS-LM caricature of Keynes's theory, continuing through the Monetarist and New Classical reactions to Old Keynesian policy exercises, and including today's New Keynesian search for microfoundations on which to base sticky wages and prices, presumed to be necessary for underemployment to arise in even the short-run in a rational world.

Post Keynesian Macroeconomic Theory is firmly grounded in The General Theory. An overview of its contents follows. Davidson first demonstrates that equilibrium can result and persist at less than full employment when people hoard money, a nonproducible asset without ready substitutes. He then examines the components of domestic spending and the multiplier. His treatment of investment instability turns on the difficult but powerful concepts of backwardation and contango in the forward market for capital assets, where speculation can make for periodic surpluses and where, in the long-run, an incompressible liquidity premium on money can cause net investment to stall at zero.

Scarce money is a prime culprit in Davidson's theory. He criticizes contributions to monetary economics by Hicks, Samuelson, Tobin, Patinkin, Savage, Friedman, Lucas, and Barro and asserts that an elastic money supply is essential to avoid congestion in a growing capitalist economy. Davidson here emphasizes Keynes's finance motive for holding money. An increase in intended investment, he points out, leads to an increase in the demand for money and an upward shift in LM at the same time as IS shifts outward. Unless it is accommodated by the banking system, such an increase in investment demand will crowd itself out. Contrary to conventional teaching, an endogenous money supply need not be inflationary, Davidson asserts, since money's value is anchored by nominal wage contracts which lend stability to flow-supply prices and price expectations.

When economic expansion pushes against diminishing returns, however, costs and prices rise, real wages fall, and inflation threatens. Davidson here champions incomes policies to contain the wage-price spiral that high employment can trigger, as opposed to high interest rate policies that repress inflation with recession. He also praises postwar commodity price stabilization programs, where business costs were insulated from commodity price shocks by government managed buffer stocks. Davidson reinforces the positions advanced thus far in the book with formal treatments of Keynes's aggregate supply and demand analysis and its implications for the labor market. Unemployment, Davidson shows, does not depend on sticky wages and is only worsened when falling wages depress aggregate demand.

Davidson applies the lessons of Post Keynesian theory to international monetary issues in the last third of the book. Tight money strangles worldwide economic growth, he argues, unless international reserves increase in pace with trade. The game of Monopoly, where the supply of money increases arithmetically as players pass GO but obligations increase exponentially as building proceeds, nicely makes his point: all players but one soon go broke. According to Davidson, U.S. willingness to emit liquid liabilities while running outsized trade deficits in the 1980s enabled Germany and nations of the Pacific Rim to enjoy export-led economic miracles. This mechanism, however, entailed destabilizing short-term capital flows and disruptive exchange rate swings which are best avoided. Drawing on Keynes's thoughts on Bretton Woods, Davidson advances a scheme for expanding liquidity in a fixed exchange rate, growing world economy. He would force surplus nations to adjust when imbalances arise, either by expanding their economies and their imports, revaluing their currencies to keep them aligned with efficiency wages, or donating their surpluses to poorer nations. His rules-based proposal evokes Meltzer's guide to Keynes [1]. With its restraints on capital flows and its expansionary bias, its various provisions are sure to be controversial; Davidson offers them in hopes of stimulating thought and debate.

Post Keynesian Macroeconomic Theory is a good introduction to Post Keynesian thinking, suitable for use in intermediate level courses. Since much of the book takes exception to mainstream analysis, it would best be used together with a mainstream text. The "Foundation for Successful Economic Policies for the Twenty-first Century" that Davidson advocates is essentially The General Theory. He sweeps away formalisms, such as the permanent income hypothesis, that obscure the potency of Keynes's analysis. He ignores, however, more recent work, such as the literature on overlapping contracts and investment under uncertainty, that extend and strengthen Keynes's positions. In this book, Davidson well demonstrates Keynes's continued relevance to policy economics.

Bernard Malamud University of Nevada Las Vegas

Reference

1. Meltzer, Allan H. Keynes's Monetary Theory: A Different Perspective. Cambridge: Cambridge University Press, 1988.