Reconstructing Keynesian Economics with Imperfect Competition.

"This book is unusual." So begins the preface (by Lal Jayawardena) to Robin Marris's reconstruction of the Keynesian economics as a computer simulation model with improved microeconomic foundations. A description of the book by Marris himself is ". . . the work is a mixed-fish medicinal soup intended to cure an otherwise fatal weakness in the Keynesian theory by providing microfoundations of 'imperfect' rather than 'perfect' competition". The comparison to a soup is apt because of the mix of ingredients in the book.

The author lists four aims which are briefly:

* to replace the Achilles heel of the General Theory with an implant from the theory of imperfect competition.

* to construct a computer simulation model based on the revised Keynesian model.

* to apply the model to economic problems of industrialized nations in the 1970s and 1980s.

* to "embellish the narrative with a personal view of the relevant history of thought".

A little theory, a little policy, some numerical simulations, some history--and a little gossip.

To begin with the Achilles heel, Marris sees the problem in Keynes's explanation of why a fall in nominal demand results in a fall in output not just a proportionate fall in price. Explanations within a perfectly competitive framework depend on "price stickiness" which in Marris's view means that the price level is externally constrained to change slowly. His remedy is to have a firm in an imperfectly competitive setting with a flat short-run labor productivity schedule (which he argues is in line with the empirical evidence).

The firm in this market structure sets price as a mark-up on costs--the size of the mark-up depending on the elasticity of the firm's demand curve. If demand changes, then unless the elasticity of demand changes (which in Marris' view it may or may not and we do not know in which direction it would if it did) the firm has no incentive to change price. A fall in demand, for example, then leads to a fall in output with price unchanged. The wage may fall, with a lag, as the labor utilization rate falls, then price will decline.

Marris does not argue that such microeconomic foundations are in the General Theory. At one point, in fact, Keynes is called the world's first non-Keynesian. Marris's point is rather that only in an imperfectly competitive setting does the General Theory make sense and conform to the facts of most modern real-world product markets.

Pursuing his second aim, the author describes a desktop computer simulation program, the Imp-Mac model, which is consistent with Marris's reconstruction of Keynes. A diskette containing the program is provided in an insert on the back cover. Chapter 6 contains a technical description of the program to get the user started. In essence, the Imp-Mac model enables the user to simulate the effects of shocks to nominal aggregate demand or aggregate supply on the labor and product markets. The user can trace out the effects of these shocks on variables such as output, employment and the real wage under various assumptions about wage indexation, changing elasticity of demand, and other features of the labor and product markets. The model has no monetary or financial sector.

In the book's final chapter, the author uses the model to demonstrate the effect of a sample of shocks. Fiscal policy effectiveness, the real wage-employment link, and mechanisms generating stagflation are considered.

Marris's final aim of providing a personal view of the history of thought relevant to his theoretical view occupies about one-fourth of the book. History of thought in this context includes a good bit of what Jayawardena in the preface calls "Cambridge (England) 'gossip'." Marris also warns the reader of his non-conventional approach where ". . . in discussing these works we do not even pretend to appear impartial; we are constantly plugging our own opinions". The relevant history of thought includes, of course, the General Theory. It also includes Kahn's 1929 dissertation which set out the theory of imperfect competition several years before the books of Robinson and Chamberlin and Kalecki's review of the General Theory which interpreted the Keynesian model as based in imperfect competition. There is also a survey of recent contributions of the new Keynesians.

What does one make of all these ingredients in what Marris, in another culinary comparison, calls a bouillabaisse? It is hard not to agree with him that perfect competition is a poor description of modern industrial economies. Marris's work fits in the mainstream of the new Keynesian effort to study alternative microeconomic foundations for Keynesian economics. His is a simple market structure, but that is not a criticism.

I am also sympathetic to the computer simulation methodology. Perhaps this is because my Ph.D. thesis was a computer simulation model of the money-income relationship, inspired by the work of Jay Forrester |1; 2~. The flexibility of these types of models could be further exploited by Marris. The lack of a monetary or financial sector in the Imp-Mac model severely limits the range of questions it can address. It would also be useful to provide an input-output structure to the model to address the coordination problems discussed in Gordon |3~. Along different lines, while the market structure in the Imp-Mac model (symmetrical heterogeneity with many firms) is plausible for some industries, there is no reason not to combine industries with different market structures and perhaps different wage policies within this type of model.

Finally, what about the personal narrative part of the book. Were I reading it at a prepublication stage, there are digressions and asides that I would suggest be edited out, e.g., the paean to the Poles, boxes on Turing and Von Neumann (digressions within a digression) and a terrible liquidity preference pun. Some of the peripheral material, was, however, thought provoking and I close with an example. With reference to the swing toward restrictive macroeconomic policies in the early 1980s, Marris observes, "For political reasons it then became necessary to say that Keynes had been abandoned (if not discredited). Governments could not say openly that they were 'squeezing out' inflation by means of unemployment. It was therefore necessary to make up other explanations of what was happening, a game in which . . . the economics profession joined only too easily".

References

1. Forrester, Jay W. Industrial Dynamics. Cambridge: MIT Press, 1961.

2. -----. Urban Dynamics. Cambridge: MIT Press, 1969.

3. Gordon, Robert J., "What Is New Keynesian Economics?" Journal of Economic Literature, September 1990, 1115-71.