Post keynesian economics

What Is Post Keynesian Economics?

Post Keynesian economics is a school of economic thought that builds upon and reinterprets the work of John Maynard Keynes, particularly his General Theory of Employment, Interest and Money. Unlike other branches of Keynesian thought that sought to integrate Keynes's ideas with traditional models, Post Keynesian economics emphasizes the radical implications of Keynes's concepts, focusing on a monetary production economy characterized by fundamental uncertainty, endogenous money, and the paramount role of effective demand. This approach falls under the broader category of economic schools of thought and offers a critique of mainstream economic theory, particularly neoclassical economics.

Post Keynesian economics posits that capitalist economies inherently operate with involuntary unemployment and do not possess a natural tendency toward full employment equilibrium. It highlights the significance of financial markets, income distribution, and institutional factors in shaping economic outcomes, rather than simply optimizing individual behavior. The school maintains that aggregate demand is crucial in both the short and long run, influencing economic growth and employment levels⁴⁴.

History and Origin

The origins of Post Keynesian economics can be traced to a group of economists at Cambridge University, particularly in the post-World War II era. Figures such as Joan Robinson, Nicholas Kaldor, and Piero Sraffa, who had direct connections to John Maynard Keynes, believed that mainstream interpretations of Keynes's work, especially the "neoclassical synthesis," misrepresented his core message. They sought to develop a more authentic and radical interpretation, one that retained Keynes's emphasis on uncertainty, the non-neutrality of money, and the importance of aggregate demand in determining output and employment⁴², ⁴³.

During the 1970s, the "Cambridge School of Post-Keynesian Economics" became a recognized term, reflecting the distinctive research undertaken at the University of Cambridge's Faculty of Economics⁴¹. Key contributions from this period include the Cambridge capital controversies, which challenged the neoclassical theory of capital, and the development of the theory of endogenous money. Another pivotal figure, though primarily based in the United States, was Hyman Minsky, whose "Financial Instability Hypothesis" became a cornerstone of Post Keynesian analysis, particularly after its relevance was recognized during the 2008 financial crisis³⁸, ³⁹, ⁴⁰.

Key Takeaways

• Fundamental Uncertainty: Post Keynesian economics asserts that genuine, non-quantifiable uncertainty about the future is central to economic decision-making, in contrast to the probabilistic risk often assumed in mainstream models³⁶, ³⁷.
• Endogenous Money: The money supply is determined from within the economic system, primarily by the demand for bank credit, rather than being exogenously controlled by the central bank. Banks create deposits when they issue loans³⁴, ³⁵.
• Principle of Effective Demand: Aggregate demand is the primary determinant of output and employment, both in the short run and the long run, and economies do not naturally tend towards full employment³², ³³.
• Role of Institutions and History: Economic outcomes are shaped by social conventions, institutions, and the historical path an economy follows, challenging the notion of a timeless, universal equilibrium³⁰, ³¹.
• Financial Instability: Capitalist economies are inherently prone to financial crises due to the endogenous accumulation of debt and shifts in financial structures over periods of stability²⁸, ²⁹.

Interpreting Post Keynesian Economics

Interpreting Post Keynesian economics involves understanding an economy as a dynamic, evolving system, rather than one that always tends toward a stable equilibrium. It emphasizes that economic agents, facing fundamental uncertainty, rely on conventions and institutional structures to make decisions, especially concerning investment and consumer spending. This perspective suggests that macroeconomic outcomes, such as sustained unemployment or financial fragility, are not deviations from a natural state but rather inherent features of a monetary production economy.

For Post Keynesians, changes in monetary policy or fiscal policy do not simply shift an economy from one equilibrium to another. Instead, they interact with complex institutional frameworks and agents' expectations, leading to path-dependent outcomes. This means that past events and current institutional arrangements significantly influence future possibilities, making policy interventions critical for guiding economic performance²⁶, ²⁷.

Hypothetical Example

Consider a hypothetical economy facing a mild recession. A mainstream neoclassical approach might suggest that flexible wages and prices would eventually lead the economy back to full employment as labor and goods become cheaper, stimulating demand.

In contrast, a Post Keynesian perspective would highlight the role of fundamental uncertainty and expectations. During a recession, firms, facing an uncertain future demand for their products, might reduce investment and hiring even if wages fall. This hesitation is not purely "irrational" but a rational response to unknowable future conditions. If households simultaneously increase their saving due to fear of job loss, aggregate demand could fall further, leading to the "paradox of thrift," where attempts to save more collectively lead to less overall saving and deeper recession²⁵.

From a Post Keynesian viewpoint, the solution would not rely on price flexibility alone. Instead, robust fiscal policy (e.g., government spending programs) would be necessary to directly boost effective demand and restore confidence, breaking the cycle of pessimistic expectations and insufficient private sector activity.

Practical Applications

Post Keynesian economics has several practical applications, particularly in understanding and addressing real-world economic challenges:

• Financial Regulation: Hyman Minsky's Financial Instability Hypothesis, a core Post Keynesian concept, explains how periods of economic stability can encourage excessive risk-taking and debt accumulation, eventually leading to financial crises²⁴. This analysis informs the need for robust financial markets regulation to mitigate systemic risk and prevent speculative bubbles²², ²³.
• Macroeconomic Policy: Post Keynesian economists advocate for active government intervention to achieve and maintain full employment and stable prices, given that market forces alone may not achieve these goals. This often includes using fiscal policy to manage aggregate demand and a monetary policy that targets interest rates rather than directly controlling the money supply, acknowledging money's endogenous nature²⁰, ²¹.
• Development Economics: The framework is applied to understand issues in economic development, particularly how structural factors, institutions, and the distribution of income and wealth can perpetuate underdevelopment or foster sustainable economic growth¹⁹.
• Critique of Austerity: Post Keynesians often critique austerity measures during economic downturns, arguing that cuts in public spending can further depress aggregate demand and exacerbate unemployment¹⁸.

Limitations and Criticisms

While Post Keynesian economics offers a distinct and often insightful perspective, it also faces limitations and criticisms:

One common critique relates to its perceived lack of formal, quantitative modeling compared to mainstream macroeconomics. Critics sometimes argue that this makes it challenging to generate precise, testable predictions or to formulate policy recommendations within a consistent analytical framework¹⁷. However, Post Keynesians contend that their focus on fundamental uncertainty and historical time makes traditional econometric modeling based on stable relationships less appropriate¹⁶.

Another area of debate revolves around the specific mechanisms through which money is created and circulates, even within the endogenous money framework. Different strands within Post Keynesianism, such as "horizontalism" and "structuralism," offer varying accounts of the interplay between commercial banks, the central bank, and the demand for credit¹⁴, ¹⁵. Some critics also argue that the Post Keynesian theory of price formation can be circular, explaining prices by other prices or the value of money¹³.

Furthermore, some academic economists have criticized Post Keynesian economics for lacking a single, universally agreed-upon set of foundational principles or a unified methodology, leading to a diverse but sometimes fragmented body of work¹².

Post Keynesian Economics vs. Neoclassical Economics

Post Keynesian economics fundamentally differs from neoclassical economics in several core aspects, particularly regarding their assumptions about economic behavior, the role of money, and the nature of equilibrium.

While neoclassical theory often views money as a neutral "veil" over real economic activity in the long run, Post Keynesian economics asserts that money is non-neutral and plays a crucial role in both short-run and long-run economic outcomes, affecting asset prices, investment, and income distribution⁶.

FAQs

What is the primary difference between Post Keynesian and New Keynesian economics?

Post Keynesian economics differs from New Keynesian economics in its more radical interpretation of Keynes's ideas. While New Keynesian economics attempts to incorporate elements like sticky wages and prices into a mainstream macroeconomics framework with optimizing agents, Post Keynesianism rejects many core neoclassical assumptions, such as the idea of a natural tendency towards full employment and the exogeneity of the money supply. It places greater emphasis on fundamental uncertainty, endogenous money, and the paramount role of effective demand⁵.

Why is "endogenous money" a key concept in Post Keynesian economics?

Endogenous money is central because it reverses the conventional understanding of how money is created. Instead of the central bank controlling the money supply directly (exogenous money), Post Keynesians argue that commercial banks create money (deposits) when they make loans, driven by the demand for credit from firms and households. The central bank then accommodates the banking system's demand for reserves, primarily by setting the short-term interest rate³, ⁴. This view has significant implications for monetary policy and financial stability.

Does Post Keynesian economics advocate for specific government policies?

Yes, Post Keynesian economics generally advocates for active government intervention, particularly through fiscal policy, to ensure full employment and stable prices. Given their belief that capitalist economies do not naturally achieve full employment due to inherent instability and the principle of effective demand, they argue for sustained public spending and investment. They also support strong financial regulation to prevent crises and policies aimed at addressing income distribution¹, ².