Ana’s Reviews > John Maynard Keynes > Status Update

Davidson examines the US 2008 financial crisis in light of Keynes Liquidity Preference Theory: mortgages, packed into MBSs, were sold as "highly liquid", or "cash equivalents", but the financial firms did not guarantee their so-called liquidity by acting as market makers. When the inverstors became bearish, the orderliness of the MBS market was disrupted rendering those assets illiquid.

Davidson tells the story of how Paul Samuelson, who called himself a "Keynesian", maimed Keynes's GT by assuming neutral money and ergodicism in his Foundation of Economic Analysis. Keynes will be rediscovered, he thinks, when a new Great Depression hits the world and economists stop playing with "computer games". "Post-Walrasians prefer playing ... games so they can be precisely wrong instead of roughly right."

In 1944, at Bretton Woods, Keynes argues that "free trade, flexible exchange rates and free capital mobility across international borders is likely to be incompatible with the economic goal of global full employment and rapid economic growth."

Keynes predicted that international free trade would follow patterns of cost of labor (wages, benefits, safety, working conditions) than differences in climate and natural resources, as claimed by the Ricardian view. This leads to a global environment where the standard of living of workers in the developed nations declines towards that of the workers in cheap labor nations.

Keynes General Theory deals with international trade and currency exchange issues by proposing an International Clearing Bank that would put responsibility of trade imbalances on creditor nations. This plan was overturned at Bretton Woods, where the American proposal to create the International Monetary Fund won over Keynes's ICB.

Davidson criticizes Milton Friedman's definitions of consumtion and savings, for his theory of permanent income and transitory income. For Friedman, buying a luxury car is accounted as "savings", and the consumption is equal to the depreciation of the luxury car during the accounting period. Contrary to Keynes's, this definition of "savings" implies that saving does increase demand.

Keynes, Aggregate Demand does not equal Aggregate Supply because of the demand for liquid assets (saving vehicles as bonds, mutual funds, etc). These assets not induce employment. Two essential properties of Interest and Money: 1. the elasticity of production of liquid assets including money is zero or negligible, 2. the elasticity of substitution between liquid assets and producible goods is zero or negligible.

Classical economic theory holds that aggregate supply and aggregate demand are equal, according to Say's law: "Supply creates its own demand". But for Keynes, the aggregate demand function has its own behavior and DOES NOT coincide with the aggregate supply function "over all possible levels of employment."

Keynes's General Theory discarded three fundamental axioms of Classical Economic Theory: 1. the Neutral Money axiom (quantity of money has no effect on production/employment), 2. the Gross Substitution axiom (all inventories, including labor, can be "sold" by lowering the price relative to alternatives), 3. the ergodic axiom (the future can be perfectly known by studying past and present market statistics).

By 1924, Keynes has already made the connection between employment (the major economic problem for Britain at the time) and the volume of bank credit. He also has suggested for the first time that the government may intervene in the economy by purchasing goods therefore increasing market demand for the private industrial sector.