10.3 Post-Keynesian economics
3 min read•august 9, 2024
Post-Keynesian economics challenges mainstream theories, emphasizing uncertainty, , and endogenous money. It explores how these factors shape economic cycles, highlighting the role of credit creation and income distribution in driving aggregate demand.
This approach offers unique insights into policy-making, advocating for active government intervention and financial regulation. It connects to broader Keynesian ideas while pushing beyond them, providing a critical perspective on modern economic challenges.
Uncertainty and Instability
Fundamental Uncertainty and Financial Instability
Top images from around the web for Fundamental Uncertainty and Financial Instability
Keynesian economics - Wikipedia View original
Is this image relevant?
Stages of the Economy | Introduction to Business View original
Is this image relevant?
Keynesian economics - Wikipedia View original
Is this image relevant?
Stages of the Economy | Introduction to Business View original
Is this image relevant?
1 of 2
Top images from around the web for Fundamental Uncertainty and Financial Instability
Keynesian economics - Wikipedia View original
Is this image relevant?
Stages of the Economy | Introduction to Business View original
Is this image relevant?
Keynesian economics - Wikipedia View original
Is this image relevant?
Stages of the Economy | Introduction to Business View original
Is this image relevant?
1 of 2
- underlies economic decision-making processes
- Differs from calculable risk in that probabilities cannot be assigned to future outcomes
- Impacts investment decisions, consumption patterns, and market behavior
- Financial instability hypothesis developed by explains economic cycles
- Economy naturally moves from periods of stability to instability
- Three types of financing: hedge, speculative, and Ponzi
- Financial innovation and deregulation can amplify instability
- principle emphasizes role of aggregate demand in determining output
- Contrasts with Say's Law, which assumes supply creates its own demand
- Highlights importance of government intervention to stimulate demand during downturns
Economic Cycles and Policy Implications
- Business cycles viewed as endogenous to capitalist economies
- Fluctuations arise from internal dynamics rather than external shocks
- Boom-bust cycles linked to credit expansion and contraction
- Policy recommendations focus on stabilizing the economy
- to smooth out economic fluctuations
- Financial regulation to prevent excessive risk-taking (Glass-Steagall Act)
- Long-term economic growth influenced by institutional factors
- shapes economic trajectories
- Historical events and policy decisions have lasting impacts (Great Depression)
Money and Finance
Endogenous Money Theory
- Money supply determined within the economic system, not externally by central banks
- Banks create money through lending, responding to demand for credit
- Reverses causality in traditional monetary theory
- Credit creation process involves:
- Banks extending loans, creating deposits in the process
- Central bank accommodating reserve needs of the banking system
- Implications for monetary policy:
- Interest rates, not money supply, as primary policy tool
- Limited effectiveness of quantitative easing in stimulating economic activity
Modern Monetary Theory and Fiscal Policy
- (MMT) emphasizes sovereign currency-issuing governments' fiscal capacity
- Governments with monetary sovereignty face no financial constraints in their own currency
- Taxes and bonds do not finance spending but serve other economic purposes
- Key policy implications of MMT:
- should focus on full employment and price stability
- as automatic stabilizers (Employer of Last Resort)
- Inflation, not government deficits, as the primary constraint on spending
Stock-Flow Consistent Modeling
- Stock-flow consistent models integrate real and financial sectors of the economy
- Ensure accounting consistency between stocks (wealth) and flows (income)
- Capture complex interactions between sectors (households, firms, government, financial)
- Model features and applications:
- Track financial balances across sectors
- Simulate impacts of policy changes or economic shocks
- Analyze debt dynamics and financial stability (Godley-Lavoie models)
Distribution and Demand
Income Distribution and Aggregate Demand
- Income distribution plays crucial role in determining aggregate demand
- Wage-led vs. regimes
- Functional income distribution (wages vs. profits) affects consumption and investment
- Kaleckian approach to distribution and growth:
- Emphasizes role of effective demand in determining output and employment
- Highlights impact of income inequality on economic performance
- Policy implications for inclusive growth:
- Progressive taxation to reduce income inequality
- Wage policies to support aggregate demand (minimum wage laws)
Effective Demand and Economic Stability
- Effective demand principle central to Post-Keynesian analysis
- Output and employment determined by aggregate demand, not supply-side factors
- Challenges notion of natural rate of unemployment
- Hysteresis in labor markets:
- Long-term unemployment can lead to skill deterioration and reduced employability
- Justifies active labor market policies to prevent persistent unemployment
- Investment dynamics and demand:
- influence investment decisions
- links investment to changes in aggregate demand
Endogenous Money and Credit Cycles
- interacts with distribution and demand
- Credit creation process influences income distribution and spending patterns
- Financial innovation can lead to increased inequality (securitization)
- Credit cycles and economic instability:
- Expansion of credit during booms can fuel asset price bubbles
- Deleveraging during busts exacerbates economic downturns
- Policy approaches to manage credit cycles:
- to limit systemic risks
- policies to direct lending towards productive investments
Key Terms to Review (20)
Accelerator effect: The accelerator effect refers to the phenomenon where an increase in consumer demand leads to a more than proportional increase in investment by firms. This effect emphasizes how changes in demand can influence production levels and, consequently, spur further economic activity by prompting businesses to invest in more capital to meet that demand.
Animal spirits: Animal spirits refer to the emotional and psychological factors that drive human behavior in economic decision-making, influencing individuals' confidence and willingness to invest or consume. This concept highlights the idea that economic agents are not always rational and are often swayed by their instincts and emotions, which can lead to fluctuations in economic activity and investment patterns.
Countercyclical fiscal policies: Countercyclical fiscal policies are government strategies that aim to counteract economic fluctuations by adjusting spending and taxation in response to the business cycle. During periods of economic downturns, these policies typically involve increasing government spending or cutting taxes to stimulate demand, while during booms, they may involve reducing spending or increasing taxes to cool off an overheating economy.
Credit guidance: Credit guidance refers to the recommendations and policies aimed at directing the allocation of credit in the economy to achieve certain economic goals, particularly in the context of Post-Keynesian economics. It emphasizes the role of financial institutions and government interventions in influencing the availability and cost of credit, thus impacting investment, consumption, and overall economic activity. This concept is crucial for addressing issues like unemployment and inflation, aligning financial resources with societal needs.
Effective Demand: Effective demand refers to the actual level of demand for goods and services in an economy at a given time, which is influenced by the willingness and ability of consumers to spend. It goes beyond mere desire for goods; it emphasizes purchasing power and market conditions. Understanding effective demand is crucial for analyzing economic fluctuations, as it plays a pivotal role in determining production levels and employment rates.
Endogenous money theory: Endogenous money theory posits that the supply of money in an economy is determined by the demand for loans rather than being exogenously controlled by central banks. This theory highlights how banks create money through lending activities, suggesting that money supply is a result of economic activity rather than a precursor to it. It shifts the focus from traditional views that emphasize central bank control over money supply to an understanding of how credit and demand shape monetary conditions.
Financial instability: Financial instability refers to a situation where there are significant fluctuations or disruptions in financial markets, which can lead to adverse effects on the economy, including recessions, unemployment, and loss of savings. It often arises from excessive risk-taking by financial institutions, mispricing of assets, or the presence of economic bubbles, and it highlights the vulnerabilities within the financial system.
Fiscal policy: Fiscal policy refers to the use of government spending and taxation to influence a country's economy. It plays a crucial role in managing economic cycles, aiming to stimulate growth during recessions or cool down an overheated economy through adjustments in public expenditure and tax rates. By understanding how fiscal policy interacts with economic theory and practice, especially during significant economic theories like those proposed by Keynes, we see its vital role in shaping economic outcomes.
Fundamental uncertainty: Fundamental uncertainty refers to the inherent unpredictability in economic behavior and outcomes due to the complexity of human actions and the limitations of information available. This concept emphasizes that not all future events can be anticipated or quantified, leading to a lack of confidence in predictions about economic conditions and markets. It challenges traditional economic theories that assume agents have perfect information and can make rational decisions based on it.
Historical specificity: Historical specificity refers to the idea that events, ideas, and economic theories must be understood in the context of the particular historical and social conditions in which they arose. This concept emphasizes that economic phenomena cannot be viewed in isolation, as they are shaped by unique circumstances and cultural contexts that influence their development and interpretation.
Hyman Minsky: Hyman Minsky was an American economist known for his work on financial instability and the dynamics of capitalist economies. He is best known for his 'Financial Instability Hypothesis,' which suggests that financial markets are inherently unstable due to the behaviors of investors and the structure of financial systems. His ideas connect deeply to Post-Keynesian economics, emphasizing the importance of uncertainty and the role of finance in economic cycles.
Job guarantee programs: Job guarantee programs are government initiatives that ensure all individuals who are willing and able to work can find employment, typically at a living wage. These programs aim to provide full employment while addressing economic inequality and social welfare by offering jobs in various sectors, including public services and community projects.
Kaleckian model: The Kaleckian model is an economic framework developed by Michal Kalecki, focusing on the role of effective demand in determining output and employment levels. It emphasizes the importance of income distribution and market power in influencing investment decisions and overall economic performance, distinguishing itself from classical economic theories that prioritize supply-side factors. The model illustrates how changes in demand can impact business cycles and suggests that full employment is not automatically achieved in a capitalist economy.
Liquidity preference: Liquidity preference refers to the desire of individuals and businesses to hold cash or easily convertible assets rather than investing in long-term securities. This concept is crucial in understanding how people value liquidity, especially during times of uncertainty, and is a cornerstone of Keynesian economics, influencing interest rates and investment decisions.
Macroprudential regulation: Macroprudential regulation refers to a set of policies and tools aimed at overseeing and managing the stability of the financial system as a whole, rather than focusing solely on individual institutions. It seeks to identify systemic risks and vulnerabilities that can lead to financial crises, promoting overall economic stability by addressing issues like asset bubbles and excessive credit growth. By looking at the interconnectedness of financial institutions, macroprudential regulation helps ensure that the financial system can withstand shocks.
Modern monetary theory: Modern Monetary Theory (MMT) is an economic framework that argues that a government that issues its own currency can never 'run out' of money in the same way a household or business can. This theory posits that such governments can and should use their ability to create money to achieve full employment and stimulate economic growth without the constraint of budget deficits, as long as inflation is managed. MMT redefines how we view fiscal policy, connecting it to broader discussions about economic stability and social welfare.
Path dependency: Path dependency is a concept that suggests decisions and outcomes are heavily influenced by previous choices and events, making it difficult to change directions once a certain path has been established. This idea emphasizes that historical processes can shape current and future economic realities, illustrating how institutions, policies, and behaviors evolve over time based on earlier developments.
Profit-led growth: Profit-led growth refers to an economic framework where increases in profit margins drive overall economic expansion. In this model, businesses invest in productivity and innovation to boost profits, which in turn leads to higher levels of investment, job creation, and consumer spending, creating a positive feedback loop in the economy.
Stock-flow consistent modeling: Stock-flow consistent modeling is a framework used in economics that ensures all stocks (accumulated values) and flows (changes over time) in an economy are logically and consistently linked. This approach helps to maintain coherence in economic models, as it takes into account how different variables interact and ensures that the flows of income and expenditure reflect changes in stock positions, particularly relevant in understanding dynamic processes.
Wage-led growth: Wage-led growth refers to an economic theory suggesting that higher wages for workers can stimulate economic growth by increasing consumer demand. This concept highlights the importance of income distribution, where rising wages can lead to increased consumption, ultimately benefiting the economy as a whole. It contrasts with profit-led growth, where economic expansion is driven primarily by investment and profits rather than by consumer spending.