THE KEYNESIAN REVOLUTION

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2 THE KEYNESIAN REVOLUTION

3 THE KEYNESIAN REVOLUTION SECOND EDITION BY LAWRENCE R. KLEIN WHARTON SCHOOL OF FINANCE AND COMMERCE UNIVERSITY OF PENNSYLVANIA

4 Lawrence R. Klein 1966 All rights reserved. No part of this publication may be reproduced or transmitted, in any form or by any means, without permission First edition 1949 Second edition (USA) 1966 Second edition (UK) 1968 Reprinted 1970, 1980 Published by THE MACMILLAN PRESS LTD London and Basingstoke Associated companies in Delhi Dublin Hong Kong Johannesburg Lagos Melbourne New York Singapore Tokyo ISBN ISBN (ebook) DOI / The paperback edition of this book is sold subject to the condition that it shall not, by way of trade or otherwise, be lent, resold, hired out, or otherwise circulated without the publisher's prior consent, in any form of binding or cover other than that in which it is published and without a similar condition including this condition being imposed on the subsequent purchaser

5 To My Parents

6 PREFACE TO THE SECOND EDITION On the occasion of a visit to Japan durjng the autumn of 1963, I found myself putting together new thoughts about The Keynesian Revolution. This book has enjoyed some success in postwar Japan, and my reconsiderations of the Keynesian contribution formed the subject of addresses given to Japanese university students. The written content of these lectures was published in Economic Studies Quarterly in November 1964, and M. Shinohara suggested that the material might usefully be included in a new Japanese translation. This suggestion inspired the new English language edition. It is essentially the old Keynesian Revolution with two added chapters, one being the paper from &onomic Studies Quarterly and the other being a more careful econometric statement of the Keynesian system. The revisitation published in Economic Studies Quarterly is not likely to come to the attention of most Western economists. This accounts for the new Chapter VIII. After more than 20 years of intensive econometric research inspired by the Keynesian Revolution (and Tinbergen's League of Nations study), I felt that it was time for a pause to relate an up-to-date version of my econometric researches to my original doctoral work. When I first visited Cambridge, England, after having worked in relative isolation in Cambridge, Massachusetts (under the guiding light, of course, of my supervisor, Paul Samuelson), I found great interest among some of Keynes' colleagues in my econometric attempts to build statistical models of their system. This interest inspired me to continue working along these lines, but as systems and areas of application grew the results seemed to become more remote from the General Theory as such; therefore the time is now appropriate to return to my starting place. The esprit that gripped me in 1944 while I was writing The Keynesian Revolution as a dissertation will never be recaptured. Therefore, I did not want to make changes in the original chapters and appendix except to point out amendments of errors, misstatements, or vii

7 viii PREFACE TO THE SECOND EDITION viewpoints. Economic life naturally looks more complicated to me at 45 than it did at 23. I have retained the book's youthful vigor by not tampering with it in the main, except to right some wrongs, and have added the less racy materials in two new chapters, VIII and IX. Chapter VIII, as I pointed out above, is a reconsideration of the Keynesian analysis and theoretical system. In Chapter IX, I lay out an empirical model and other econometric materials to show how far we have gone in the measurement of the Keynesian system, a second-order stage of intellectual development. I would like to thank Mr. Harry Eisenpress of the IBM Corporation for his considerable assistance in the programming and carrying out of the computations for the estimation of the model in Chapter IX. Modern econometric research has become more and more a team effort. I would also like to thank those associates, colleagues, and research assistants who have toiled with me over the years in econometric studies. The material presented here is based on cumulated effort and would not have its present form or power were it not for the arduous years of build-up of econometric research and knowledge. L. R. K.

8 PREFACE TO THE FIRST EDITION What is essential and what is unessential in the economic theories of the late Lord Keynes? What are the minimum assumptions that must be made in order to obtain the theoretical results usually claimed by the adherents of Keynesian economics? How did the revolutionary book The General Theory of Employment, Interest, and Money develop out of Keynes' earlier writings? To what extent is the Keynesian theory indebted to those of older writers, and how does it compare with the theory of classical economics? What is the relationship between the economic theories and the economic policies of Keynes and his followers? Do the policy measures advocated by the Keynesians lead to socialism, or do they endeavor to preserve capitalism? These are the leading questions which this book attempts to answer. The Keynesian theory is viewed in the following pages as a revolutionary doctrine in the sense that it produces theoretical results entirely different from the body of economic thought existing at the time of its development. The "Revolution" discussed here is a revolution in thought, not in the economic policies of governments. The first six chapters deal with the development of the theory and an analysis of the implications of the theory. The final chapter evaluates the influence of the theories of Lord Keynes upon the forces of economic and social reform. The Keynesian Revolution is addressed to a mixed group of readers. For the non-professional economist Chapters I (exclusive of parts of the last section), II, and V deal with the historical development of economic theories, Chapter III with the structure of the Keynesian system, Chapters III and VI with the use of Keynesian theories to analyze the economic problems of deflation and inflation, and finally Chapter VII with the practical consequences of this theory for economic policy. All these ideas are presented in non-technical terms. For the professional economists, in addition IX

9 X PREFACE TO THE FIRST EDITION to those parts which are of interest to the layman, a section in Chapter I gives a technical analysis of the theory of A Treatise on Money; a section in Chapter III compares Keynes with the classical writers; Chapter IV attempts to clear up controversies on the interest rate, the savings-investment equation, and the effect of wage cuts on unemployment; finally an appendix develops mathematical models of Keynesian economics. The hi.y reader will probably do well to skip over some of these technical discussions, but the remainder of the book is quite understandable to those without any formal training in economic theory. This book is so designed that most of the major problems are treated in simple terms that laymen can follow with an application of careful thought. It is, however, frankly not intended to be "Keynes for the Layman." That is another subject which deserves to be treated separately. Much of this material was originally contained in a doctoral thesis written in 1944 at the Massachusetts Institute of Technology, during the author's tenure as May Fellow at that institution. However, in the two years ~lapsing since the original writing the manuscript has been considerably revised with the end in view of making the material more understandable to the general reader, although, it is hoped, without an undue sacrifice of standards of scholarship. In addition, the final chapter contains material which was not presented in the original version. This chapter on economic policy was written primarily for the general reader in order to relate the abstract arguments to the concrete problems that now confront us. There are many persons associated with the author's intellectual development whose teachings led to the ideas set forth in this book. It was the late Struan T. Robertson who first interested the author in the writings of Keynes, and Professors William Fellner and Norman S. Buchanan who convinced him of the usefulness of studying economic problems. But no single person is more responsible for The Keynesian Re?Jolution than Paul A. Samuelson. It was

10 PREFACE TO THE FIRST EDITION xi the lectures of Professor Samuelson that first pointed out to this author the truly essential points of Keynesian economics. If any of the ideas of this book are accepted as contributions to economic thought, Paul Samuelson should receive credit. The author, of course, assumes full responsibility for any errors. Numerous friends and colleagues have read the manuscript and have made important suggestions and criticisms. They are R. Bishop, D. V. BroV<n, 0. Lange, J. Letiche, J. Lintner, G. Malanos F. T. Maim, J. Marschak, C. Myers, D. Patinkin, and S. Pu. Miss Beatrice Rogers of the Industrial Relations Section of the Massachusetts Institute of Technology was very helpful in editing the original thesis. The author gratefully acknowledges receipt from the following of permission to quote from their publications: Bankers Publishing Company; Free-Economy Publishing Company; Harcourt, Brace and Company; London School of Economics and Political Science; The Macmillan Company; the Ronald Press; the American &onomic Review; the Economist; the New Republic; the Quarterly Journal of &onomics, and the Review of Economic Statistics. L.R.K.

11 CONTENTS PREFACE TO THE SECOND EDITION PREFACE TO THE FIRST EDITION vii ix I. Keynes as a Classical Economist 1 II. The Birth of the General Theory 31 III. The New and the Old 56 IV. A Polemical Digression 91 v. Anticipations of the General Theory 124 VI. Depression Economics? 153 VII. Keynes and Social Reform 165 Notes to the Original Edition 188 VIII. The Keynesian Revolution Revisited 191 IX. The Econometrics of the General Theory 227 TECHNICAL APPENDIX 255 INDEX 281 xiii