Thread by @pablobortz

1/ I can finally share with you all my paper on the evolution of Keynes’s theories of the business cycle, from his earliest writing in 1913 (and some stuff from even before) to his work on commodity buffer stocks in WWII. As usual, a long thread ahead.
levyinstitute.org/publications/?…

2/ Many have written on some of these theories. @John_T_Harvey on the GT; Seccareccia on the Treatise on Money; Marcuzzo, Patinking and Hirai, on the transition from the Tract to the ToM and to the GT, Bridel on JMK’s 1st writing. This is the 1st to review them all as a whole.

3/ JMK’s 1st writing on business cycles dates from 1913. Typically from JMK: “your work has suggested to me what appears at first sight a superb theory about fluctuation. I believe it synthesises an enormous number of your facts”. 'You say something important, here is MY theory.'

4/ Key element: a rising share of loans (directly or indirectly) for fixed investment or capital goods producers in the balance sheets of banks. The driver is the demand for loans and other forms of finance, for investment purposes, based on expectations of future profitability.

5/ The determinants: expectations, fashion, “purely irrational waves of optimism and pessimism” (both about profitability and ABOUT RISK), liquidity. Impossibility of mathematical relation between profitability and risk preferences, JMK says.

6/ The story also includes financial innovations (underwriting of loans, at that time), asymmetric information, wrong incentives for banks, credit rationing, debt-deflation and financial instability, ineffectiveness of monetary policy (due to inelastic credit demand).

7/ His views are also expressed in his lectures (from 1912 onwards) and in other writings such as in his dissertation (the Treatise on Probability) and his earliest published writing (1910).

8/ In 1921, in a couple of articles for the Manchester Guardian, he blamed a “cyclical fluctuation” on a “bad season in Asia and the miscalculations of merchants”, intermediaries between producers and consumers, who use borrowed funds.

9/ Inflation and deflation expectations reinforce and amplify cyclical movements. Small & persistent movements in the interest rate will not do the trick. The same goes for exchange rate movements. For expectations, it’s preferable once-and-for-all changes to stabilize the cycle.

10/ There isn’t much in the Tract on Monetary Reform. The driver are self-feeding expectations of rising and falling prices, leading to speculation (with borrowed funds), in one case for investment, in the other for money hoarding.

11/ Monetary and financial policy (no talk of fiscal) have a role to play in the stabilization, by influencing expectations. Capital movements can be an obstacle, though. Between ER & price stabilization, JMK favoured the latter.

12/ Shortly after the Tract, in 1924, JMK already started to publicly advocate for active fiscal policy, particularly public investment. The leitmotiv: “prosperity is cumulative”. It shows the shift to the saving-investment mechanism.

13/ In the Treatise on Money, imbalances between S and I result in windfall “profits” (if I>S) or “losses” (if S>I) of businessmen. When I=S everybody receives their normal rates of remuneration, and the interest rate is at its natural level. The ToM is Wicksellian. But not only.

14/ I think that in the ToM you’ll find ALL the elements of the General Theory, some even better explained (“state of bearishness”, for instance). It is a very interesting book, with numerous findings and attractive arguments.

15/ It has problems, of course. A major difference with the GT is the existence of a natural rate of interest. Cheryl Smith differs, and she has a good point. For her, in the TM the “natural” rate is of a monetary character, unlike in Wicksell.

16/ Coming back to our topic, the business cycle in the ToM is driven by changes in the inducement to invest, because of new inventions, changes in asset prices, or cheap money. It requires the "acquiescence of the banking authorities”.

17/ For stabilization, the investment rate must be brought under control. The main instrument is the short-term rate, because of investors’ ignorance about the future. But authorities can also influence credit restrictions (non-price related).

18/ Main complications are of an international order, by changes in international liquidity preferences (“differences in the demand schedule for borrowers”, in the ToM). The government has the responsibility to pick up the slack, with public investment.

19/ In 1931 JMK went to the US. When he came back, he wrote a very important memo about the US economic and financial situation. If you ask me, the transition from the ToM to the GT is right there in that memo. @JoergBibow wrote about it: levyinstitute.org/publications/t…

20/ In early 1932 JMK accepts the necessary equality between I and S, he includes ToM’s “profits” or “losses” within S. Now fluctuations are not due to S≠I, but to the character of a monetary economy. He’s on a path to a monetary theory of production, where money is not neutral.

21/ The business cycle in the GT is driven by profit expectations that “are destined to disappoint”, because of the precarious basis of expectations. Crises originate because of sudden collapses in the Marginal Efficiency of Capital.

22/ In his 1937 QJE article (academic.oup.com/qje/article-ab…) the talk is not of “mistakes” but rather about “flimsiness of forecasts”. Please, read that article, it’s impossible to do it justice in a tweet.

23/ There is a return to the 1913 article in terms of the emphasis on “profit expectations which are bound to disappoint”. About proposals, one is to raise the propensity to consume, and/or to socialize investment. But DO NOT RISE INTEREST RATES!

24/ What to do in a boom? Do not increase demand, but DON’T DIMINISH IT EITHER. “Too much alarm about a hypothetical boom will be just the way to make a slump inevitable”. Solution: Investment planning.

25/ Later on, in the war, he’ll devise and talk of commodity buffers for (among other reasons) smooth international income and trade, particularly through the feedback with commodity producing countries.

26/ Summing up, throughout his evolution as economist, we see an ontology, a “vision” (in Schumpeter’s sense) in search of an epistemology, of a theory that fitted the facts according to this vision, escaping from acquired “modes of thoughts and expressions”.

27/ And policies also changed along the way. Less and less trust in the interest rate, more and more reliance in active government (fiscal) policy, particularly through investment.

28/ I barely touched upon the influences of other economists on JMK. That requires a book-length treatment. It’s a lot. @CUPAcademic, if you’re interested, we can talk about it ;).

29/ Finally, I thank the comments of great scholars, like Kregel, Kurz, Storm, Rotheim, Cheryl Smith (who also wrote about fluctuations in JMK), and even @RSkidelsky. Of course, usual caveats apply. I look forward for your comments too. END.

cc @NathanTankus @JoMicheII @rgbetancourt @geofftily @JWMason1 @danielle_guizzo @cacrisalves @Undercoverhist