by Keynesian vs Newtonian economics To complete his theory, Keynes tied these elements together. The market for money determined interest. Interest (and the state of business confidence) determined investment. Investment, alongside consumption, determined effective demand for output. Demand for output determined output and employment. Consumption out of incomes determined savings. Employment determined the real wage. In this world, a change in monetary policy, such as a cut in interest rates leading to an increase in bank credit, now had fundamental real consequences. The classical dichotomy, in economics as in physics, had been broken. And with the deconstruction of labor and capital markets, the reductionist idea of microfoundations had also to be
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Keynesian vs Newtonian economics
To complete his theory, Keynes tied these elements together. The market for money determined interest. Interest (and the state of business confidence) determined investment. Investment, alongside consumption, determined effective demand for output. Demand for output determined output and employment. Consumption out of incomes determined savings. Employment determined the real wage.
In this world, a change in monetary policy, such as a cut in interest rates leading to an increase in bank credit, now had fundamental real consequences. The classical dichotomy, in economics as in physics, had been broken. And with the deconstruction of labor and capital markets, the reductionist idea of microfoundations had also to be abandoned. Workers, Keynes pointed out, bargain for money wages, not real wages. The act of dropping money wages would generate feedbacks through previously unrecognized–monetary–channels in the system … The system interacts with itself, and a full employment equilibrium cannot be achieved within the labor market. Economic space-time is curved.
In the long run, Keynes did not achieve what he hoped … In the United States, the prevailing view became that of Paul Samuelson, who transposed Keynes’s unemployment theory into the proposition that wages are “sticky” … What Samuelson did was to push the daemon of Keynesian relativity back into its box. And modern American Keynesians, even down to the New Keynesians currently in fashion around Harvard, MIT, Princeton, and the Council of Economic Advisers, are Newtonian and Samuelsonian to the core …
Too bad. For one cannot say, as one can with Newtonian physics, that Newtonian economics is good enough for practical situations … The failure of Keynesian macroeconomics to establish full theoretical independence from the classical labor market and the classical neutrality of money means that we are, in effect, now denied fair discussion of Keynesian solutions to policy problems. The end result is that we cannot cope now, any more than could the classics in their day, with stagnation and involuntary unemployment.