Post Keynesian Theory and Policy

Post Keynesian Theory and Policy

A Realistic Analysis of the Market Oriented Capitalist Economy

New Directions in Post-Keynesian Economics series

Paul Davidson

How did economic “experts” worldwide fail to predict the financial crisis of 2007-2008? Eminent economist Paul Davidson discusses how mainstream economic theory may not be applicable to the world of experience. Post Keynesian theory is designed to be applicable to the real world, and this book demonstrates how applying it to policy formulation could help practically resolve economic problems. Davidson goes on to demonstrate how many Post Keynesian economists warned of the impending financial crisis as early as 2002.

Chapter 3: Unemployment and the classical theory’s axioms

Paul Davidson

Subjects: economics and finance, history of economic thought, post-keynesian economics


John Maynard Keynes wrote, “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else.” The ideas embodied in classical economic theory continue to rule the economic policy decisions of government officials and central bankers despite Alan Greenspan’s admission that he does not know why his classical economic theory failed to recognize the possibility of the global financial crisis of 2007–2008 and since then the failure of developed economies to rapidly recover from what is now often called the “Great Recession.” In this chapter we will examine the axiomatic foundation of classical economic theory’s ideas and their subsequent application to the economic world in which we live. More often these classical ideas have encouraged the adoption of policies that have led to economic events that have failed to resolve our economic problems and have, at times, resulted in worsening the economic distress. The classical theory rests on the premise that all free markets in a capitalist system are perfect and all-wise. Accordingly, the market can and will solve any economic problems that may arise due to some shock to the system. For example, classical theory argues that when wages are perfectly flexible, if unemployment should occur, then the market wage would almost instantaneously decline. This wage decline would offer entrepreneurs in every industry more profit opportunities as the labor costs of product would be lower.

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