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 5: Why traditional mainstream Keynesian theory is not Keynes’s theory

Paul Davidson

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

Extract

Long before Keynes developed his general theory to explain why persistent unemployment could occur in the economy, classical theory had explained unemployment as the result of short-term imperfections or monopoly elements on the supply side of the market system. These imperfections took the form of rigidities in the market money wage rate and/or product prices due to noncompetitive labor and product markets. If there was no government interference during these periods of unemployment, then the resulting weakened markets would induce sufficient competition to make wages and prices more flexible in a downward direction and would ultimately weed out the imperfections leaving a stronger, more powerful full employment economy to carry on. In essence, classical theory suggested that unemployment and depressions were merely the working of nature’s law of the jungle. Ultimately, the market would solve the problem by inducing a competitive economic environment that, in Darwinian fashion, would kill off the weak and inefficient, thereby assuring the survival of the fittest. When the economy purged itself of its imperfections, it would generate full employment and prosperity for all the survivors. An example of how this classical economic theory affected government decision making is provided in the autobiography of President Herbert Hoover, who was president of the United States when the Great Depression began in 1929. Hoover indicates that whenever he wanted to take some positive action to end the depression, his Treasury Secretary, Andrew Mellon, always cautioned against government action and gave the same advice.

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