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 7: Inflation policy

Paul Davidson

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


Keynes’s general theory analysis was developed in the 1930s after Britain had suffered more than a decade of high unemployment and depression – and not inflation. It is not surprising therefore that Keynes devoted most of the theoretical analysis in his general theory to curing the unemployment problem and relegated his discussion of changes in the price level to Chapter 21 entitled “The Theory of Prices.” In this chapter of his book, as a student of Alfred Marshall, Keynes suggests that rising prices of newly produced goods and services are primarily due to the same forces Marshall believed explained why the price of the products of a firm would increase. These inflationary aspects occurred when, at any point of time, enterprise expanded its production and this resulted in (1) “diminishing returns” or “bottlenecks” in production and therefore increasing production costs and/or (2) increases in the money “wage unit,” that is, a money wage rate increase that caused higher labor production costs per unit of output. Since Keynes had explicitly rejected the classical neutral money axiom in 1933, his theory of inflation cannot be the classical theory where it is changes in the quantity of money relative to the level of output that directly affects the price level. Inflation in classical theory is solely the result of “too much money chasing too few goods.” The classical cure for inflation is for the nation’s central bank to cut back the supply of money so that there are fewer dollars to chase the available goods.

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