Academic journal article Journal of Economic Issues

The "Fatal Flaw" of Classical Economics: Aspects of Keynes's Evolution from 'The Treatise' to the 'General Theory.'

Academic journal article Journal of Economic Issues

The "Fatal Flaw" of Classical Economics: Aspects of Keynes's Evolution from 'The Treatise' to the 'General Theory.'

Article excerpt

The theme of this article is that Keynes's "revolution" in The General Theory of Employment, Interest and Money (GT) evolved out of earlier work, particularly his A 7realise on Money (TM). The continuity between these two works suggests that their central messages concerning the structure and function of the laissez-faire market system can, and should be, viewed as a whole.(1)

In this paper, I argue that the bridge linking the two works was their respective theories of liquidity preference. The argument will be that these two theories of the interest rate are distinct but complementary in that the theory of the TM is microanalytic in method and bears on the determination of aggregate supply, while the theory of the GT is macroeconomic and bears on the determination of aggregate demand. Furthermore, it is suggested that these monetary theories of interest reflect an underlying monetary theory of value that, in turn, imparts coherence to an interactive theory of aggregate supply and demand.

But first two caveats. Value theory is among the most problematic areas in economic analysis. It is inherently a normative notion, yet its explication is fundamental to systematic attempts at "positive" analysis. Thus, the monetary theory of value developed here is of necessity tentative and subject to further elaboration. Still, a monetary theory of value undergirding the analysis of the capitalist economy is consistent with Keynes's well-known concern with the pathological and morbid "love of money" that he saw as inherent under the regime of laissez-faire [e.g., Keynes 1972, vol. 9, 329!. As Keynes noted, under capitalism money is ". . . the grand substitute motive, the perfect 'ersatz,' the anodyne for those who, in fact, want nothing at all . . . " [Keynes 1972, vol. 9, 320!. Yet, also is money ". . . the main motive force of the economic machine" [Keynes 1972, vol. 9, 293].

Second, this paper is not an attempt to add to the already overloaded literature concerning what Keynes really said, or meant to say, or should have said, nor is it an attempt to put forth a tight theoretical model as the latter term is typically understood in contemporary economics. Rather, this paper attempts to outline an overall "pattern model,"(2) a heuristic, that Keynes was evolving and that is implicit in his work, most notably in the TM and the GT.


Keynes's "right (methodological) dichotomy" for doing economics [Keynes 1973, vol. 7, 293] set the stage for the GT's theory of effective demand 3 by establishing the analytical sphere that we today label macroeconomic, distinguishing it from (again, in today's parlance) a microeconomic one. In the macro sphere, output as a whole was a variable within an aggregated framework that recognized interactive fallacy-of-composition effects; while in the latter micro sphere, the analytical focus was on distribution and allocation where resources and output were taken as given.

Keynes opposed his "right dichotomy" to what he saw as the "false division" of classical economics. This false division separated a (Benthamite) theory of value and distribution (i.e., the theory of relative prices) from the theory of neutral money (i.e., the theory of the price level) and thereby implicitly took total output (and employment) as a given in both spheres [see Keynes 1973, vol. 7, 293!. Thus, what Keynes called "output as a whole" was, in classical theory, a fixed (real) pie, the division of which was analyzed by price-analytic theories of value and distribution. In short, a major difficulty with classical economics was that it could not explain a fundamental macroeconomic question, the determination of the level of output, with a methodology that was appropriate to microallocative issues. A pertinent example of this is provided by Keynes himself in the TM. Here an orthodox Keynes employed the classical dichotomy--the relative price/microeconomic methodology along with the quantity theory of money--to analyze intra-period disequilibrium conditions. …

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