Re: Pkers Hahn and Solow?

[Basil Moore <bmoore@xxxxxxxxxxxxxxxxx>]

Robert
H&S assume the money supply is given, and do not consider that production
takes time.

        If one introduces endogenous credit money, and recognizes that bank
loans finance business working capital demand,(a monetary production
economy) the case against wage and price flexibility becomes much stronger.

         The AD curve becomes vertical in p - y space, as I argued in H&V.
There is no Pigou or Keynes effect, so price flexibility is not
automatically stabilizing. The economy looses its homeostatic properties.

         But in pdot - y space the AD curve is now positively sloped
( remember as inflation increases we are going up, and as deflation
increases we are going down). If one introduces instantaneous price
flexibility, AD approaches zero exponentially when p dot<0, since demand for
loans vanish as the real cost of borrowing  (the negative of the inflation
rate) increases indefinitely, reducing the money supply, while concurrently
the demand to hold money (deposits) increases as the expected real return on
money rises indefinitely, reducing the income velocity of money.
Perfect price and wage flexibility is super destabilizing.

        Conversely the AD curve is positively sloped and approaches infinity
exponentially when p dot >0, as the ex ante real cost of borrowing becomes
negative, increasing the money supply, and the demand to hold money falls as
the expected real return becomes negative, increasing the income velocity
of money.

        This offers a much stronger attack agains the widestream mainstream
view that if only prices were perfectly flexible, the economy left to itself
would be self stabilizing at full employment.

Basil Moore

At 02:03 PM 3/3/96 -0500, you wrote:
>I just purchased Frank Hahn and Robert Solow's book _A Critical Essay on
>Modern Macroeconomic Theory_ (MIT Press, 1995) and wondered if anybody had
>any opinions on it. I've read the first chapter and lightly skimmed the
>last so far.
>
>Some quotes:
>
>  'Chapter 2 is a good example...We insist on an essentially monetary
>  economy...At this stage we stick to the assumptions of universal
>  perfect competition and perfect (but only short-term) foresight...
>  The adjustment dynamics are very badly behaved...A contractionary
>  shock induces a fall in the nominal wage, and prices will normally
>  follow. If the resulting deflation is sharp enough, the real interest
>  rate must rise because the nominal interest rate cannot fall below
>  zero. Investment is then depressed and the economy suffers an unnecesary
>  fall in output...There is a clear role for stabilization policy ,
>  even with perfect flexibility of wages and prices - in a sense *because
>  of* wage and price flexibility."
>
>  Chapter 5...is a formalization of the notion that excess supply of
>  labor can persist because workers (and employers) regard wage undercutting
>  as a violation of a social norm - as "unfair...We go further by
>  exhibiting such behavior as an equilibrium strategy for a repeated game...
>  Any of these non-Walrasian models will yield a locus of real wage rates
>  and employment levels that leave the labor market in equilibrium from
>  the supply side...higher employment goes with a higher real wage."
>
>  Much contemporary macroeconomic theory leaves the impression that
>  unemployment and recession are primarily the result of excessive
>  rigidity of wages and prices...If only the artificial barriers to
>  wage and price flexibility were removed - by the weakening of trade
>  unions and the deregulation of industry and trade - the market
>  mechanism would see to it that the labor market cleared...We have no
>  sympathy with either view.
>
>  It is then no great trick to show that a little sluggishness in wage
>  adjustment can actually be stabilizing for the economy.
>
>  But even under perfect competition there is doubt that the demand curve
>  has been correctly specified in the literature...It now follows that
>  even here the demand for labor depends on the demand for goods. In that
>  case [constant returns to scale - RV] higher employment need not entail
>  lower real wages.
>
>  The demand curve most frequently found in the literature seems to be the
>  "steady-state" demand curve...But it is, as we now know, almost too easy
>  to justify economies with a multiple steady-state equilibria...In that
>  case there are multiple demand curves for labor, and it is perhaps
>  unnecessary to spell out why a simple relation between employment and the
>  real wage is not to be had.
>
>  ...with the consequences of imperfect competition for labor demand. In
>  such a regime it makes no sense to ascribe unemployment to the cause:
>  "real wages are too high." Real wages are what firms, with given demand
>  expectations and facing a given money wage, make them. If [demand] were
>  higher and production is subject to diminishing returns, employment
>  would be higher and real wages lower. But it would be nonsensical here
>  to maintain that a reduction in real wages *causes* employment to be
>  higher; one is reading off the (real wage-employment) pair from an
>  equilibrium relation that does not include a clearing labor market.
>
>  We have been intent to take advantage of the imperfect competition
>  setting to allow for increasing returns to scale...Then, of course,
>  real wages and employment may be...positively related...Real wages
>  and employment are *both* endogeneous variables. But equally interesting
>  to us has been the ease with which both multiple steady-state equilibria
>  can be constructed and how these depend on the beliefs of agents...
>  Practical economists and politicians...seem all along to have been
>  aware of the relevance of "confidence."
>
>  Our own particular hobbyhorse is that there may be several equilibrium
>  (natural?) levels of employment and unemployment in a reasonable...model.
>  there may be a whole interval of levels of unemployment, any one of
>  which could be an equilibrium with the *same* real wage. The equilibrium
>  real wage could have a large element of convention (or history dependence)
>  about it
>
>  The course of events may be controlled by the dynamics, and therefore
>  by the beliefs and expectations of firms and households.'
>
>So is this the economics of Keynes? I suspect Barkley Rosser and Paul
>Davidson will have different answers. I also expect to not approve of
>Hahn and Solow's treatment of money and capital. However, they are
>explicit about choosing some of their assumptions as near as possible
>to the New Classical economics following Lucas, thereby providing an
>internal critique. So can Post Keynesians declare victory?
>
>
>Robert Vienneau                  Whether strength of body or of mind, or
>rvien@xxxxxxxxxxxxxxxxxxxxx      wisdom, or virtue, are always found...in
>                                 proportion to the power or wealth of a man
>                                 [is] a question fit perhaps to be discussed
>                                 by slaves in the hearing of their masters,
>                                 but highly unbecoming to reasonable and
>                                 free men in search of the truth.
>                                              -- Rousseau
>
>
>


Basil Moore, Department of Economics
Wesleyan University
685-2363