WEBVTT NOTE 20. Employment, Money, And Prices 1 00:00:00.000 --> 00:00:09.000 Chapter 20 Employment, Money and Prices 2 00:00:09.000 --> 00:00:14.000 An Unproved Functional Relationship 3 00:00:14.000 --> 00:00:24.000 I hope I have not said it too often, but as we advance in the general theory, the confusions and fallacies become progressively denser 4 00:00:24.000 --> 00:00:43.000 This is not surprising. In chapters 20 and 21, for example, which we shall now consider together, Keynes applied to the theory of money and prices, as one Keynesian has put it, the tools of analysis which he had developed earlier in the book. 5 00:00:43.000 --> 00:00:49.800 and Prices, as one Keynesian has put it, the tools of analysis which he had developed earlier 6 00:00:49.800 --> 00:00:51.440 in the book. 7 00:00:51.440 --> 00:00:58.000 But as these tools of analysis, as we have seen, nearly all consisted of faulty and confused 8 00:00:58.000 --> 00:01:04.720 concepts, a discussion of their supposed interaction merely compounds the confusion. 9 00:01:04.720 --> 00:01:10.680 As we have already analyzed these basic confusions, I need not repeat the analysis, though it 10 00:01:10.680 --> 00:01:16.480 It may be necessary to remind the reader from time to time of these basic confusions in 11 00:01:16.480 --> 00:01:21.680 calling attention to the additional and derived confusions that arise when these fallacious 12 00:01:21.680 --> 00:01:28.640 concepts are made the basis of further reasoning concerning their alleged interrelationships. 13 00:01:28.640 --> 00:01:34.240 The substance of Chapter 20, the employment function, need not detain us long. 14 00:01:34.240 --> 00:01:40.960 It is in effect to work out a series of mathematical equations concerning the employment function. 15 00:01:40.960 --> 00:01:47.240 Keynes offers an alleged definition of the employment function on page 280, but what 16 00:01:47.240 --> 00:01:53.320 he really gives us is, as in other cases, an equation without a definition. 17 00:01:53.320 --> 00:01:56.520 He does tell us, however, that 18 00:01:56.520 --> 00:02:02.180 The object of the employment function is to relate the amount of the effective demand 19 00:02:02.180 --> 00:02:08.040 measured in terms of the wage unit directed to a given firm or industry or to industry 20 00:02:08.040 --> 00:02:13.300 as a whole with the amount of employment, the supply price of the output of which will 21 00:02:13.300 --> 00:02:16.660 compare to that amount of effective demand. 22 00:02:16.660 --> 00:02:18.400 Page 280. 23 00:02:18.400 --> 00:02:23.740 The reader may make whatever he can of this, but a few hints will probably economize his 24 00:02:23.740 --> 00:02:26.020 time and mental effort. 25 00:02:26.020 --> 00:02:31.980 The first thing he can do is to put aside the phrase measured in terms of the wage unit. 26 00:02:31.980 --> 00:02:38.980 Though Keynes defined the wage unit as a quantity of employment, page 41, his explanation showed 27 00:02:38.980 --> 00:02:45.540 that he really defined it as meaning merely a quantity of money paid to persons employed. 28 00:02:45.540 --> 00:02:51.200 In fact, it seems to mean merely the average national hourly wage rate at any moment as 29 00:02:51.200 --> 00:02:54.320 measured in shillings or dollars. 30 00:02:54.320 --> 00:02:59.700 But in accordance with the philosophic principle of Occam's razor that entity should not be 31 00:02:59.700 --> 00:03:06.700 If these mean nothing more than the average national hourly wage rate, and if this is, say, $2, then it is easy to convert total wage payments into total man-hours worked, or vice versa. 32 00:03:29.700 --> 00:03:35.540 vice versa if we know one sum or the other. Then we shall at least know whether what we 33 00:03:35.540 --> 00:03:41.980 are talking about is total man-hours worked or average hourly wage rates in dollars or 34 00:03:41.980 --> 00:03:47.420 total wage payments in dollars, and we shall be at least one step nearer to clarity of 35 00:03:47.420 --> 00:03:53.720 thought. When a few other simplifications have been made, we shall find that all Keynes 36 00:03:53.720 --> 00:04:00.720 Hans is talking about is the relation of effective demand, another confused conception, the aggregate 37 00:04:00.720 --> 00:04:07.920 income or proceeds which the entrepreneurs expect to receive, page 55, to the amount 38 00:04:07.920 --> 00:04:09.880 of employment. 39 00:04:09.880 --> 00:04:15.720 But without analyzing this further, what reason is there to suppose that this relationship 40 00:04:15.720 --> 00:04:21.800 is a functional relationship at all, that there is any such thing as the employment 41 00:04:21.800 --> 00:04:23.800 Function. 42 00:04:23.800 --> 00:04:30.640 Keynes never condescends to offer any statistical evidence that any such function exists, or 43 00:04:30.640 --> 00:04:36.380 for that matter, that any of his other functions exist, and certainly he does not offer any 44 00:04:36.380 --> 00:04:40.040 plausible deductive proof that it exists. 45 00:04:40.040 --> 00:04:45.280 We touch here upon an economic error that long antedates Keynes. 46 00:04:45.280 --> 00:04:52.280 It can be traced back as far as Cournot in 1838, and was revived in its modern form chiefly 47 00:04:52.280 --> 00:04:55.520 by Jevons in 1871. 48 00:04:55.520 --> 00:05:00.920 It is the basis today of a huge literature of mathematical economics. 49 00:05:00.920 --> 00:05:07.220 When an empiric or presumptive relationship seems to exist between one economic quantity 50 00:05:07.220 --> 00:05:14.420 and another, so that one seems to vary proportionately or increasingly, decreasingly or inversely 51 00:05:14.420 --> 00:05:19.620 Similarly with another, some economists have fallen into the habit of calling the first 52 00:05:19.620 --> 00:05:22.180 a function of the second. 53 00:05:22.180 --> 00:05:27.780 This suggests a mathematical analogy, and perhaps little harm is done as long as it 54 00:05:27.780 --> 00:05:31.860 is treated merely as an analogy, as a figure of speech. 55 00:05:31.860 --> 00:05:38.340 It is unobjectionable to say, for example, that other things remaining unchanged, the 56 00:05:38.340 --> 00:05:50.340 The demand for a commodity, in the sense of the amount bought, seems to vary almost as if this demand were a decreasing function of the price of the commodity. 57 00:05:50.340 --> 00:06:07.340 But the moment we put this in the form of a mathematical expression, the moment we write, for example, D equals F P, or use some similar notation to stand for such a relationship, we are in danger of making an illicit leap. 58 00:06:07.340 --> 00:06:13.340 We have assumed in our formula that this mathematical relationship exists. 59 00:06:13.340 --> 00:06:20.200 We can, of course, assume such a relationship by hypothesis, but this can never yield anything 60 00:06:20.200 --> 00:06:23.300 better than a hypothetical conclusion. 61 00:06:23.300 --> 00:06:29.620 We can no more prove that a relationship exists by expressing it in a mathematical equation 62 00:06:29.620 --> 00:06:33.220 than by expressing the same assumption in words. 63 00:06:33.220 --> 00:06:38.540 We are merely more in danger of deceiving ourselves because we have made our assumption 64 00:06:38.540 --> 00:06:42.940 precise, though it may be precisely wrong. 65 00:06:42.940 --> 00:06:49.100 Let us remind ourselves, for example, of exactly what a function is. 66 00:06:49.100 --> 00:06:51.540 Once more I take the definition. 67 00:06:51.540 --> 00:06:58.040 If a variable y is related to a variable x in such a way that each assignment of a value 68 00:06:58.040 --> 00:07:22.040 That a given value of x in any assigned meaning definitely determines one or more values of y is something that we must prove to be true, not something that we make true simply because we have assumed it. 69 00:07:22.040 --> 00:07:31.040 Section 1 of Chapter 20 on the Employment Function consists of a set of equations concerning this alleged function. 70 00:07:31.040 --> 00:07:37.040 Keynes assumes that the functional relationship exists, but never attempts to prove it. 71 00:07:37.040 --> 00:07:48.040 There is in fact no good reason whatever to assume that any functional relationship exists between effective demand and the volume of employment. 72 00:07:48.040 --> 00:07:56.680 Everything depends, in fact, upon the interrelationships of wage rates, prices and the money supply. 73 00:07:56.680 --> 00:08:03.920 No matter how low total monetary demand falls, full employment could exist at the appropriate 74 00:08:03.920 --> 00:08:07.380 relationship of wage rates to prices. 75 00:08:07.380 --> 00:08:14.520 No matter how high total monetary demand is pushed, unemployment will exist if an unworkable 76 00:08:14.520 --> 00:08:21.080 General relationship exists between wage rates and prices, but even Keynes does not seem 77 00:08:21.080 --> 00:08:25.680 to take his mathematical explorations very seriously. 78 00:08:25.680 --> 00:08:32.120 At the beginning of section 1, he remarks in a footnote, those who rightly dislike algebra 79 00:08:32.120 --> 00:08:39.600 will lose little by omitting the first section of this chapter, page 280. 80 00:08:39.600 --> 00:08:44.960 Equal Value Theory vs. Monetary Theory 81 00:08:44.960 --> 00:08:51.560 As all the other major questions raised by chapter 20 are also raised by chapter 21 on 82 00:08:51.560 --> 00:08:56.600 the theory of prices, we may proceed to the latter forthwith. 83 00:08:56.600 --> 00:09:02.920 Keynes opens this chapter with a long paragraph that is worth quoting in full. 84 00:09:02.920 --> 00:09:07.920 So long as economists are concerned with what is called the theory of value, they have been 85 00:09:07.920 --> 00:09:14.120 In a custom to teach that prices are governed by the conditions of supply and demand, and, 86 00:09:14.120 --> 00:09:20.040 in particular, changes in marginal cost and the elasticity of short period supply have 87 00:09:20.040 --> 00:09:22.020 played a prominent part. 88 00:09:22.020 --> 00:09:27.540 But when they pass in volume two, or more often in a separate treatise, to the theory 89 00:09:27.540 --> 00:09:33.560 of money and prices, we hear no more of these homely but intelligible concepts, and move 90 00:09:33.560 --> 00:09:39.760 is relevant to a world where prices are governed by the quantity of money, by its income velocity, 91 00:09:39.760 --> 00:09:45.760 by the velocity of circulation relatively to the volume of transactions, by hoarding, 92 00:09:45.760 --> 00:09:53.040 by forced saving, by inflation and deflation, et hoc genus omni, and little or no attempt 93 00:09:53.040 --> 00:09:58.140 is made to relate these vaguer phrases to our former notions of the elasticities of 94 00:09:58.140 --> 00:10:00.600 supply and demand. 95 00:10:00.600 --> 00:10:05.720 If we reflect on what we are being taught and try to rationalize it, in the simpler 96 00:10:05.720 --> 00:10:11.600 discussions, it seems that the elasticity of supply must have become zero, and demand 97 00:10:11.600 --> 00:10:17.160 proportional to the quantity of money, whilst in the more sophisticated we are lost in a 98 00:10:17.160 --> 00:10:21.640 haze where nothing is clear and everything is possible. 99 00:10:21.640 --> 00:10:26.880 We have all of us become used to finding ourselves on the one side of the moon and sometimes 100 00:10:26.880 --> 00:10:45.100 This satire would have had considerably more point if it had been made a generation earlier. 101 00:10:45.100 --> 00:10:52.080 It sounds, indeed, suspiciously like a sly allusion to Keynes's own teacher, Alfred Marshall. 102 00:10:52.080 --> 00:10:58.740 But at the time it appeared, in 1936, it no longer applied, at least to the pioneers of 103 00:10:58.740 --> 00:11:00.720 economic thought. 104 00:11:00.720 --> 00:11:08.200 Newt Wicksell's Lectures on Political Economy, in two volumes, volume 1, General Theory, 105 00:11:08.200 --> 00:11:15.660 volume 2, Money, appeared in an English edition in 1934 and 1935. 106 00:11:15.660 --> 00:11:21.440 They had existed in German since 1901 and 1906. 107 00:11:21.440 --> 00:11:27.280 These lectures made giant strides toward a reconciliation and unification of value theory 108 00:11:27.280 --> 00:11:29.320 and monetary theory. 109 00:11:29.320 --> 00:11:36.000 Ludwig von Mises's Theorie des Geldes und der Umlosmüter, which carried this unification 110 00:11:36.000 --> 00:11:42.840 even further, appeared in its first German edition as early as 1912, and in its second 111 00:11:42.840 --> 00:11:44.920 in 1924. 112 00:11:44.920 --> 00:11:51.460 It had been translated into English as The Theory of Money and Credit in 1934. 113 00:11:51.460 --> 00:11:58.260 In America, Benjamin M. Anderson's The Value of Money, which appeared first in 1917, was 114 00:11:58.260 --> 00:12:04.040 in large part a protest against the tradition and practice of putting general economic theory 115 00:12:04.040 --> 00:12:09.080 and monetary theory in separate compartments. 116 00:12:09.080 --> 00:12:14.180 Anderson's book has appeared in a second edition in 1936. 117 00:12:14.180 --> 00:12:21.880 Was Keynes aware of all this? If so, why did he ignore it, all in the paragraph just quoted? 118 00:12:21.880 --> 00:12:28.000 One dislikes to write of him, as Wicksell wrote of Gustav Kassel, that he ignored those 119 00:12:28.000 --> 00:12:34.480 who had anticipated him because he desired, at all costs, to be esteemed an original and 120 00:12:34.480 --> 00:12:41.140 even path-breaking theorist. But one must choose between this explanation or the explanation 121 00:12:41.140 --> 00:12:48.060 of Sheer Ignorance, and Keynes, even in the general theory, makes references, though largely 122 00:12:48.060 --> 00:12:52.500 disparaging, to the work of both Huycksell and Mises. 123 00:12:52.500 --> 00:12:58.080 But perhaps the dichotomy between general value theory and monetary theory was never 124 00:12:58.080 --> 00:13:03.140 quite as sharp as Keynes's satiric portrait assumes. 125 00:13:03.140 --> 00:13:08.740 Scientific progress in all fields is made by isolating a problem, by studying the effect 126 00:13:08.740 --> 00:13:12.220 of one force or factor at a time. 127 00:13:12.220 --> 00:13:18.620 In the physical sciences, this is done through a method of hypothesis tested by experiment. 128 00:13:18.620 --> 00:13:24.660 In the social sciences, experiment in any meaningful scientific sense is impossible, 129 00:13:24.660 --> 00:13:29.900 and the method of isolating hypotheses must be the chief reliance. 130 00:13:29.900 --> 00:13:33.760 Keynes himself admits this in Chapter 20. 131 00:13:33.760 --> 00:13:39.720 The object of our analysis is to provide ourselves with an organized and orderly method of thinking 132 00:13:39.720 --> 00:13:45.780 out particular problems, and, after we have reached a provisional conclusion by isolating 133 00:13:45.780 --> 00:13:51.480 the complicating factors one by one, we then have to go back on ourselves and allow, as 134 00:13:51.480 --> 00:13:56.720 well as we can, for the probable interaction of the factors amongst themselves. 135 00:13:56.720 --> 00:13:59.360 Page 297 136 00:13:59.360 --> 00:14:04.880 This was the method originated by the Classical Economists, and specifically by Keynes's 137 00:14:04.880 --> 00:14:07.260 Baich-Nord, Ricardo. 138 00:14:07.260 --> 00:14:13.200 They abstracted, among other things, from money, in order to simplify and make manageable 139 00:14:13.200 --> 00:14:15.360 the problem of value. 140 00:14:15.360 --> 00:14:22.060 In a perhaps unfortunate phrase of Mills, they tried to look behind the monetary veil. 141 00:14:22.060 --> 00:14:27.040 Their mistake was not in doing this, but in later forgetting that they had abstracted 142 00:14:27.040 --> 00:14:32.480 from Money, and that their conclusions were therefore oversimplified and more hypothetical 143 00:14:32.480 --> 00:14:34.440 than realistic. 144 00:14:34.440 --> 00:14:40.020 And when they reintroduced money, or discussed monetary problems, they made the further mistake 145 00:14:40.020 --> 00:14:44.940 of forgetting what they had learned when they had abstracted from money. 146 00:14:44.940 --> 00:14:51.100 They failed, in short, to put the two sets of problems together, or rather, their solutions 147 00:14:51.100 --> 00:14:55.000 were merely pasted together, not unified. 148 00:14:55.000 --> 00:14:59.840 monetary economists and general economists worked within separate frames of reference 149 00:14:59.840 --> 00:15:03.080 and both lost by the separation. 150 00:15:03.080 --> 00:15:06.880 Curiously enough, Keynes does much the same thing. 151 00:15:06.880 --> 00:15:12.480 His own effort at unification of monetary theory and general value theory, as well as 152 00:15:12.480 --> 00:15:16.840 of static and dynamic theory, is unsuccessful. 153 00:15:16.840 --> 00:15:22.840 It is unsuccessful because of a number of specific errors, some of them astonishing. 154 00:15:22.840 --> 00:15:28.640 Mises' general method in Chapter 20 of introducing a number of simplifying assumptions in the 155 00:15:28.640 --> 00:15:34.560 theory of value and money and prices, and then reintroducing the possible complications 156 00:15:34.560 --> 00:15:39.840 which will in fact influence events, is correct in principle. 157 00:15:39.840 --> 00:15:46.160 But he is unsuccessful in result, because some of his simplifications and complications 158 00:15:46.160 --> 00:15:52.640 are the wrong simplifications and complications, and because some of his fundamental concepts 159 00:15:52.640 --> 00:15:55.740 are either misleading or false. 160 00:15:55.740 --> 00:16:00.220 In discussing money, for example, he tells us in italics, 161 00:16:00.220 --> 00:16:06.420 The importance of money essentially flows from its being a link between the present 162 00:16:06.420 --> 00:16:07.980 and the future. 163 00:16:07.980 --> 00:16:09.820 Page 293. 164 00:16:09.820 --> 00:16:16.600 And again, money in its significant attributes is, above all, a subtle device for linking 165 00:16:16.600 --> 00:16:18.880 the present to the future. 166 00:16:18.880 --> 00:16:19.880 Page 294. 167 00:16:19.880 --> 00:16:26.860 Now, I should say, on the contrary, that the importance of money flows essentially from 168 00:16:26.860 --> 00:16:33.080 its being a medium of exchange, and that its most significant attribute is that it functions 169 00:16:33.080 --> 00:16:35.400 as the medium of exchange. 170 00:16:35.400 --> 00:16:40.960 In performing this function, it is true money does incidentally serve as a link between 171 00:16:40.960 --> 00:16:46.000 present and future, but so do all sorts of other things. 172 00:16:46.000 --> 00:16:49.780 Money is far from unique in this respect. 173 00:16:49.780 --> 00:16:55.460 It may be doubted whether in economic life it serves even as the chief link between the 174 00:16:55.460 --> 00:16:57.500 present and the future. 175 00:16:57.500 --> 00:17:02.620 That honor should preferably be reserved for the rate of interest, which is not, Keynes's 176 00:17:02.620 --> 00:17:07.460 theory is notwithstanding, a purely monetary phenomenon. 177 00:17:07.460 --> 00:17:13.140 Another link between the present and the future is the system of forward and future prices 178 00:17:13.140 --> 00:17:16.180 on the organized exchanges. 179 00:17:16.180 --> 00:17:22.500 All prices in fact, even present prices of securities and commodities, are links between 180 00:17:22.500 --> 00:17:28.100 the present and the future, because they embody and reflect the anticipations of buyers and 181 00:17:28.100 --> 00:17:31.340 sellers respecting the future. 182 00:17:31.340 --> 00:17:37.320 It is true that such prices happen to be expressed in terms of money, but they would anticipate 183 00:17:37.320 --> 00:17:41.860 the future just as much if they were expressed in terms of each other. 184 00:17:41.860 --> 00:17:47.660 If the price of wheat were expressed in terms of cotton, or of cotton in terms of wheat, 185 00:17:47.660 --> 00:17:53.960 of course, prices expressed in terms of money also reflect anticipations regarding the future 186 00:17:53.960 --> 00:17:57.260 value of the monetary unit itself. 187 00:17:57.260 --> 00:18:02.860 But money, as such, has no unique quality in reflecting anticipations regarding the 188 00:18:02.860 --> 00:18:03.860 future. 189 00:18:03.860 --> 00:18:09.940 It is, in fact, men's anticipations regarding the future, and not the particular material 190 00:18:09.940 --> 00:18:15.980 Real terms in which these anticipations are expressed that constitute the real link between 191 00:18:15.980 --> 00:18:18.420 the present and the future. 192 00:18:18.420 --> 00:18:23.760 Men constantly act with an eye on the future, and their actions and valuations express their 193 00:18:23.760 --> 00:18:26.060 anticipations regarding that future.