An Introduction to Post-Keynesianism

I recently attended a 3 day Post-Keynesian Study Group (PKSG) workshop at Kingston University, and here is some of what I learnt on the course. I am sure this will spawn many other research interests, leading to future blog articles on some of the theory discussed.

Day 1

The course was to be split up into 3 days, on the first day we would cover Post-Keynesianism, on the second we would continue with PK and financial crises in the morning, followed by Marxist Political Economy in the afternoon and then on the final day we would round off what we had learned, ask any further question and debate the success of student movements in encouraging pluralism.

The day began with an introduction into Post-Keynesianism from Engelbert Stockhammer who gave the 3 foundations of the school as Fundamental Uncertainty, Social Conflict and Effective Demand and explained other central beliefs of Post-Keynesians.

This school of thought believes that investment is the most important component of demand and has a key role in driving business cycles due to the volatile nature of investment.

Fundamental Uncertainty

This explains why Fundamental Uncertainty is a core tenet of Post-Keynesianism. It holds that people can’t be rational and instead have to rely on conventions such as social norms, anchoring and institutions. This goes further than bounded rationality – which, according to Herbert Simon, states that individuals are constrained in their decision-making by the availability of information, the time they have to make the decision, and the size and processing power of their brains. Neoclassical economists do away with uncertainty by assigning probabilities to incorporate unknowns into models, yet PKs believe there are always unknown outcomes which make models redundant. Engelbert used the example of a copper-producing factory owner before WWII, say in 1933. How does this owner make investment decisions as to whether he should increase capacity. Even if war was a known-known (i.e. the possibility of it occurring was evident), it would have only had a certain probability attached to it. When making his investment decisions, the factory owner would need to consider this probability, but would have to go further. He would then need to attribute a probability to the value of Allied success (this is a British copper factory), and the probability of failure. Once the probability of failure was incorporated he needs to estimate the increase in taxes which would arise from Nazi victory. On the other hand, if he believed the Allies would win he would then need to estimate the increase in taxes needed to pay down debts. He would need to consider what would happen to demand in either situation. In short, he has many decisions to consider – these are only the known-known’s: there are many possible outcomes which would be impossible to fathom, such as the creation of electronic computers which would increase the demand for copper – and each decision tree has to be continued ad-infinitum, which probabilities assigned and various other outcomes analysed.

This seems implausible to PKs who instead believe that decisions are based on conventions to achieve social justification. This can lead to herd behaviour, and may arise to justify actions to shareholders. For example, a CEO may be forced to invest in the dot-com bubble, even if he saw it as simply a bubble, because if he didn’t then he would be punished by shareholders. Similarly, an ordinary person may conduct an action, because everybody else is doing it, and he fears that he will miss out and regret, in the future, not taking action. Furthermore, Keynes believed that people assume the future is similar to the past: that is, they have adaptive expectations. This is quite a reasonable assumption when you look to behavioural economics and their theory of heuristics.

Due to this uncertainty money is held as an insurance and leads to Keynes’ liquidity preference theory of money. This makes it rational to hold on to cash, despite 0% return (and possibly a real loss if inflation is positive), due to its nature as the most liquid asset if we assume that it is a stable currency. The 2007/8 financial crisis highlights this role when the liquidity crisis meant people could no longer sell assets, even at firesale prices, because they were illiquid as everybody wished to sell them to hold on to cash.

This tenet ties back to investment demand, because it is largely driven by “animal spirits”, which would need to be included in the investment function and which may dilute the effect of the real interest rate and expected future profitability/return, as neoclassical proponents believe.

Social Conflict

The theory of social conflict is more of a Post-Keynesian belief than a traditional Keynesian one. It holds that there are 3 classes in a society: workers, capital owners and rentier/financial capital owners. Capital owners hire labour and use the firing threat as a source of control. There is no need for full employment, in fact it may be desirable for the capital owners for their to be unemployment, so that the firing threat is credible. It is the capitalists who make investment decisions. Neoclassicalists would say that it isn’t important who makes the investment decision because whoever makes them would base their decision on marginal productivity, which is the same calculation for whomever calculates it. But with the tenet of fundamental uncertainty in mind it might be the case that workers would base the investment decisions on the level of employment (i.e. it is more desirable for them to create a situation of full-employment), whereas the capital owners have the profit motive in mind. Therefore fundamental uncertainty means that investment decisions are based on more than just marginal productivities. In reality this makes sense: a firm-owner isn’t going to hire a worker during a recession, just because the marginal productivity of the worker is positive. If the owner wouldn’t be able to sell the increased produce he would make a smaller profit, thereby making it uneconomical for him to hire this worker, and demonstrating that who makes an investment decision is actually quite important. In this scenario the firm-owner made the decision and he based his decision on the fact that he might make a smaller profit. If the decision had been left to the state then it may have preferred a smaller profit in return for greater employment.

Rentiers advance capital to the capital owners in return for interest and dividends. Post-Keynesians believe that it is their liquidity preference which matters: if they would rather hold cash then they would demand  high interest rate which would make it more expensive for capital owners to make profits and thus investment falls.

If we assume that each group has different consumption propensities then their profits and actions are quite important. Keynesians typically believe that workers have the highest propensity, followed by capital owners and then the rentiers. If the profit/wage share was in favour of the workers then there may be greater economic activity due to their higher MPCs.

What this boils down to is a rejection by Keynesians of an endogenised quantity theory of money (MV=PY) instead believing that inflation is due to unresolved distributional conflicts. If the income/profit share isn’t at an equilibrium then there will be inflation caused by workers pushing up wages to increase the income share, whilst rentiers will demand higher interest rates to increase their profit share and capitalists will increase product prices so they have a higher markup. The effect of this is a wage-price spiral which causes inflation.

Effective Demand

In neoclassical theory the interest rate adjusts such that investment equals savings. In a Keynesian framework income changes so that savings adjust to equal investment, although this may be constrained by the availability of finance and credit. This is supposed to arise because an increase in investment causes greater output and a multiplier process means that income rises by more than 1, such that savings can also rise to finance this increased investment.

In summary, this means that investment isn’t constrained by the availability of savings – which adjust to meet investment – but can be limited by the prudence of commercial banks.

Involuntary Unemployment

Extreme neoclassical proponents believe that any unemployment must be voluntary because workers are choosing not to work. They believe that if a worker is unemployed at a given wage rate, the wage should fall and the worker should accept this. If he chooses not to then it is a voluntary choice to remain unemployed.

PKs believe that this adjustment mechanism is flawed, because wage contracts are nominal whilst workers and firms only care about real terms. Firms care about real wages in terms of a retail price index (how much they have to pay a worker relative to how much the produced goods can be sold for) and workers care about real wages in terms of a consumer price index (how much they get paid relative to how many goods they can purchase with this wage). Therefore a nominal wage cut is irrelevant, we need to instead consider real wage effects.

Keynes argued against wage cuts as a mechanism because consumption is likely to fall causing downward pressure on prices and therefore a possibility of a Fisher debt-deflation spiral which could lead to an upward sloping aggregate demand curve.

A wage cut would see consumption fall, investment could rise if capitalists see cheaper labour and thus find it cheaper to invest, yet low animal spirits and expected future return means it is more likely (in a Keynesian framework) that investment will fall. Remembering that investment is the most volatile component of AD and we find that this wage cut is likely to cause a recession. The effects on net exports are that lower prices mean the economy is more competitive on an international basis but only if we assume that foreign economies are fairing well. If they similarly are having an economic downturn (which is likely in today’s globalised world) then they will also see prices fall and a currency war could potentially break out resulting in a fall in NX exacerbating the domestic recession.

If instead we have a real wage cut then it is likely that it will have a contractionary effect because workers have a higher marginal propensity to consume than capitalists. This is unless investment is highly sensitive to profit margins in which case it might be possible that a real wage cut is expansionary.

All of this analysis is without venturing into hysteresis theory which would further exacerbate the effects of unemployment.

Money and Finance

He briefly mentioned how Post-Keynesians see money supply as being created endogenously by commercial banks (more on this in a future article on Positive Money). We also talked a little about Minsky debt cycles, whereby during a boom investors become willing to take more risks, so increase their leverage which causes a fragile system and leads to an endogenous cycle of boom and bust. More on Minsky later.

Development of the school

In the 1950s and 60s the Keynesian school of thought was predominant in politics and the Cambridge group were developing the theory. It was mainly based on long run analysis and was critical of the Synthesis* developments to produce models such as ISLM. Eventually controversy engulfed the Cambridge group over the issue of capital. After the 1970s the mainstream (neoclassical/neoliberal ideology) consolidates gains and becomes the dominant school of thought. Post-Keynesians emerge who try to return to the work of Keynes and develop new journals focusing on endogenous money theory, Minsky financial instability, Kaleckian models of short run analysis, and focus on empirics and economic policy.

*Synthesis Keynesians tried to fuse Keynes with neoclassical ideology and was led by Modigliano, Solow and Samuelson.


Engelbert identifies 3 main streams within the Post-Keynesian branch: Sraffians, Monetary Keynesians and Kaleckians. He believes that the Sraffians have lost importance as they became engulfed in the capital controversies, but had a preference for long run analysis. The monetary Keynesians were led by Minsky and Paul Davidson, focusing on uncertainty, money and short run analysis. Finally, the Kaleckians looked at social conflicts (different consumption propensities) and liked short/medium analysis.

NB: You can view Engelbert’s presentation here – Engelbert Stockhammer – Introduction

Read Part II here.

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