CHAPTER 23. WOULD KEYNES BE A "NEW" KEYNESIAN?*

*This paper was published in the Eastern Economic Journal, v ol. 18, 1992.

The principle of a truth in labelling law that protects consumers1 from false and misleading claims is often violated by economics textbooks. Under the truth in labeling law, a minimum quantity of beef is required in a patty before society permits anyone to sell it as a hamburger. Similarly some minimum quantity of Keynes's logical analysis should be an essential ingredient in any theory being sold as Keynesian, especially in textbooks to yet uneducated consumers. Paraphrasing a famous slogan of the 1988 Democratic presidential primary, "Where's the Keynesian beef in New Keynesian economics?".

This paper demonstrates [1] New Keynesian Economics [hereafter NKE] does not contain any of Keynes's logical building blocks, and [2] NKE leads to policies that are the opposite of what Keynes advocated as solutions to the major problems facing real world economies.

I. WHAT IS NEW KEYNESIAN ECONOMICS?

In his article "What is New-Keynesian Economics?", Gordon [1990] claims that Parkin [1984] was the first to use the term "New Keynesian."2 Parkin 3 claims that his original definition of NK was "A class of models of the labor market that assume rational expectations and fixed term multiperiod possibly but not necessarily overlapping wage contracts." Parkin contrasted this with his original definition of New Classical economics [hereafter NCE]: "A class of models of the labor market based on rational expectations and market clearing." NKE is a "theory of aggregate supply" [Parkin 1984, p. 74]; it puts an ad hoc constraint on the classical aggregate supply curve by assuming a short-run fixity of nominal wages.

Parkin indicates that he would now propose new and different definitions for both NKE and NCE. He now defines NCE as: "a research program that seeks to explain aggregate fluctuations as the consequence of perfectly coordinated Pareto efficient intertemporal substitution," and NKE as "a research program that seeks to explain aggregate fluctuations as the consequence of impediments to the coordination of the choices of rational agents who are individually maximizing but who are collectively prevented from achieving a Pareto efficient allocation." This new set of definitions changes the NKE emphasis from a per se fixed money wage system to one where coordination failures can induce (short-run?) nominal fixities and thereby cause underemployment equilibrium4.

Gordon defines NKE as "research within the Keynesian tradition that attempts to build the microfoundations of wage and price stickiness" [1990, p. 1115, italics added]. Gordon insists that "price setting behavior is the essence of Keynesian economics. Any attempt to imbed it in microfoundations must begin from monopolistic or imperfect competition" [Gordon, 1990, p. 1136]. The NKE game plan "is to tease a failure of macro markets to clear from a starting point of rational expectations and the maximization of profits and individual welfare at the micro level" [Gordon, 1990, p. 1137]. "Any satisfactory explanation of business cycles that warrants the label Keynesian must incorporate not just price stickiness, but ... [must also recognize that] the necessary condition for non-market clearing is a barrier to the full adjustment of nominal prices" [Gordon, 1990, p. 1138-9]. Finding rationales for the short- run stickiness of nominal values imbedded in an aggregate supply function is apparently the sine qua non for New Keynesian analysis!

Indicating that "an under-full-employment equilibrium can occur only if wages and prices are less than perfectly flexible", Colander [1993, pp. 2, 8] agrees. He claims that coordination failures are the sole rationale for explaining unemployment in NKE. Colander expands a traditional neoclassical production function to include "a new term coordination in the production function...[where] X = f(K,L,C)... The New Keynesian research agenda is to examine and understand that coordination function and how it relates with markets"5 [Colander, 1993, pp. 10-11].

If one accepts these NKE definitions, then, in the absence of any wage or price stickiness, it is theoretically impossible to experience a lack of aggregate demand. Gordon rationalizes this NKE view that it is supply failures and not a demand fault that causes unemployment when he claims that the complete research agenda for macroeconomics is circumscribed by "Lucas' famous paper" [Gordon, 1990, p.1118]. In asserting that "demand side topics can be omitted, simply because they are not at the heart of the conflict between New-Keynesian and new-classical macroeconomics", Gordon [1990, p. 1117] is throwing out Keynes's baby with the NCE bathwater!

Mankiw [1990, p. 1647] agrees that the NKE research agenda is solely a response to Lucas. In NCE, short-run unemployment is the result of "imperfect information regarding prices" [Mankiw, 1990, p. 1652] as agents confuse movements in the price level with changes in relative prices. Consequently, involuntary unemployment is at most an ephemeral phenomenon due to incorrect expectations. Unemployment can never persist [Mankiw, 1990, p. 1652-3] in the long run as long as rational expectations are assumed ( since by definition, persistent expectational errors are not possible).

NCE explanations of unemployment are, according to Mankiw [1990, pp. 1653-4] at odds with the "common presumptions...[and] the strong prior beliefs of many economists ... [and are] unlikely to be plausibly reconciled with observed economic fluctuations". Apparently, the Latter Day NKE Saints reject the inevitable logical conclusion of "theory" based on classical axioms as inconsistent with their native good judgment (i.e., prior beliefs). For example, Gordon exclaims [1990, p. 1138] that "any satisfactory explanation of the business cycle that warrants the label Keynesian must incorporate not just price stickiness, but in addition some element that explains the evident unhappiness of the employed in recessions and depressions." Gordon's common sense tells him that during a recession even the remaining employed experience an uneasiness as they fear for their jobs. Moreover, unemployed workers neither prefer the enforced leisure compared to the dignity of working for a living, nor are they confusing general price movements for relative price changes.

In uncritically accepting Lucas's view of the scope of macroeconomics, NKE are embracing the classical axioms as the basis of an economic theory which holds that markets are the instrument of coordination. The common sense beliefs of these New Keynesians, therefore, require scientific justification in terms of market failure. Mankiw [1990, p. 1654] states that the "grand scale" market failure "most frequent in Keynesian theories is the failure of wages and prices to adjust instantaneously to equilibrate supply and demand [i.e., clear the market]". Mankiw [1990, pp. 1654-5, italics added] declares the NKE research agenda is to develop "a cogent theoretical foundation of hard headed microeconomic reasoning" to explain the failure of market wages and prices to adjust instantaneously "to clear the market".

NKE proponents are continually invoking the need for a "hard headed" approach by which they mean an analysis that is compatible with the fundamental postulates of NCE. Since NKE and NCE are founded on the identical axiomatic base, the basic litmus test of NKE is the presumption of some on ad hoc constraint to the classical aggregate supply conditions to temporarily fix nominal magnitudes so that the classical neutrality of money axiom is, in the short run, inoperative.

If fixities due to coordination failures are the sole basis of any so-called Keynesian research agenda, then these "Keynesians" are in the position of a defendant trying to respond to the classic "when did you stop beating your wife?" cross-examination. By claiming that NKE research is limited to finding "barriers to the full adjustment of nominal prices" [Gordon, 1990, p. 1139], the NCE presumption that a free, unregulated market with flexible prices and no coordination failures "is for the best in the best of all possible worlds provided we will let well enough alone" [Keynes, 1936, p. 33] is implicitly accepted. If, as a matter of faith6, the axioms of classical economics are believed to be the basis for all theory, then the only substantial difference between NKE and NCE analysis for policy purposes is the duration of time it takes to remove all impediments to coordination so that all nominal values (wages, prices, exchange rates, etc.) are fully flexible. In that long period, the economic system will achieve the Panglossian, Pareto-efficient equilibrium where everyone stops beating their wives. After all, in the long run when we are all dead, no one can lift a hand to strike one's spouse!

It is only common sense that prevents New Keynesians from accepting the NCE fable that efficient markets will bring the capitalized value of the future's Panglossian bliss to today's economic markets. To prove their scientific manhood, however, New Keynesians are forced to "tease out" the special cases within the microfoundations of NCE that Lucas used to circumscribe the acceptable research agenda for macroeconomics. To step outside the Lucas drawn boundaries would be to expose New Keynesians to charges of non-scientific thinking by the Economics Establishment.

New Keynesians envy the attribute of "hard headedness" associated with the intellectually prestigious results forged in the axiomatic ovens of the New Classical analysis. New Keynesians seek to demonstrate that their heads are just as hard as the New Classical economists. They attempt to forge different results from the same axiomatic ovens and thereby deflect attention from the nakedness of their soft hearts (or what Mankiw calls their "strong prior beliefs") which recognize that, in the real world, the unemployed who lose their jobs during recession are neither maximizing intertemporal utility in the labor market nor confusing absolute price changes for relative price changes. Ad hoc constraints (fixities induced by market supply failures) are the NK spanners thrown into the NCE axiomatic machine to show that short-run fluctuations in employment and output are not "the Pareto- efficient response of the economy to changes in tastes and technology, but rather some sort of market failure on a grand scale" [Mankiw, 1990, p. 1654]. Hiding behind the fig leaf claim that NCE axioms are the only foundation for scientific inquiring minds, New Keynesians profess that their "hard heads" have developed a "tough minded economics for a just society" [Blinder, 1987].

Ever since Ricardo, mainstream economists have believed that classical economics is the general theory, where full employment is the inevitable long run outcome. Keynes [1936, p. 192] noted that true classical believers such as Ricardo "offered us the supreme intellectual achievement, unattainable of weaker spirits, of adopting a hypothetical [classical] world remote from experience as though [as if?] it was the world of experience and then living in it consistently." From time to time, however, there were some orthodox economists who still accepted classical axioms as the foundations of "theory" yet whose native good judgment told them that, even in the competitive environment of the 19th and early 20th centuries, unemployed workers were not enjoying voluntary leisure. These preKeynesian "reasonable" classical economists attempted to explain unemployment as short-run maladjustments due to wage and price rigidities, frictions, erroneous expectations, etc. which lengthen the time until free markets produce the long-run full employment equilibrium outcome. Those who tried to explain unemployment in this manner were, "weaker spirits" whose "common sense cannot help breaking in -- with injury to their logical consistency " [Keynes, 1936, p. 192].

In order to demonstrate that Say's Law "was not the true law relating the aggregate demand and supply functions" [1936, p. 26] Keynes believed it was essential to demonstrate that even in the absence of all market imperfections, underemployment equilibrium was possible7. Otherwise, policy prescriptions would get hung up on how to remove the market failures which prevent price flexibility rather than focusing on the essential nature of an entrepreneurial, money-using economy where an insufficiency of aggregate demand was a sufficient cause of the system's failure "to provide full employment" [Keynes, 1936, p. 372]. Aggregate supply constraints per se are neither necessary nor sufficient to demonstrate an underemployment equilibrium. The fundamental cause of unemployment is not nested in imperfect competition. Unemployment is a structural fault of a money using, laissez-faire market system.

New Keynesians, however, stress only aggregate supply factors-- not demand -- as the sole cause of unemployment equilibrium. What Mankiw and Gordon claim is the essence of the New Keynesian research agenda, therefore, is conceptually unnecessary to explain Keynes's analysis of unemployment. NKE diverts attention from Keynes's logical analysis of the necessary and sufficient conditions for the existence of underemployment equilibrium in both the short- and long-run and the policy decisions necessary for restoring and maintaining full employment to an economy in recession8.

New Keynesians are unwilling to challenge Lucas's vision that demand per se can never be insufficient with perfectly flexible supply conditions. Only postulated constraints on Lucas's supply analysis can short-circuit the power of supply to create its own demand. In the absence of such ad hoc constraints in a Lucas world -- one which Lucas [1981, p.563] describes as "a patently artificial world" -- Say's Law would prevail. If New Keynesians read Keynes's analysis of aggregate supply and demand, however, then they would realize they can not claim Keynes as an intellectual forefather .

II. KEYNES'S TREATMENT OF AGGREGATE SUPPLY AND DEMAND

If we accept the NK agenda, then a more honest title for Keynes's book would have been The Special Case Theory of Employment, Interest and Money; (Why Market Failures Prevent Flexible wages and Prices From Doing their Job). All the definitions of NKE lay the emphasis on some difference between classical supply conditions and the supply environment assumed by NKE. Keynes, on the other hand, claimed that his aggregate supply function "is simply the age old supply function" [Keynes, 1973, p. 513] derived from Marshall's "ordinary supply curve" [1936, p. 45] and which can be associated with any degree of competition including pure competition9. In a further explanation to Dennis Robertson, Keynes stated that he spent so little time developing aggregate supply conditions because the aggregate supply function "is only a reconcoction of our old friend the supply function. Virtually the whole rest [of The General Theory]...is, therefore, directed to discovering what determines D [aggregate demand]" [Keynes, 1973, p. 513]. In other words, Keynes insisted that the assumed conditions of supply were not what distinguished his approach from the "old" classical analysis of his day. The fundamental difference was that Keynes recognized the possibility of an "insufficiency" of demand no matter what the conditions of supply [1936, p. 33].

What is more important, from a truth in labelling history of thought context, Keynes specifically denied that fixed nominal wages and prices were a necessary condition for underemployment equilibrium10. One complete chapter11 of The General Theory demonstrates why the existence of instantaneously flexible money wages can not assure full employment -- even if no coordination failures exist. "For the Classical Theory has been accustomed to rest the supposedly self-adjusting character of the economic system on the assumed fluidity of money-wages; and, when there is rigidity, to lay on this rigidity the blame of maladjustment ...My difference from this theory is primarily a difference of analysis" [Keynes, 1936, p.257]. In section VII infra, it will be shown that Keynes's use of wage units to measure his aggregate functions brings to the foreground this "difference of analysis" by requiring a tracing of the feedback effects of flexible wages on components of aggregate demand. These feedback effects had nothing to do with coordination failures!

Keynes's chapter 19 analysis demonstrates that complete wage (or price) flexibility was neither a necessary nor a sufficient condition for full employment equilibrium. Keynes's two major conclusions regarding the effect of instantaneously flexible money wages -- even in condition of purely competitive supply --are that "there is, therefore, no ground for the belief that a flexible wage policy is capable of maintaining a state of continuous full employment" [1936, p. 267] and that "to suppose that a flexible wage policy is a right and proper adjunct of a system which on the whole is one of laissez-faire, is the opposite of the truth" [1936, p. 269].

Consequently, anyone selling New Keynesian theoretical patties for students (or uneducated policy makers) consumption in which the fixity of nominal wages or prices is the main ingredient would not get a franchise from the originator of Keynesian economics to use his name.

III. KEYNES ON EXPECTATIONS AND POLICY IRRELEVANCE

Keynes recognized the possibility of policy irrelevance long before Lucas. In the chapter on long-term expectations, Keynes [1936, p. 162] warned that economic prosperity "is excessively dependent on the political and social atmosphere which is congenial to the average businessman. If the fear of a Labour Government or a New Deal depresses enterprise" then policy interventions may be offset by entrepreneurial reactions. The basis for Keynes's conclusion that policy actions can induce offsetting private expectations about the future, however, is just the opposite of Lucas's on this very practical point. For Keynes "human decisions affecting the future ... cannot depend on strictly mathematical expectations, since the basis for making such calculations does not exist; and that it is our innate urge to activity that makes the wheels go round" [1936, pp. 162-3, italics added] rather than rational expectations and flexible wages and prices.

It is this crucial difference on how, in an uncertain world, expectations are formed that distinguishes Keynes and Keynes's economic analysis from both Old and New Classical economists and Old (i.e., neoclassical synthesis) and New Keynesians.

Elsewhere, [Davidson 1984, 1988, 1990] I have developed Keynes's view on expectational formation in an uncertain world and the implications of such expectations for the long-run non-neutrality of money in an entrepreneurial market-oriented economy. Such an analysis provides a more general theory than one where the classical axioms of money neutrality and ergodicity-induced rational expectations characterize a special case. "The characteristics of this special case assumed by the classical theory happen not to be those of the economic society in which we actually live with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience" [Keynes, 1936, p. 3] To the extent that New Keynesians allow Lucas's "patently artificial world" to operate "as if" it was the general case and hence circumscribe the macroeconomic research agenda, the policy implications derived from such research can be misleading and disastrous to the world of experience.

IV. WOULD A GOVERNMENT POLICY TO END COORDINATION FAILURE PROMOTE FULL EMPLOYMENT?

We have seen that the concept of coordination failure is the basis of the new New Keynesian research agenda. In fact, Gordon [1990, p. 1139] insists that "coordination problems represent the core problem in economics"12. Colander introduces "coordination" as an additional production factor input to explain NKE. Following this logic, these "coordination failure" New Keynesians should support all public policies that promote better coordination.

For example, at a 1982 press conference, President Reagan presented a proposal for solving the unemployment problem that then was approaching 10.7 per cent of the labor force. In response to a question regarding what could be done to reduce unemployment, the President stated that the unemployment problem could be solved if each business firm immediately hired one more worker. The solution was, of course, statistically accurate as there were more operating firms than unemployed workers.

New Keynesians who attribute unemployment solely to a coordination failure should have applauded Reagan's clarion call for the coordinated increased hiring by all private enterprises. Keynes, on the other hand, would never have endorsed Reagan's Say's Law supply-side solution to the unemployment problem13! Unless the employment these additional workers created an additional demand (at a profitable price) for the increased output produced by the newly employed (additional supply creating pari passu additional demand), however, it would not be profitable for entrepreneurs to hire additional workers.

V. WHAT ABOUT MONEY AND NEW KEYNESIAN ANALYSIS?

Neither Parkin, Mankiw, Colander, nor Gordon associated the existence of unemployment directly and explicitly with the use of money per se in any market system. The rationale for this textual omission is suggested by Blanchard [1990]. Oblivious to what Keynes wrote, Blanchard asserts at the very beginning of his paper [1990, p. 780] "economic theory does not lead us to expect" that the existence of money per se can cause fluctuations in output and employment; "indeed it [theory] holds that, with flexible prices, money should be approximately neutral." In other words Blanchard accepts the classical neutrality of money axioms as basic to all economic theory. Keynes, however, explicitly rejected the classical postulate of the short-run and long-run neutrality of money, even with flexible prices as a fundamental tenet of his General Theory (see Keynes's quotation infra).

Blanchard [1990, p. 780], like the others, sees the NKE agenda as solely "why prices do not adjust fully and instantaneously to nominal money...to focus on the reasons for and the implications of imperfect price adjustment14". Blanchard [1990, p. 828] insists that all NKE models must be based on "hard-headed" microfoundations that "impose long-run neutrality of money as a maintained presumption. This is a matter of faith, based on theoretical considerations rather than on empirical evidence."

In 1933, on the other hand, Keynes specified his research agenda when he wrote:

"In my opinion the main reason why the problem of crisis is unsolved, or at any rate why the theory is unsatisfactory, is to be found in the lack of what may be called a monetary theory of production. An economy which uses money as a neutral link between transactions in real things and real assets and does not allow it to enter into motives or decisions might be called - for want of a better name - a real exchange economy. The theory I desiderate would deal ... with an economy in which money plays a part on its own and affects motives and decisions and is, in short, one of the operative factors in the situation, so that the course of events cannot be predicted either in the long period or in the short, without a knowledge of the behavior of money between the first state and the last. And this is what we ought to mean when we speak of a monetary economy....Booms and depressions are peculiar to an economy in which ... money is not neutral...I believe the next task is to work out in some detail a monetary theory of production...that is the task on which I am now occupying myself in some confidence that I am not wasting my time" [Keynes, 1973, italics added, pp. 408-10].

In contradistinction to the New Keynesian presumptions, Keynes believed that there is a fundamental analytical difference between a money-using production economy (where even "in the long period" money is not neutral) and the real exchange economy of classical economics where the long run neutrality of money is a matter of faith. In Keynes's monetary theory of production, the absence of flexible wages and prices is not the fundamental criterion upon which the nonneutrality of money depends. Even if prices are perfectly flexible in the long period the existence of money per se can cause "booms and depressions." In Keynes's general theory, there is no self-adjusting mechanism built into a laissez-faire market system that assures the clearing of all markets including the labor market if only nominal wages and product prices are perfectly flexible.

If the absence of instantaneous and full price adjustments is not a necessary condition for underemployment equilibrium, then one might ask what are the essential conditions for unemployment in Keynes's analysis and why is his analysis a more general theory than the classical analysis? A response to this query will be provided in section VII infra. First, however, it should be emphasized that the absence of any of Keynes's beef in NKE is important, not only from a history of economic thought -- truth in labelling -- prospectus, but also in terms of determining public policy.

VI. SO WHAT IF THERE IS NO KEYNESIAN BEEF IN NKE?

In presentations of an earlier draft of this paper to some audiences, one response often encountered was "So what if NKE has a different logical foundation than Keynes's analysis? The NKE research would still exist in the literature even if they had taken a different epithet more in keeping with a truth in labelling law, e.g., NMCCE -- Non Market Clearing Classical Economics."

Although a rose by any other name is still a [sweet smelling] rose, it does not follow that calling the foul smelling fruit of the ginkgo tree a rose will make it smell any better for policy making purposes. Since economists offer policy advice, they bear a responsibility to the public as well as to their students to refrain from using misleading labels for their policy nostrums.

The NKE and Keynes's General Theory approaches have significantly different -- and often conflicting -- domestic and international policy implications for important economic questions facing the real world in which we live. Keynes argued that "the tacit assumptions [of classical economics] are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world" [Keynes, 1936, p. 378]. If one builds an analysis on the classical axioms, then the only logical long run role of government is to promote wage and price flexibility (including exchange rate flexibility). In the short-run, New Keynesians can merely prescribe that government act merely as (1) a coordinator (e.g., Reagan's 1982 suggestion for curing unemployment) and (2) as an instrument for encouraging competitive market solutions to all our economic maladies.

Keynes, however, believed that one of the "outstanding faults of the economic system in which we live" is "its failure to provide full employment" [Keynes, 1936, p. 372]. Unemployment involves the "public scandal of wasted resources" [Keynes, 1936, p. 380-1]. Nevertheless, Keynes's "theory is moderately conservative in its implications" [Keynes, 1936, p.377] in that in the long-run "[A]part from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest, there is no more reason to socialise economic life than there was before" [Keynes, 1936, p. 379]. In other words, we should not permit the public scandal of a waste of resources in order to rely on a competitive market solution to assure a full employment level of effective demand - even in the long run. Government has a permanent role in adjusting aggregate demand to its full employment potential without getting bogged down in the nitty-gritty of production planning. The latter is best left to the private sector after government has assured that there is never a significant lack of aggregate demand [Keynes, 1936, pp. 380-81].

NKE, on the other hand, implicitly accepts the "public scandal of wasted [unemployed] resources" as an inevitable short-run outcome of the inherent fixities and lack of perfect coordination in an imperfectly competitive capitalist system. Colander [1993, p.9], for example, hypothesizes a situation with two full employment equilibria -- one with 400 widgets produced and one with 1000 widgets produced. He hypothesizes that if the economy gets stuck at the 400 output level, then any institutional coordinating rearrangement that limits wage and price flexibility while increasing output to 600 widgets (due to a higher C in Colander's production function) is preferred. Colander fails to explain, however, why once the higher C level is reached, the economy will not prefer to produce a full employment level of 1000 widgets. To assume the economy can not reach the 1000 level of full employment at the higher C level is to assume away the demand problem by hypothesizing some unspecified barrier to full employment.

By accepting the classical axioms, the long run logic of NKE, implies that prosperity is just around the long-run corner. Only short-run, unexpected shocks, for which a coordinated equilibrating reaction is not instantaneously available, prevents the system maintaining continuous full employment.

What are the policy implications of this New Keynesian logic? Securing continuous full employment is unlikely -- except in the most stationary of worlds that never experience any shocks. A competitive, flexible price, laissez-faire system is the best of all possible worlds. The role for government should be to encourage more rapid wage and product price flexibility through freeing-up domestic markets and, in an open system, requiring exchange rate flexibility. There can be no permanent positive role for government fiscal policy, or cooperative regulatory policy in order to create and maintain a full employment demand environment. Because of the postulates underlying NKE, the private sector can never suffer from a long-run deficiency in effective demand.

Clearly, the NKE prescription pill box contains medicines that Keynes would have labelled as dangerous to the health of the economic system in which we live. Moreover, Keynes would have argued that the NK pillbox does not contain the necessary medicine to insure a prosperous capital economy -- in either the short-run or the long-run!

VII. PROVIDING A TRUE GENERAL THEORY VIA A TAXONOMIC ATTACK ON SAY'S LAW

Keynes became convinced that the axioms of classical economics were too restrictive to explain why an economy might become mired in unemployment. By developing an expanded demand category classification system requiring fewer classical axioms [Davidson 1984], Keynes produced a more general theory than the classical analysis. As a result Say's Law could be shown to be applicable only if one imposed additional axioms to produce a specific case of Keynes's general theory. As we will demonstrate in this section, in the absence of the additional classical axioms, Keynes could demonstrate that Say's Law "is not the true law relating the aggregate demand and supply functions...[and therefore] there is a vitally important chapter of economic theory which remains to be written and without which all discussions concerning the volume of aggregate employment are futile"[Keynes, 1936, p. 26].

Say's Law specifies that all expenditure (aggregate demand) on the products of industry is always exactly equal to the total costs of aggregate production (aggregate supply) including gross profits. Letting D symbolize aggregate demand and Z aggregate supply, if

D = fd(N)	(1)

and

Z = fz(N)	(2)

then Say's Law asserts that

fd(N) = fz(N)	(3)

"for all values of N, i.e., for all values of output and employment" [Keynes, 1936, pp. 26]. In other words, in an economy subject to Say's Law, all costs of production incurred by firms (whether in pure competition or not) are recouped by the sale of output. There is never a lack of effective demand. The aggregate demand and aggregate supply curves coincide (see Figure 1). In a Say's Law economy there is no obstacle to achieving the full employment level of Naf in Figure 1.

To challenge the applicability of Say's Law, Keynes had to develop a model where the aggregate demand and aggregate supply functions, fd(N) and fz(N), are not coincident (see Figure 2). The equilibrium level of employment could be Nb1 rather than the full employment level of Nbf. Keynes accepted the "age-old" classical supply function that could be associated with pure competition (or any degree of monopoly)15 as the micro-basis for the aggregate supply function of equation (2). The existence of monopolistic power in the product and/or the labor markets is, therefore, not a necessary condition for the existence of a barrier to full employment.

The existence of a possible less-than-full employment equilibrium is due to the fact that the determinants of the aggregate demand function are not identical with the determinants of aggregate supply. Keynes specifically differentiated his theory from classical economics solely via the concept of aggregate demand which he split into two classes i.e.,

D = D1 + D2 =fd(N)	(4)

where

D1 = f1(N)	(5)

and

D2 f(N)	(6)

D1 represented all expenditures which "will depend on the level of aggregate income and, therefore, on the level of employment N" [Keynes, 1936, p. 28]. D2 represents all expenditures not related to income and employment. Since classical theory does not recognize the possibility of a D2 category, Keynes's taxonomy provides an inherently more general theory, where the classical system is a special case where, among other things, D2 is always equal to zero.

The axioms of ergodicity, gross substitution and neutral money underlie the expenditure decisions of utility maximizing agents in the classical model. Because of these postulates, the only reason people will exert the necessary distasteful effort to earn income (aggregate supply) is to spend it all (aggregate demand) on the only things that are expected to provide utility -- the products of industry. In the simplest classical analysis, therefore, there can be no D2 spending. Aggregate demand consists entirely of D1 expenditures, and for utility maximizing individuals, the marginal propensity to spend on D1 must be unity; Say's Law implies fd(N) = fz(N) and figure 1 is relevant16.

To assure that Keynes's second expenditure category, D2, is neither an empty cell nor always equal to the "planned" savings function [fz(N) - f1(N)] in either the short- or long-run, Keynes had to reject the ergodic axiom that presumes that the future is merely the statistical reflection of the past and therefore market price data are statistically reliable indicators of future events. Rejecting the ergodic axiom means recognizing the existence of an uncertain future that can not be reliably predicted by analyzing past and current market price signals. In a nonergodic environment, expectations of future profits (the basis for investment spending, D2) can not be statistically forecasted from existing market data. Neither can any current information regarding the "planned" savings function [fz(N) - f1(N)] be used to provide the basis for formulating rational expectations regarding each future period's aggregate D1 spending in a nonergodic, uncertain world [see Davidson, 1991]. In a general theory, therefore, expected future profitability of current investment projects can not be determined endogenously by the current propensity to save and/or past or current spending patterns. Rather investment expenditures depend on the exogenous (and therefore, by definition, sensible but not rational) expectations of entrepreneurs, or what Keynes called "animal spirits".

Keynes's analysis is a more general theory than classical theory because [a] it requires fewer axioms, and [b] it explicitly recognizes the possibility of two different classes of current demand for producible goods and services, with each class having some different and independent determinants. Classical analysis ultimately presumes that supply [fz(N)] is the sole determinant of demand and therefore creates its own identical demand so that all markets clear. The latter becomes "a special case and not...the general case" [Keynes, 1936, p. 3] where

D2 = 0 (7)

and

D1 = f1(N) = fz(N) = Z (8)

for all values of N17.

Keynes's most important task, however, was not merely to provide a general theory. Rather it was to demonstrate that "the characteristics of the special case assumed by classical theory happen not to be those of the economic society in which we actually live".[Keynes, 1936, p.3] In other words, Keynes had to demonstrate that even if D2 = 0, the D1 function would not be coincident with his macroanalogue of the age-old supply function. To accomplish this, Keynes dropped the classical axioms of gross substitution and money neutrality. This permitted utility maximizing agents to withhold some portion of their aggregate income from the purchase of the products of industry. i.e., the marginal propensity to spend of D1 on currently produced goods and services is less than unity.

Instead of planning to spend all of their aggregate income on the products of industry, self-interested agents might purchase (with their savings) liquidity by the possession of money. Liquidity implies the ability to discharge one's contractual obligations when they come due. In an economy that uses money contracts to hire inputs and organize production and exchange, only money can discharge contractual obligations under the civil law of contracts. (In a civilized society where slavery is illegal, enforcement of labor employment contracts in real terms is not permitted.) The ability to be liquid requires holding sufficient money (or other liquid assets that are readily resalable in a well organized, orderly spot market for money) to meet all known upcoming contractual obligations plus, in an uncertain world, sufficient liquid assets to meet currently unknown but potential future contractual obligations.

The "attribute of `liquidity'", Keynes [1936, p.241,n.1] insisted required that money and other liquid assets had to be nonproducible18 and non-substitutable for producible goods. As long as the possession of liquidity provides agents with utility, then the mere existence of non-producible liquid assets for which (for liquidity purposes) producible goods are not good substitutes is a necessary and sufficient condition for involuntary unemployment equilibrium to develop whenever private sector demands for additional liquidity out of their full employment income exceed planned investment [D2] spending. Or, in the words of Hahn [1977, p. 31] involuntary unemployment equilibrium requires demand conditions such that people can find "resting places for savings other than reproducible assets".

In Keynes's general theory the demand for liquidity and the existence of a nonproducible supply of money for which producible durables are never a good liquidity substitute assures a nonneutral monetary system, even if prices are completely flexible. "Unemployment develops, that is to say, because people want the moon; - men cannot be employed when the object of desire (i.e., money) is something which cannot be produced and the demand for which cannot be readily choked off" [Keynes, 1936, p. 235] -- and not because imperfect competition creates a nonflexible price environment.

Assume that the gross substitution between nonproducible liquid assets (including money) and producible goods for liquidity purposes is approximately zero19 [Keynes, 1936, Chapter 17; Davidson, 1983-4]. If the demand for liquidity increases, then the induced rise in the relative price of liquid assets can neither induce employers to hire workers to produce more liquid assets including money nor induce demanders of liquidity to accept the relatively cheaper producible (nonliquid) goods instead. In other words, the existence of nonproducible and nonsubstitutable liquid assets (including money) for which producible goods are not a good liquidity substitute can affect employment -- in both the short- and long-run. These essential properties of liquid assets are independent of the degree of competition, price flexibility and coordination failures .

Thus, a general theory of a monetary economy which emphasizes liquidity needs in an uncertain world and therefore rejects the axiom of nonneutral money implies that

D1 = f1(N) fz(N)	(9)

whenever that portion of income that people earn that is not spent on producible goods, i.e., that is saved, is used instead to demand nonproducible money and other liquid assets as a store of value.	By proclaiming a "fundamental psychological law" associated with the detailed facts of experience "where the marginal propensity to consume was always less than unity", Keynes [1936, p. 96] finessed the possibility that equation (8) was applicable to the "facts of experience". If the marginal propensity to consume is always less than unity, then f1(N) can never coincide with fz(N). Even if D2 = 0, equation (9) holds and Say's Law is not applicable to "the economic society in which we actually live."

VIII. CONCLUSION

If economists would only take up the challenge of Keynes's revolutionary general theory and investigate the properties of a system of microeconomic demand and supply functions that throw out the axioms of ergodicity, ubiquitous gross substitutability, and nonneutral money, then a truly New Keynesianism -- dare I call it Post Keynesian economics -- could be developed which could again permit economists to provide useful and realistic guides to both micro and macroeconomic policies20. This would be a New Keynesianism that Keynes could readily endorse.

Unfortunately, the moral of the history of the development of New Keynesianism vs. New Classicism when compared to the dichotomy of views in the Economics Establishment between old classical economists such as Ricardo and other "weaker spirits" before 1936 can be summed up in a quote from Dennis Robertson who wrote [1956, p. 81]: "Now as I have often pointed out to my students, some of whom have been brought up in sporting circles, high brow opinion is like the hunted hare; if you stand in the same place, or nearly the same place, it can be relied upon to come around to you in a circle." No wonder mainstream economists provide policy advice which does not differ significantly from that offered by classical economists and their weaker spirit brethren more than 60 years ago. No wonder that more than a half century after Keynes published his General Theory, the world's major economies are enmeshed in ubiquitous unemployment conditions. Given the research agenda of mainstream economics, no wonder economics has again become the dismal science.

FOOTNOTES