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Failure of New Economics

Failure of New Economics

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Published by: markbd on Dec 26, 2009
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Section VI of Chapter 17 contains a short discussion of
Knut Wicksell's concept of a "natural" rate of interest.
Keynes discusses it only to dismiss it. Here again his dismis-
sal is not based on anything that can properly be called an
analysis, but simply on his personal "opinion":

I am now no longer of the opinion that the concept of a
'natural' rate of interest, which previously seemed to me a
most promising idea, has anything very useful or significant
to contribute to our analysis. It is merely the rate of interest
which will preserve the status quo; and, in general, we have
no predominant interest in the status quo as such (p. 243).

It is hard to call this anything else than a deliberate mis-
representation. The implication of Keynes's statement is
that what the "natural" rate of interest would preserve is
the existing distribution of wealth or income, or the existing



level of production or employment. But the only thing that
the "natural" rate of interest would preserve, on Wicksell's
definition, is the established pre-existing average of prices.
What Wicksell meant by the "natural" rate of interest, in
other words, was the rate of interest that would be neither
inflationary nor deflationary.
He saw that if the rate of in-
terest were pushed above this level, it would unduly dis-
courage borrowing, cause a contraction in the volume of
money and credit, and hence a fall in prices, activity, and
employment. But if the rate of interest fell or were held
down below the "natural" level, it would lead to overstimu-
lation of borrowing, and hence to an inflationary expansion
in the volume of money and credit.
Though it was defective in some respects (as pointed out
by Ludwig von Mises and others who improved upon it),
Wicksell's discussion of the interest rate, and of its relations
to changes in the volume of money and credit, marked a
great forward step in economic analysis. While Wicksell
correctly saw (unlike Keynes) that the rate of interest is
primarily determined by "real" factors, he took full account
of the disturbances caused (and he even to some extent exag-
gerated the disturbances caused) by changes in the volume
of money and credit.
Thus Wicksell took full account of the one germ of truth
in Keynes's otherwise naive and false theory of interest—the
truth that changes in the volume of money and credit have
something to do with changes in the interest rate. But
Wicksell saw clearly that in the absence of changes in the
quantity of money and credit the interest rate would be
determined by "real" factors, and that changes in the quan-
tity of money act only as disturbing factors which only
transitionally and temporarily affect the interest rate.
That Keynes's purely monetary theory of interest is quite
naive and completely fallacious we have already seen in
Chapters XIV and XV. But we may notice again here that,
though Keynes's few references to Wicksell's contribution
to the theory of interest are all disparaging (telling us


merely that he rejects it), they reveal that he was acquainted
Wicksell's contribution. Yet in his chapter on "The
Classical Theory of Interest" Wicksell's name appears only
once, and then merely in a three-line footnote (p. 183). The
reader unacquainted with the literature of the subject
would get no hint that Wicksell had fully anticipated the
only valid point in Keynes's discussion of the "classical" the-
ory of interest, viz., that some account must be taken of the
relation of interest rates to changes in the money supply.
Even his disciple, Alvin H. Hansen, calls Keynes to task for
this injustice:

With respect to another subsidiary point Keynes is clearly
wrong. He calls attention to the failure of the classical school
to bridge the gap between the theory of the rate of interest in
Book I dealing with the theory of value and that in Book II
dealing with the theory of money. This is formally correct,
at least with respect to many writers, but then he adds the
opinion that also the neoclassical school had made a muddle
of its attempt to build a bridge between the two. Now this
certainly could not be said of Wicksell. This paragraph (p.
183) is far from convincing.7

It is hard to escape the conclusion that Keynes, in order to
try to prove his own originality and the wrongness of every-
body before him, failed to give a clear account of Wicksell's
contribution and sought to salve his conscience by a dis-
paraging reference to it.

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