Oscar Lange and John Maynard Keynes

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In their History of Economic Thought (2011), E.K. Hunt and Mark Lautzenheiser nicely capture a curious contribution to the eventual, and damaging, mainstream rejection of Keynesian macroeconomics. One of the inspirations for the anti-Keynesian New Classical insurgency was a professed socialist economist, Oscar Lange. Almost immediately upon publication of The General Theory, he began a major effort to reconcile it with mainstream general-market-equilibrium analysis. To Lange, “Keynes had sought to explain an economic equilibrium in which a significant amount of involuntary unemployment existed, that is, a general equilibrium in which one very large and economically significant market, the labor market, was in disequilibrium.” Hunt and Lautzenheiser continue: “In 1940, Lange published his Price Flexibility and Employment in which he attempted to recast Keynes’s arguments in the context of Walrasian general equilibrium. Basically, Lange argued, Keynes had identified special situations that involved involuntary unemployment – and hence were disequilibria in a Walrasian system – in which market forces would not tend to establish equilibrium and the disequilibrium would persist.” (p.494)

From the perspective of their general-market-equilibrium model class, anti-Keynesian insurgents cited Lange’s special-case status for The General Theory and its focus on involuntary job loss as grounds for its dismissal. If Keynesian labor-market disequilibrium is a special case, occurring outside the consensus micro-coherent, market-centric general-equilibrium model class, it can be ignored. From Hunt and Lautzenheiser: “Macroeconomics increasingly became the study of the general conditions in which a market would more or less automatically attain the general Walrasian [market] equilibrium and the special conditions under which problems might arise…. Although some college texts continue to devote a chapter or two to traditional Keynesian economics, by 1990 it no longer occupied the privileged place as one of the two pillars of orthodoxy. Neoclassical theory once again dominated orthodoxy.” (p.494)

There is alternative, more insightful way to look at Lange’s work on Keynes. We know that Lange understood that the General Theory’s focus was the causes and consequences of involuntary job loss (IJL). He also recognized that proper analysis must involve the failure market forces to prevent IJL. In their Oedipal rush to obliterate anything Keynesian, neoclassical insurgents simply assumed that market failure resulted from non-fundamental, therefore dismissible, special factors.

The GEM Project provides a more careful narrative. It fills out Lange’s intuition by organizing baseline macroeconomics around two-venue general decision-rule equilibrium that accommodates IJL and crucial nominal-to-real causation. More specifically, the Project recognizes that the existence of IJL requires suppression of labor-price recontracting that in turn requires meaningful wage rigidity. MWR uniquely motivates rational causation from nominal demand disturbances to IJL and recognizably-sized movement in employment, output, and income. The Project has finally microfound that crucial process by intuitively generalizing optimizing exchange from the marketplace to the large, highly specialized workplace.

Recall from above that Keynes “sought to explain an economic equilibrium in which a significant amount of involuntary unemployment existed, that is, a general equilibrium in which one very large and economically significant market, the labor market, was in disequilibrium.” Given the generalization of exchange, what seemed like a conundrum – an economic equilibrium in which the labor market is in disequilibrium – loses its shock value. In highly specialized economies, general decision-rule equilibrium (with microfounded MWR) easily accommodates – indeed, mandates – the labor market being in chronic disequilibrium. Involuntary job loss is delivered from its neoclassical status as a “special situation”. It happily returns to the front rank of economic phenomena that policy-relevant theorists must closely study.

Hunt and Lautzenheiser wrap up their brief treatment of Lange’s role in the mainstream rejection of Keynesian macroeconomics with an assessment. “The latest financial crisis and subsequent prolonged recession hitting much of the global economy has led to a mild reemergence of Keynesian economics. On the other hand, soon after the latest crisis, many from the economics profession began a spirited defense of the orthodoxy. It will take time to determine the impact of this latest crisis on neoclassical economics.” (p.494) Why is more time needed? Don’t insightful economists know that the days of the New Neoclassical Synthesis posing as stabilization-relevant are numbered? Don’t they know that it will take a new theory, one capable of microfounding both the suppression of wage recontracting and the causation from nominal demand disturbances (typically propagating a macro shock) to IJL and recognizably-sized movement in employment, output, and income, to adequately explain critical instability evidence and inform effective policymaking.

It comes down to this. Time is needed to see whether mainstream gatekeepers will live up to their larger responsibilities. Will they ever set aside personal considerations of market-centric human and reputational capital and move on to generalizing rational exchange? When will they accept that only then will they be able to construct macroeconomics that is simultaneously micro-coherent and stabilization-relevant?

Blog Type: New Keynesians Saint Joseph, Michigan

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