Keynes: A non-sequetor of Wicksell
Hayek accuses Keynes of being ignorant of the contributions of Böhm-Bawerk in the treatment of capital, presuming that Keynes could not read German and was thus unaware of the German literature. Keynes, however, acknowledged Spiethoff, Knapp, and mainly Wicksell, whose writings at the time were mostly available in German.[1] There is in fact striking similarity between some of the thoughts expressed by Keynes in his Treatise and those in Wicksell’s Interest and Prices (1936) and Lectures on Political Economy (1956). On the surface, it might even appear that Keynes so intensively appropriated ideas from Wicksell that some of the so-called novelty of Keynes is already to be found in Wicksell’s work (see Appendix as well).[2]
The major, common emphasis in both Keynes and Wicksell is to have brought the interest rate to the forefront in the analysis of prices and to have deemphasized, even trivialized, the Quantity Theory of Money. As already explained in Chapter 2, both belong to the tradition of the Credit School as opposed to the majority of economists who were steeped in the Currency School. Both used the concepts of a ‘natural’, ‘normal’, ‘money’, or ‘bank’, ‘market’, and ‘real’ rate of interest. Both incorporated ‘normal’ prices and ‘market’ prices into their economic picture.
As in Wicksell, for Keynes the root cause of economic fluctuations is to be found in the existence of discrepancies between the real and money rates of interest, and as Wicksell put it:
… for so long as an entrepreneur obtains a larger return on the capital employed in his production than he need pay in interest for borrowed capital – or can himself obtain by lending his own – he will of course, be inclined to increase his employment of capital. Conversely, if the interest on borrowed capital is higher than the return on capital employed in production, or on the last portion employed, then he will, as far as possible, curtail his employment of capital to the most necessary purposes or to the more profitable branches of his production. (1934, I, p. 148)[3]
Furthermore, in Wicksell’s “Note on the Trade Cycle and Crises” in Volume II of his Lectures,[4] the similarities between his ideas and those of Keynes’s later Treatise, explaining price movements in prosperity and in depression in relation to the interest rate, go beyond striking:
Since the demand for new capital in an upward swing of the trade cycle is frequently much too great to be satisfied by contemporary saving even if it is stimulated by a higher rate of interest, and since on the other hand in bad times this demand is practically nil, though saving does not nevertheless entirely cease, the rise in the rate of interest and commodity prices in good times and their fall in bad times would presumably be much more severe than now if it were not that the replenishment and depletion of stocks in all branches of production producing durable goods acted as regulator or parachute. (1935, II, pp. 212-213)
New capital and the resorting to stocks of durable goods as regulator are important themes in Keynes’s theory as well. Wicksell’s notion of a direct correlation between “additional” profits and losses, rises and falls in the prices of the factors of production, stocks of commodities, money incomes, and “the normal, natural rate” of interest is also to be found in Keynes’s Treatise.[5] At times Keynes’s text is, with some degree of acknowledgement, almost verbatim Wicksell. Witness Wicksell: “The loan rate, which is a direct expression of the real rate, we call the normal rate. (1935, II, p. 192) and
The rate of interest at which the demand for loan capital and the supply of savings exactly agree, and which more or less corresponds to the expected yield on the newly created capital, will then be the normal or the natural real rate. (1935, II, p. 193)
and Keynes: “Following Wicksell … the natural-rate of interest is the rate at which saving and the value of investment are exactly balanced” (1930, pp. 154-155)[6].
The two works can be contrasted in much more detail to find out further common ingredients to their respective theories. Having noted the similarities, there is, however, a fundamental difference in their semantics, in their methodological approach, and in the building of their theoretical dynamics:
- the Fundamental Equations are unique to Keynes. Wicksell did have a coherent, general theoretical description as to how interest impacts prices, but nowhere in Wicksell can one find a definite expression, similar to Keynes’s or otherwise, relating price level to the interest rate, even though it is the core relation of Wicksell’s entire theory.
- the important concept of the capital on which trade cycles are built includes in Wicksell, descriptively, “all auxiliaries to production … the houses and buildings … the implements, tools and machinery … livestock … raw materials … the provisions and other commodities which must be saved up [to support labour] …” (1934, I, pp. 144-145). These ‘auxiliaries’ resemble some of Keynes’s categories of capital. Wicksell, however, theoretically, abstracted altogether from them and reduced capital to a single entity:
…all these requisites have only one quality in common, namely that they represent certain quantities of exchange value, so that collectively they may be regarded as a single sum of value. (1934, I, p. 145)
He then steeped himself in the marginalist capital theory of Böhm-Bawerk. Wicksell remained a strong proponent of the Austrian marginal productivity theory. For him,
Capital is saved-up labour and saved–up land. Interest is the difference between the marginal productivity of saved-up labour and land and current labour and land. (1934, I, p. 154).
Upon close reading of Wicksell and Keynes, the meaning, incorporation, and causal links around the idea of capital are decidedly different. First, Keynes’s different categories of capital, Fixed, Working, and Liquid, which each play a different role in the dynamics of the various phases of the cycle, are not to be found in Wicksell. Second, Wicksell’s collapse of all capital into a single unit expressed in terms of saved-up labour and land runs into all the problems of the heterogeneity of physical capital and the controversies related to it.[7] While Wicksell himself raised some of the difficulties, Keynes avoided them altogether. Third and most importantly, while for Wicksell, the real rate of interest is expressed by its marginal productivity, an ex-post concept, for Keynes, it is determined by the expectations and anticipation of future returns on investment, ex-ante notions. Conceptually and methodologically thus, the two theories of capital and interest are on different plains.
- While the main cause of fluctuations in Wicksell is due to the introduction of new technology, — monetary effects being secondary –, which triggers discrepancy between two rates of interest, the money and the real rate, in Keynes, though he admits that technological change might cause discrepancy, the main cause of fluctuation is the state of bullishness and bearishness of the market based on the entrepreneurs’ expectations of future earnings or losses. For Wicksell,
The principle and sufficient cause of cyclical fluctuations should rather be sought in the fact that in its very nature technical or commercial advance cannot maintain the same even progress as does, in our days, the increase in needs—especially owing to the organic phenomenon of increase in population – but is sometimes precipitate, sometimes delayed (1935, II, p. 211)
Wicksell’s perspective is long-term, an application of neoclassical production theory, in which capital and labour are factors of production, and the cost of production is made up of Fixed and Circulating (or Liquid) capital, respectively. For Wicksell, since “new discoveries, inventions, and other improvements nearly always require various kinds of preparatory work for their realization, there occurs the conversion of large masses of liquid into fixed capital which is an inevitable preliminary to every boom…” (1935, II, p. 212). Keynes’s approach is short-term; it is the behaviour of working capital that makes his theory original. Fixed and Liquid Capital, defined entirely differently from Wicksell and the Classics, as explained above, do come into play.
In sum, given points i), ii), and iii), it is clear that Keynes and Wicksell present two entirely different theoretical approaches to describing the economy, even though Wicksell’s ideas predate those of Keynes, and Keynes was aware of them. Further, as will be seen in Chapter 6, Section III, in terms of the policy implications of their thought, they also presented two different perspectives. For now, with Keynes’s definitions and semantics explained and clarified, the criticism that the Treatise generated can be addressed.
[1] Given the depth of Keynes’s understanding of Wicksell, is it likely that he would have acquired his knowledge of him through secondary literature?
[2]By proponents of the Swedish school, the same is said about Keynes’s relationship to their ideas.
[3] “And similarly, in certain cases a great rise in prices, may, in fact be maintained by private credit alone, i.e., by substitution of credit on goods for money transactions. … A person who procures goods or services on credit might for one reason or another offer a higher rate of interest without a loss, if the chances of profit have increased. If, however, the seller only demands the usual interest, or, in the case of a short loan, no interest at all, then the buyer might instead offer a higher price for purchased goods.” (1935, II, p. 193)
[4] Wicksell himself credits some of these ideas to Spiethof and finds similarities between his own observations and those of Juglar. (p. 209)
[5] Entrepreneurs who see their expected additional profits vanishing owing to the rise in price of raw materials and labor will wholly or partly realise these profits thanks to the rise—which has already taken place–in the prices of the goods they produce, whereas workmen and landlords whose incomes are apparently increased only to a small extent will derive no benefit because the stock of the commodities in demand are limited. The gains they actually reap correspond in this case principally to the positive losses suffered by the other consumers, borrowers, pensioners and others, whose money income has not been increased at all in the process. On the basis of these new prices the future is judged. Entrepreneurs who until now have been able to offer workmen, owners of raw materials, etc., higher prices simply because they are themselves able to borrow money at cheap rates without expecting more than normal prices for their products, will now, even if bank rates revert to the normal natural rate, on an average be able to offer the same high price, because they have reason to expect the same increased price for their own products (or rents or freights) in the future. If, therefore the banks maintain the lower rate of interest, it will act as a tempting extra profit to entrepreneurs and by competition between them they will force up still further the price of labour and materials and indirectly of Consumption-goods, and so on. (1935, II, 196)
[6] Following Wicksell, it will be convenient to call the rate of interest which would cause the second term of our second Fundamental Equation to be zero the natural-rate of interest, and the rate which actually prevails the market-rate of interest. Thus the natural-rate of interest is the rate at which saving and the value of investment are exactly balanced, so that the price-level of output as a whole (II) exactly corresponds to the money-rate of the efficiency-earnings of the Factors of Production. Every departure of the market-rate from the natural-rate tends, on the other hand, to set up a disturbance of the price-level by causing the second term of the second Fundamental Equation to depart from zero.
We have, therefore, something with which the ordinary Quantity Equation does not furnish us, namely, a simple and direct explanation why a rise in the Bank-rate tends, in so far as it modifies the effective rates of interest, to depress price-levels. (1930, pp. 154-155)
[7] The literature on the capital controversy from Wicksell to Knight to the dispute between the two Cambridges however enormous is well documented and should not concern us here.