Is the Keynes’s Theory Static? | Keynes’s General Theory

Get the answer of: Is the Keynes’s Theory Static?

Subject-Matter:

A common criticism of the ‘General Theory’ is that it is not dynamic.

The issue may be regarded here as one of form versus substance.

It may be remarked at the outset that Keynes’ formal method of analysis was in many respects static the theoretical problems with which he was concerned were problems of the ‘short-run’. His model was static, but his theoretical structure was dynamic.

Keynes’ model is static as he assumed certain elements as given. He says, “We take as given the existing skill and quantity of available labour, the existing quantity of available equipment, the existing techniques, the degree of competition, the tastes and habits of the consumers; this does not mean that we assume these factors to be constant, but merely, that in this place and context, we are not considering or taking into account the effects and consequences of changes in them.”

Prof. Schumpeter in an earlier paper (in 1936) was highly critical of Keynes because he assumed a unique relation between employment and output. Keynes, in fact, assumed an invariant production function and as such ruled out all changes involved in the capitalist process. Even the use of expectations was not recognised as dynamic by Schumpeter. He lamented Keynes reluctance to use the process or period analysis.

However, later on by 1946, Schumpeter changed his position and was ready to accept some dynamic elements in Keynes especially in the discussion of expectations. Harrod was also critical of Keynes failure to present a truly dynamic study. Despite use of expectations, Keynes’ theory was still static, not dynamic. Reference to anticipations was not, in Harrod’s view, enough to make a theory dynamic.

“The distinguishing feature of the dynamic theory will not be that it lakes anticipations into account, for these may affect the static equilibrium also, but that it will embody new terms in the fundamental equations, rate of growth, acceleration, deceleration etc.” Before arriving at our evaluation of Keynes theory, we must know clearly statics and dynamics.

Economic Statics:

Economic statics is essentially a state of equilibrium in which we take certain fundamental conditions to be given and known. Suppose we consider a given point of time ‘t’ then, at this point the magnitudes of all the variables X_t, Y_h Z_t will be given through the evolution of the systems.

Thus, by a static theory, we mean a theory where all variables (magnitudes to be explained) relating to a certain point or period of time are explained by data relating to the same point or period of time. If the system is allowed to evolve, it will go on indefinitely on the same path without a tendency to diverge. Such a situation is then a situation of static equilibrium.

The variables most likely to remain constant in a static analysis are many, for example, tastes, preferences of individuals, the size and ability to work of the labour force, quantum of capital or land, state of technology etc. These variables, taken together, determine the values of certain unknowns’ for instance, the size of national income or the mode of output in an economy.

As these variables do not change in a static state, the unknowns also remain fixed or known and the economic system also remains in equilibrium for there are no signs of growth. This, however, does not mean that no changes take place; certain changes do take place, for example, new persons are born and old ones die, prices change etc. But if we consider the economy as a whole, the results of all these changes are cancelled out and the system can be taken to be in a state of rest.

Comparative Statics:

So far the description of static state has been given in terms of older analysis. A line of departure from the older analysis of static state was suggested by Prof. R.F. Harrod in the case of a once = over change. Let us assume that an economic system is in static equilibrium and a change occurs in any one of the variables.

Now if the adjustment to the new situation is instantaneous and without time-lag, the economy is again restored to equilibrium and the phenomenon can be explained statically. Take, for instance the case when there is no consumption expenditure lags.

If with an increase in income, consumers at once adjust their expenditures to the changed income, then there would be no consumption-expenditures lag. The system would, therefore, again be in equilibrium.

All these cases of ‘once­over change’ must be included in economic statics. However, in so far as we consider these cases to be in different equilibrium situations we may call them ‘comparative static’. It can therefore, be defined as the body of comparison of two or more successive equilibrium situations.

It enables us to ascertain tire direction and magnitude of changes in the variables when changes in the data have caused a movement from one equilibrium situation to another.

Static analysis, whether simple or comparative static, concentrates only on equilibrium positions. It neither concerns itself with the path it takes for an equilibrium position to be achieved nor with the time by which variables approach their equilibrium state. This is the concern of dynamic analysis.

The ‘General Theory’:

The ‘General Theory’ is however, “cast mainly in terms of equilibrium analysis.” Keynes method, in much of the book, can indeed be described as comparative statics. That is the change from one equilibrium position to another. In such an analysis we investigate “the response of a system to changes in given parameters.” Thus, remarks Prof. Hansen “While Keynes method is formally that of comparative statics, it is nonetheless a highly useful method of studying an economy undergoing change.”

Since statics assumes certain things to remain fixed while dynamics tries to know all such changes, “The equations of comparative statics are then a special case of the general dynamic analysis.” The exact skeleton of Keynes system belongs-to use the term proposed by Ranger Frisch, to “macro-statics, not to macro-dynamics.” However, in Keynes hands, comparative statics becomes a useful tool for analysing and solving practical problems in a manner which is essentially dynamic.

Prof. J.R. Hicks in his paper on General Theory singles out the role of expectations as a feature for special mention. “The use of the method of expectations,” said Hicks, “is perhaps the most revolutionary thing about this book,” Keynes felt that the current economic theory was frequently unrealistic because it assumed too often a “state where there is no changing future to influence the present.” He accordingly took care to introduce the influence of changing expectations about the future on decisions in the present.

Expectations became the basis of two of his strategic relationships-the Investment-Demand function and the Liquidity Preference function. On this count, therefore, Hicks would regard the General Theory dynamic. But he observed “General Theory is neither the beginning nor the end of all dynamic economics.”

Economic Dynamics:

The ground for explaining pure economic dynamics is clear. By dynamic theory we mean, “a theory that explains how one situation grows out of the foregoing. We consider under it not only a set of magnitudes in a given point of time and study the inter-relations between them, but we consider the magnitudes of certain variables in different points of time.” A theory is dynamic if there are lags in the causal nexus.

The acceleration principle is a dynamic relationship because investment is explained by a change in demand for the product which the investment-good was due to produce. Dynamics is concerned not with the absolute amount of change but with the rates of change. Harrod defined dynamics as the study of an “economy in which the rates of output arc changing.”

Dynamic economic analysis can be classified into:

(i) ‘period analysis’

(ii) ‘rates- of-change analysis’.

In period analysis, we split time into periods and study the events of each period in relation to the previous period. This is a study of discrete process so that instead of talking of a rate of flow at a point of time we consider rates of flows at each and every moment of time-the economic process is treated in this case as continuing through time. From period analysis point of view, dynamics deals with time lags, lagged adjustments in a process of change.

This type of theory is dynamic because some variables are thought to depend on the lagged values of other variables. The method uses different equations as its tool of analysis. From Harrod’s point of view, however, dynamics deals with rates of change (differential equations) and the theory is dynamic in the respect that the rates of certain variables arc thought to depend upon the rates of change of other variables. In the latter case, there are no time lags.

In certain sections of the General Theory, the analysis is cast in terms of time-rates-of-change in a moving equilibrium. This represents perfect foresight and continuous adjustments to change so that the actual magnitudes of the different variables always correspond to the desired magnitudes. This is a time-rate- to-change analysis. Keynes here dealt with continuous functions and the system is in a state of moving equilibrium.

At this distant date, it is clear that the method of analysis employed by Keynes was comparative statics with a few dynamic glosses here and there. He was essentially a disequilibrium theorist. For this, he could use only a primitive type of dynamics because modern methods of dynamic analysis were not known then.