Patinkin as a reader of Keynes’ General Theory: Are wage cuts a good remedy to unemployment?¹

1 A preliminary version of the paper was presented at the Patinkin conference (Lausanne, 21-22 september 2001). Since then, I benefited from critiques and comments by Ingo Barens, Pascal Bridel, Michel de Vroey, Goulven Rubin and Hans-Michael Trautwein. Usual disclaimers apply.

Abstract

This paper analyses Patinkin's appraisal of Keynes’ concept of involuntary unemployment while focusing on his reading of the General Theory Chapter 19. On several critical issues, Patinkin departs from Keynes’ original matters of concerns. He leans against an individual criterion for unemployment and implicitly endorses Wicksell's understanding of voluntary unemployment as chosen leisure. His appraisal of involuntary unemployment as a disequilibrium phenomenon ultimately relies on nominal rigidities and assumes the existence of a competitive adjustment process. On all these three critical points, Patinkin departs from Keynes but also initiates the contemporary New Keynesian programme that went even further from Keynes.

Keywords:

• Adjustment process
• expectations
• involuntary unemployment
• nominal rigidities

1. Introduction

Patinkin was one of the few economists who tried to pay the same attention to his work as a theoretician with his Money, Interest and Prices (1965) – henceforth MIP - as well as his work as an historian of the economic thought with his Keynes’ Monetary Thought (1976) – henceforth KMT. In Patinkin's case the influence between theory and exegesis of “old” economists - as Keynes was probably already considered in the 60s - seems to have roughly operated both ways, and this all along his career (Backhouse 2002). Already Patinkin's PhD thesis was strongly influenced by his reading of Keynes’ General Theory (Rubin 2012). At the same time, his exegetical work on Keynes (which appeared several years after his major theoretical contributions) was substantially affected by his own theoretical concerns, with the result that some elements in Keynes’ theoretical apparatus proved more investigated than others. In particular, Patinkin was one of the neoclassical Keynesians who insisted the most on the inefficiency of a flexible wage policy as a remedy to unemployment.

For Patinkin, the rejection of wage deflation was the cornerstone of Keynes’ writings, and the General Theory Chapter 19 dedicated to the study of money wages changes its “apex” (KMT, p. 106). Chapters 13 and 14 of MIP aimed to explain the existence of involuntary unemployment without assuming rigidity in prices or in wages. Hence a conception of involuntary unemployment as a disequilibrium phenomenon, for in Patinkin's eyes Keynes’ contribution would be loose if involuntary unemployment ultimately originated in wage rigidity. Yet, Patinkin readily admitted that nominal rigidities worsen involuntary unemployment in that they lengthen the competitive adjustment process. He also integrated the real balance effect, an argument usually considered as “anti-Keynesian”, in his account of the adjustment process but he claimed that this was only for matter of internal consistency with no damage for the essential of Keynes’ message.

The primary objective of this paper is to review Patinkin's understanding of involuntary unemployment while focusing on the adjustment process issue. That will allow us to analyse the competitive mechanisms that bring (or not) a decentralised market-economy back to its full employment position after an external shock. This focus on the adjustment process will also help us to set out and clarify the role played by rigidities (considered either in nominal or in real terms) in the explanation for unemployment.

We will deal accordingly with three different kinds of materials. First, we will of course consider Keynes’ General Theory, with a particular attention devoted to its Chapter 19, as our primary material. We will consider Patinkin's MIP, and in particular Chapters 13 and 14 of this book. As well, we will investigate KMT, which can be seen as Patinkin's attempt to sustain his analysis of involuntary unemployment by a serious and deep exegetical work on Keynes’ General Theory. In a way, MIP corresponds to Patinkin's Keynesian economics while KMT corresponds to Patinkin's economics of Keynes. There is clearly a large overlap in the attempts of MIP and KMT, but the goals as well as the constraints of these two books are not the same. With hindsight, Patinkin's goal in MIP appears rather heroic. It was about nothing less than the modelling of Keynes’ arguments, which remained almost completely verbal, in the standard Walrasian framework of his time. It was also about the provision of a general theoretical apparatus that would allow at the same time for an account of the “classical” position as well as the Keynesian one. To put it in a nutshell, Patinkin's endeavour could be seen as the search for the most convincing way of translating Keynes’ ideas, the most economical and simplest way of stating the generality of the General Theory. Undoubtedly, such a Herculean task could not be undertaken without the loss of some degrees of freedom. In this respect, the most crucial difficulty undoubtedly refers to the concepts of equilibrium and disequilibrium as understood respectively in a Marshallian or a Walrasian framework (Leijonhufvud 1998, De Vroey 2002). It is now well known that in Marshall equilibrium corresponds to a state of rest, a state of the economic system with no changing forces at work (which means that equilibrium à la Marshall is compatible with non-market clearing without a problem) whereas in Walras equilibrium precisely means market clearing (otherwise there would have some equilibrating forces at work). Keynes the Marshallian had no problems whatsoever with the idea of equilibrium without market-clearing while for Patinkin and his Walrasian contemporaries non market-clearing was merely synonymous with disequilibrium. Here is to be found a crucial departure from Keynes’ initial methodology, with highly significant consequences for the understanding of his theory of unemployment.

The objective of the present study is to concentrate on the conceptual issue and to assess the extent to which Patinkin properly grasped the issue of involuntary unemployment as Keynes aimed to investigate this scourge in his General Theory. Our basic claim is that Patinkin operated several significant deviations from Keynes’ original theoretical bulk in his appraisal of involuntary unemployment. For us, this is not only a case of pure constraints due to his modelling attempt. At the conceptual level too, Patinkin missed some of Keynes’ basic claims. The first problem with Patinkin's interpretation of Keynes (in MIP as well as KMT) refers to his individual criterion in his disentanglement attempt between voluntary and involuntary unemployment while, as we will see below, a proper understanding of Keynes’ distinction requires escaping the micro-economic level. A second deviation applies to the role played by nominal rigidities. Ironically, nominal rigidities cannot but unfortunately worsen unemployment in Patinkin whereas in Keynes stability in money wages turns to be a desirable condition for the stability of the economic system. With no surprise, a last critical deviation worth mentioning ensues from Patinkin's understanding of equilibrium, and the ensuing approach to dynamics. The analysis carried out in the General Theory Chapter 19 is undoubtedly dynamic and Patinkin well perceived this critical point. But his understanding of dynamics amounts to the issue of the length of the adjustment process from a disequilibrium state of unemployment (understood as non-market clearing) towards the full employment equilibrium: this competitive adjustment process might be too long to be socially acceptable. But Keynes’ concern in this Chapter 19 is slightly different. Let us start from an unemployment equilibrium, non-market-clearing being present without any adjusting force at work in the system. What would be the result of a flexible wage policy? In case of an aggressive deflationary policy, would the economic system move closer to the full employment equilibrium? At the opposite of Patinkin, Keynes’ claim was that, in general, the answer is very likely to be negative.

All along this study we will focus on Patinkin's mature works, which means that we will roughly ignore the genesis of his disequilibrium interpretation of involuntary unemployment.² Just like Patinkin, we will deal first with definition and terminology. We will then turn the attention to the labour market functioning. Third, we will study the competitive adjustment process at work on the goods market that in Patinkin's eyes renders unemployment only temporary. The conclusion of the paper will restate the topicality of the General Theory Chapter 19 for contemporary macroeconomics.

2. Terminology and conceptual issues in MIP: involuntary unemployment and full employment

Patinkin opens his account for involuntary unemployment in MIP Chapter 13 with conceptual discussions about voluntariness and involuntariness, for “our first task in defining ‘involuntary unemployment’ is to define that behaviour which is to be taken as the norm of voluntariness” (MIP, p. 314). That is, the conceptual problem regarding involuntary unemployment is its “relativity” (MIP, p. 313). In a free society, one can hardly conceive that individuals are not doing precisely what they want to. Patinkin easily admits that defining voluntariness properly is simply impossible. What is sure is that the problem is set from the outset in terms of individual volition. Except in case of coercion, which is of little interest in a market society, voluntary behaviour must refer to an ideal norm where individuals are in capacity to maximise their utility.³

If restricted to the space of economic behaviour, voluntariness simply means that individuals face no quantitative constraints, i.e. no rationing. This norm of voluntariness corresponds to “the economic behaviour of an individual worker maximising utility in the ‘normal’ environment of a free, peacetime, democratic society, subject to the restraints imposed by the given market prices and his budget” (MIP, p. 314). Consequently, “as long as an economic unit is ‘on’ such a curve [of supply or demand], it will be said to be acting voluntarily” (MIP, p. 314). Involuntary unemployment is then defined as the complementary case to voluntary behaviour as defined above, i.e. the complementary case to full employment. Any individual worker off his individual supply curve should be considered involuntarily unemployed. As the opposite to full employment, “by definition, the extent of involuntary unemployment is identical with the extent of the excess supply of labour which exists at the prevailing real wage rate” (MIP, p. 315). Without pre-empting the discussion about the causes of this excess labour supply, it should be emphasised that Patinkin adopted here an individual criterion for unemployment. With involuntary unemployment conflated with excess labour supply, Patinkin implicitly shares Wicksell's idea about voluntary unemployment, which he defines as a situation where workers choose not to work and favour accordingly leisure (Boianovsky and Trautwein 2003).

The distinction established by Wicksell between voluntary and involuntary unemployment as an opposition between chosen and forced leisure is precisely the distinction endorsed by Patinkin. Now, even if this typology has become a commonly accepted idea in contemporary economics, it must be recognised that it does not account for the opposition established by Keynes. In this respect, it is striking that Patinkin remains completely silent, even in KMT, about Keynes’ concept of voluntary unemployment. The reader should recall here the definition of voluntary unemployment provided in the General Theory Chapter 2:

In addition to “frictional” unemployment, the [second] postulate is also compatible with “voluntary” unemployment due to the refusal or inability of a unit of labour, as a result of legislation or social practices or of combination for collective bargaining or of slow response to change or of mere human obstinacy, to accept a reward corresponding to the value of the product attributable to its marginal productivity. (Keynes [1936] 1973a, p. 6)

The quotation above makes clear that voluntary unemployment for Keynes corresponds in no way to chosen leisure, as it is now commonly considered in the Wicksellian tradition. According to Keynes’ definition, an individual worker may be off his individual supply curve because of the trade-unions behaviour, because of the existence of a minimum wage, or even because of the employer behaviour (who would for example adhere to the efficiency wage principle. This would nevertheless correspond to voluntary unemployment in Keynes’ meaning of that term. Whatever kind of market imperfections, which result accordingly in wage rigidity (noticeably either in real or in nominal terms), corresponds in Keynes to voluntary unemployment. Besides, Keynes makes it clear that the individual behaviour is not questioned at all in this issue: “The classical conclusions are intended, it must be remembered, to apply to the whole body of labour and do not mean merely that a single individual can get employment by accepting a cut in money-wages which his fellows refuse” (Keynes [1936] 1973a, p. 11; emphasis added). The analysis clearly abstracts from the individual level, which means that Keynes “directs our attention away from the individual unemployed worker towards the work force and the economy as a whole” (Hoover 1995, p. 679).

In Keynes as in Patinkin, full employment “corresponds to the absence of “involuntary” unemployment” (Keynes [1936] 1973a, p. 15). But in Keynes, full employment might coexist with some other kind of unemployment, provided that the latter is detected as voluntary, i.e. as “structural unemployment” (Keynes [1942] 1980, p. 305) to borrow Keynes’ terminology after the General Theory. In Keynes’ perspective, considering that workers are off their labour supply curve is far from enough for characterising unemployment as involuntary. And the individual volition is absolutely not at stake here: for the individual off his supply curve of labour, it is obviously not possible to ascribe a peculiar cause to his lack of job. This allows several sources of unemployment to coexist. Noticeably, Keynes abandons the voluntary versus involuntary terminology after the General Theory and he uses instead the structural versus demand-deficiency unemployment terminology.

Is this ignorance of voluntary unemployment damaging for Patinkin's appraisal of involuntary unemployment? At first glance, one might be tempted to answer negatively. In MIP Chapter 14 Patinkin particularly insists that “the involuntary unemployment of the General Theory need not have its origin in wage rigidity” (MIP, p. 340). And Patinkin repeatedly states that Keynes’ contribution to macroeconomics would have been very tiny if confined to an explanation for unemployment in terms of wage rigidity – a demonstration considered by Patinkin as highly classical indeed (KMT, p. 101). Yet, some elements in MIP show that Patinkin's careful appraisal of involuntary unemployment is marred by his basic ignorance of Keynes’ specific concept of voluntary unemployment, especially when one tries to disentangle real wage rigidity from nominal rigidity in the explanation for unemployment. To take but one example, in the quotation mentioned above from MIP, Patinkin 1965 p. 340, i.e. in the idea that involuntary unemployment does not originate in wage rigidity, what Patinkin precisely means by “wage rigidity” is the rigidity in real wages. It is precisely because his dynamic adjustment analysis allows for upward as well as for downward movement in real wages (see below) while the General Theory only accounts for anti-cyclical movements in the real wages, that Patinkin feels allowed to claim that “in this respect we are more Keynesian than Keynes” (MIP, p. 340).⁴ Patinkin makes this point explicit when he claimed to be “able to explain the existence of involuntary unemployment without placing any restrictions on the movement of the real wage” (MIP, pp. 240-1; emphasis added).

Regarding now the issue of nominal rigidities, Patinkin's appraisal for involuntary unemployment appears much more in trouble. Patinkin definitely refuses to attribute involuntary unemployment to money wage rigidity. For him, “the central question which divides classical and Keynesian economics [is] the efficacy of an automatically functioning market system with flexible money wages in eliminating involuntary unemployment” (MIP, p. 315). While real wage rigidity is set aside, Patinkin admits that “this is not to say that money wage rigidities do not aggravate the depth and duration of involuntary unemployment” (MIP, p. 342). But in Keynes’ perspective voluntary unemployment is precisely the kind of unemployment that is assignable to wage rigidity, considered either in real or in nominal terms. So it seems confusing (to say the least) to acknowledge that rigidity in money wages actually worsens involuntary unemployment: this kind, or this “source” (to borrow Lucas’ (1981) terminology) of unemployment as well as its depth and duration should precisely be ascribed to other forces than market imperfections. What clearly appears here is that an appraisal of involuntary unemployment in terms of individual volition prevents from considering the coexistence of several sources of unemployment⁵ .

Besides, it might be the case that in Keynes's macroeconomic system, a non-clearing labour market does not provide by itself the dynamic competitive forces through downward adjustment in money wages. This point drives us to the functioning of the labour market in Patinkin's MIP with regard to Keynes’ General Theory.

3. Labour market functioning

Because for Patinkin the excess supply of labour necessarily exerts a downward pressure on money wages (except in the limiting case where money wages are perfectly rigid, a case dismissed by Patinkin as an extreme classical explanation for unemployment), involuntary unemployment cannot but be explained as a disequilibrium phenomenon, which implies a dynamic process:

[…] the essence of dynamic analysis is involuntariness; its domain consists only of positions off the demand or supply curves. Indeed, it is the very departure from these curves, and the resulting striving of individuals to return to the optimum behaviour which they represent, which provides the motive power of the dynamic process itself. (MIP, p. 323)

Patinkin concedes to classical economics that involuntary unemployment cannot be a persistent phenomenon but only a temporary one: unemployment exists only during the competitive adjustment that brings the economy back to its competitive full employment position after an external shock. Leaving aside for the moment the issue of the shock at the origin of unemployment as well as the issue of the equilibrating process, two points specific to the labour market functioning are worth discussing: first the issue of nominal rigidity and second the inter-relationships between employment on the one hand and real and money wages on the other.

3.1. Money-wage rigidity

Leontieff ([1936] 1990, 1947) argues that Keynes postulated downward wage rigidity in his explanation for unemployment (together with the liquidity trap). Modigliani (1944) acknowledges that Keynes’ overall system relied on the assumption of perfectly rigid wages (but not on a liquidity trap argument as in Leontieff).⁶ Lange (1938, 1942, 1945) or Modigliani (1944)⁷ also consider an inverse-L labour supply curve to account for involuntary unemployment. In both cases, Patinkin raises objections. Regarding Leontieff in particular and the idea of nominal rigidities, Patinkin denies that involuntary unemployment à la Keynes originates in perfectly sticky money wages. For him:

[…] if the General Theory were to be interpreted as being based on the assumption of absolute rigidity of money wages, then there would be no novelty to his message: for the fact that such a rigidity can generate unemployment was a commonplace of classical economics. (KMT, p. 101; emphasis added)⁸

Precisely, Patinkin's overall project is to account for unemployment without assuming wages and prices rigidity. Regarding now the shape of the labour supply function, Patinkin also denies that Keynes’ outcome required an inverse-L supply curve, an argument that he wrongly connected to the previous one.⁹ In Patinkin's views, the objection is that one cannot even speak here of excess supply of labour for workers are definitely on their supply curve, which means that they behave voluntarily and maximise accordingly their utility. Besides, the General Theory would loose much of its generality if it rested on an assumption so specific regarding the labour force behaviour.

Both arguments, money wage rigidity and an inverse-L labour supply curve, imply a certain degree of money illusion, through the common idea that workers oppose a fall in real wage due to a rise in prices while they do not react the same way to a cut in money wages. The incriminated passage in the General Theory, often quoted to substantiate this critique, is that “whilst workers will usually resist a reduction of money-wages, it is not their practice to withdraw their labour whenever there is a rise in the price of wage-goods” (Keynes [1936] 1973a: 109). Patinkin makes it very clear that in no way Keynes’ argument relies on money illusion. In KMT, he reminds the reader that workers and employers actually bargain for relative wages in a decentralised market economy and that consequently an individual worker would react symmetrically to a rise in prices and to a general cut in wages: “and this is the true meaning of the absence of money illusion” (KMT, p. 110).

If he objects to the interpretations of the General Theory that rely on absolutely rigid wages, Patinkin easily admits that the “opposite extreme of assuming them to be perfectly flexible” (KMT, p. 108) is not to be considered either. So Patinkin clings to the idea of money wage stickiness, or sluggishness, to sustain his disequilibrium interpretation of involuntary unemployment. But this approach to money wage dynamics encounters two different kinds of trouble: the first difficulty concerns the internal consistency of Patinkin's approach; the second one is the relevance of this approach with regard to the General Theory.

Regarding the first trouble, De Vroey (2002) makes clear that “the rigidity concept remains equivocal because it can mean either fixity or sluggishness” (De Vroey 2002, p. 295). According to this distinction, Patinkin deals actually with “slow-adjustment” rigidity or “process rigidity” (De Vroey 2002, p. 295). The idea Patinkin has probably in mind regarding the speed of the adjustment process can be set by reference to the half-life of the adjustment process. That is, more time would be needed to make half the distance to the equilibrium in the Keynesian model. The problem is that the idea of slow adjustment, of process rigidity, hardly fits in Patinkin's Walrasian approach to the formation of equilibrium, especially regarding the trade technology involved: “as soon as the week device is adopted the matter is sealed against Patinkin's claim that involuntary unemployment is caused by slow adjustment, because slow adjustment can play no significant role within the week device” (De Vroey 2002, p. 298).

The problem becomes even more difficult when one turns to Keynes's original treatment of the money wage rigidity issue in his General Theory. Truly, Keynes argues that “moderate changes in employment are not associated with very great changes in money-wages” (Keynes [1936] 1973a, p. 251), a statement that seems to support Patinkin's interpretation. Now, at the analytical level Keynes is not really concerned with the idea of slowly adjusting money wages in his appraisal of involuntary unemployment: the concept of voluntary unemployment is there precisely to account for market rigidities and especially slow adjustment to changes. But Keynes’ theoretical apparatus requires considering money-wages as exogenously given as a preliminary assumption. This corresponds to the idea of fixity (understood as pre-determinacy) of money-wages. The issue of the downward inflexibility of money-wages has been unfortunately confused with the question of the exogenous character of money-wages in the General Theory, i.e. the fact that money-wages are considered as a pre-determined variable for the first 18 Chapters of this book and that all variables are measured in wage-units up to Chapter 19 where precisely changes in money-wages are studied. By definition there cannot be any kind of disequilibrium within a framework of pure competition (i.e. money wages perfectly flexible). But this is not to say that there is no room for a kind of unemployment the origin of which is wholly untouched by these concerns for market imperfections and nominal rigidities.

3.2. Money-wages, real wages and the employment level

A point that has not been emphasised so far is that in Keynes’ employment and wages dynamics money wages do not react to the excess supply of labour but instead to the hiring phenomenon. Money wage changes are an increasing function of changes in the employment level (i.e. in the demand for labour) and not a decreasing function of the gap between supply and demand for labour. This point was already tackled in the Treatise on Money (1930) where Keynes distinguished the “spontaneous” from the “induced” changes in efficiency wages (Keynes [1930] 1971, p. 151). “Spontaneous” changes correspond to some external shock (policy change, modification in the bargaining power of trade-unions, etc.) whereas “induced” changes correspond to endogenous variations in money-wages (that is changes in the level of activity and, by the way, changes in the employment level). This issue was taken up again in Keynes’ paper entitled “Relative Movements of Real Wages and Output” (Keynes [1939] 1973b, p. 394-412), where two different issues were clearly distinguished: first, “the changes in real and money wages [which] were a reflection of changes in the level of employment caused by changes in effective demand”, second the “changes in wages [which] reflect changes in prices or in the conditions governing the wage bargain which do not correspond to, or are primarily the result of, changes in the level of output and employment and are not caused by (though they may cause) changes in effective demand” (Keynes [1939] 1973b, p. 395). In the General Theory Keynes is clear that during the expansion money wages rise as employment rises; and this function might be non-linear.¹⁰

Next, there is the issue of the relationships between money wages and real wages. Regarding the second observation of the General Theory Chapter 2, namely Keynes’ claim that “there might be no expedient by which labour as a whole can reduce its real wage to a lower figure by making revised money bargains with the entrepreneurs” (Keynes [1936] 1973a, p. 105), this statement might be not so “obscure” (KMT, p. 105) as Patinkin feels it to be. In Patinkin's interpretation, this observation means that “there may be a special combination of circumstances which will prevent the decline in money wages from having any net effect on the level of aggregate demand” (KMT, p. 105). So the worst case considered by Patinkin is that the fall in prices just equates the fall in money wages, the level of real wages being thus unchanged. But the case considered by Keynes is much more serious than that seems to be: it is the possibility that cuts in money wages initiate deflationary spirals that lead to larger falls in prices, and by the way a rise in the real wage reached through the interactions between labour market (where the money wage is set) and goods market (where the price level is set). Wage bargains, which cannot operate but in nominal terms in a monetary economy, determine the real wage level only in an indirect manner, through their effects on the employment and price levels. Again, this does not imply money illusion for monetary bargains do not preclude the embedding of price expectations (and surely they do). But the fact remains that in Keynes the real wage is an end-process variable: the second postulate does not hold in a decentralised monetary economy for workers lack the bargaining possibility to secure the real wage value that would clear the labour market, allowing them to stay on their labour supply function and to maximise their satisfaction accordingly.

At the empirical ground, Keynes noticed in the Thirties that the fall in prices exceeded the fall in money wages so that what was observed during the Great Depression was actually an increase in real wages. This marked a significant moment in the analytical process towards the General Theory (Dimand 1988). So for Keynes declines in money wages are actually very likely to be accompanied by a decline in employment, a decline in prices, and by the way an increase in real wages. But to properly grasp this issue one needs to develop a truly dynamic analysis that incorporates the effects of falling prices, and not only lower prices.

This point regarding the second classical postulate brings us to the issue of the interrelationships between the employment level and the real wage as encapsulated in the first classical postulate. For Patinkin, Keynes’ acceptance of the first classical postulate means that “[Keynes] assumes that the firms of the economy are always on their demand curve for labour as determined by the latter's diminishing marginal productivity” (KMT, p. 94). From the Walrasian perspective, this means that the equality between the real wage and the marginal productivity of labour is an optimality condition. Patinkin argues that this curve should not be relevant in case of disequilibrium, when firms are sales-constrained: with the first postulate on the one hand and with the effective demand principle on the other, the Walrasian system becomes overdeterminate (Leijonhufvud 1974)¹¹ . As is well known, the dismissal of the first classical postulate led Patinkin to provide his kinked demand curve for labour in MIP Chapter 13 and to develop accordingly an analysis of the firms behaviour off their labour demand curve and their goods supply curve. Of course, such a proceeding entails several problems regarding the internal consistency of Patinkin's theoretical apparatus (De Vroey 2002, 2004; Boianovsky 2006). In particular, one can hardly conceive firms being not able to buy precisely the amount of production factors they exactly wish to at the current prices and wages in case more labour could easily be at their disposal. And Patinkin's narrative about firms behaving “off curves” clashes with the trade technology at the foundation of the Walrasian system, i.e. the tatonnement process. As Boianovsky (2002) shows, Patinkin eventually accepted Keynes’ theory of effective demand (Patinkin 1979, 1982) as a consistent bulk that implies firms being on their aggregate supply curve of goods (the analysis henceforth integrates sales-constrained firms making price expectations). But this didn't lead him to revise his view about firms being off their labour demand curve under conditions of unemployment. So Patinkin eventually maintained his interpretation of the first classical postulate as an optimality condition despite the analytical troubles this approach entails for the consistency of his theoretical construct.

Besides, there is the remaining issue of the causality between employment and wages in a monetary economy submitted to the effective demand principle. As Leijonhufvud (1974) reminds the first classical postulate maintained by Keynes should not be interpreted as an optimality condition but as a market equilibrium condition, so that Keynes’ theoretical construct does not face the internal consistency troubles Patinkin supposedly identifies. In the Marshallian framework it is not possible to disentangle individual experiments from market experiments. In particular, when firms take their hiring decisions on the labour market they have to hold at the same time forecasts regarding their sales prospects on the goods market. Both the demand price on the labour market and their supply price on the goods market depend on firms’ sales expectations. In the Marshallian economy firms react to quantity signals in sending to the market their reservation prices. The wage that firms send as signal to the labour market is the maximum level of wages they are willing to pay for a certain amount of labour. Competition among firms will bring the equality between the real wage (which is an expected value in view of firms’ sales forecasts) and the marginal productivity of labour. That is precisely the way the employment level becomes a function of effective demand instead of the real wage level. In the Walrasian economy in which production is made on order (De Vroey 1999), the whole mechanism would collapse. And Keynes’ claim that “the volume of employment is uniquely related to a given level of real wages – not the other way round” (Keynes [1936] 1973a, p. 30) would hardly make sense in the Walrasian system of simultaneous equations.

Let us take stock of Patinkin's appraisal of the labour market functioning. Patinkin is aware that an appraisal of involuntary unemployment relying on wage rigidity would be of little interest. So MIP Chapter 13 accounts for unemployment as a disequilibrium (and temporary) phenomenon where both firms and workers are off curves and neither the first classical postulate nor the second one holds in Patinkin's account. Beyond the internal consistency defects in Patinkin's theoretical construct (namely the ideas of trading out of equilibrium and price sluggishness within the Walrasian framework), this appraisal of involuntary unemployment also departs from Keynes’ original theoretical project on several critical points. First of all, while Patinkin rightly escapes real wage rigidity (for which economic policy would simply be neutral) unemployment disequilibrium à la Patinkin relies on slow adjustment in nominal wages, that is process rigidity regarding trading in nominal terms. But the fact is that Keynes precisely developed a concept for this kind of market imperfections, namely voluntary unemployment, about which Patinkin unfortunately keeps silent. Because this approach to unemployment does not disentangle between the two kinds of unemployment established by Keynes, it runs the risk to miss the point about the specificity of involuntary unemployment. Next, Patinkin's account for the labour market functioning passes over the specific dynamics between wages and employment to be found in the General Theory, especially the idea that money wages do not react to the excess labour supply (but instead to changes in the employment level) as well as the idea that the real wage is an end-process value determined by the employment level. This specific approach to the labour market functioning should undoubtedly imply a specific macroeconomic dynamics.

Let us now turn to the issue of the adjustment process that brings a decentralised market economy back to its full employment equilibrium after an external shock. As we will see, viewed from a dynamic adjustment perspective Patinkin's account for disequilibrium unemployment goes even further away from Keynes’ original concern.

4. External shock and adjustment process

Let us turn to the core of our inquiry, namely the issue of the adjustment process that brings a monetary economy back to full employment after an external shock. In hindsight, the fundamental contribution provided by Patinkin has been better perceived, namely the “path-breaking discussion of the connection between the aggregate demand constraint and the demand function for labor” (Backhouse and Boianovsky 2013, p. 44). The kinked demand curve for labour and the behaviour of sales-constrained firms being “off curves” precisely account for suboptimal situations where the principle of effective demand applies and prevents accordingly firms to implement their optimal plans. Now, disequilibrium unemployment à la Patinkin only exists during the time-consuming adjustment process. Seen from the other side, this proposition implies that the competitive process is converging and by the way that the economic system is globally stable.

Here below we will discuss Patinkin's appraisal of this adjustment process. We will assess whether the problem addressed in the General Theory Chapter 19 is actually the length of the adjustment process and, just like Patinkin, we will devote a special attention to the real balance effect.

4.1. An account for Patinkin's adjustment process

Patinkin's purpose is to account within the same theoretical apparatus for the classical position, which argues for a quick return to full employment after an external shock, and for the Keynesian one, which argues on the contrary for a long duration of unemployment. The common starting point is a full employment position that is disturbed by a negative external shock. In Patinkin, the shock considered is a fall in the demand for goods because of an augmentation of the demand for bonds.

Patinkin's account for the Keynesian position in MIP Chapter 13 (and especially MIP 13 Section 2 and 3) is built upon the classical argument according to which the adjustment process after an exogenous fall in aggregate demand is very fast: aggregate demand is stimulated directly through the price fall, i.e. through the real balance effect, which makes consumption rise, and indirectly through the interest rate fall that stimulates investment, the so–called Keynes-effect. What happens if aggregate demand is not sufficiently elastic to the price level and to the interest rate? Following the fall in aggregate demand, “the adjustment process becomes a long, drawn-out one” (MIP, p. 318). Firms’ sales are now sustainably lower than the production so that stocks accumulate. Firms can no longer react only by price reduction (which would suppose that the market absorbs inventories) but moreover need to reduce both their labour demand and their production level. The economy is henceforth in a disequilibrium position: neither entrepreneurs nor workers are in capacity to react optimally. Then, both entrepreneurs and workers are “coerced by the same force majeure of insufficient demand in the commodity market” (MIP, p. 322).¹² Noticeably, the adjustment speed of wages and prices are exactly the same in the “classical” case as in the Keynesian one: wage sluggishness in particular is not considered as more intense in the Keynesian case. Just like in the classical case, the disequilibrium on the labour market involves a downward pressure on money wages. In the same way, the disequilibrium on the goods market involves a price level reduction, leading to two positive effects on aggregate demand, a direct one through the real balance effect and an indirect one through Keynes-effect. As long as prices and money wages are falling, aggregate demand is increasing. So Patinkin's basic claim in MIP Chapters 13 and 14 as well as in KMT is that involuntary unemployment only exists during the adjustment period that brings the system back to its equilibrium position. Beyond slow adjustment in money wages that aggravate the disequilibrium duration¹³ , the adjustment process is also rendered sluggish with regard to the classical case because of redistribution effects and expectations effects (mentioned in particular in MIP Chapter 14, pp. 336-37), which are very likely to thwart the real balance effect.

Patinkin takes pain to argue two major points in order to sustain the Keynesian nature of his contention. First, Patinkin specifies in Section 1 of MIP Chapter 14 that, if the existence of unemployment requires, as a strict matter of definition, non-perfectly flexible money-wages,¹⁴ what renders unemployment inevitable is not the wage rigidity. Second, the real balance effect is taken into account in the adjustment process as a mere matter of consistency: it is a logical necessity to render Keynes's position consistent but it nevertheless does not invalidate the bulk of Keynes’ argument. In his New Palgrave article dedicated to the real balance effect, Patinkin (1987) acknowledges that, at the practical ground, the real balance effect is very likely to be offset by the adverse expectations effects. Then he argues that “no one has ever advocated dealing with the problem of unemployment by waiting for wages and prices to decline and thereby generate a positive real balance effect that will increase aggregate demand” (Patinkin 1987, p. 100). As stated by Rubin (2005), the matter at hand here is for Patinkin the generality of the General Theory; in Patinkin's eyes taking into account the Pigou-effect does not transform his position in an anti-Keynesian one:

… above all, Patinkin's solution stemmed from the internal logic of his reconstruction of the Keynesian theory. On the one hand, the Keynesian theory was deprived of any specific equilibrium concept; it was a disequilibrium theory. On the other hand, a general model had to contain a stable equilibrium solution. The Keynesian theory thus needed a stabilizing mechanism to justify the existence and the stability of a Walrasian equilibrium. Since, for Patinkin, the Pigou effect was the sole mechanism capable of doing the job, it conditioned the degree of generality of the Keynesian theory. (Rubin 2005, p. 66)

Finally, involuntary unemployment as Patinkin accounts for this phenomenon in MIP originates in the specific values of parameters of the common neo-classical model (i.e. a specific elasticity of money demand together with a specific elasticity of investment demand) associate to some “special” effects (i.e. expectation and redistribution effects). And the disequilibrium can only be temporary. In Patinkin's eyes, Chapter 19 is the “apex of the General Theory” (KMT, p. 106) where the essence of Keynes’ position appears, namely the question of the length of competitive adjustment process that might be too long to be acceptable.

The essence of Keynes’ argument in Chapter 19 is that because of a relatively high interest elasticity of demand for money interacting with a relatively low interest elasticity of demand for investment both of whose effective magnitude are very much influenced by the state of expectations – this automatic adjustment process is not very efficacious: at best it can bring about only a very slow rate of improvement in the state of employment in the economy. (KMT, p. 106; emphasis added)

Beside this general case Patinkin acknowledges three extreme possibilities regarding the adjustment process issue. In order of relevance, one can mention first the possibility that the economy might be trapped in the low employment position that follows the external shock. In this extreme Keynesian case, deflationary expectations and distribution effects exactly compensate the Pigou-effect and the Keynes-effect¹⁵ . Another possibility, which is mentioned in passing in MIP Chapter 14 but which is not repeated in KMT is that distribution and expectations effects might render the process “unstable” (MIP, p. 338): “In such a case, the return to full employment would have to await the fortunate event of some exogenous force that would expand aggregate demand sufficiently” (MIP, p. 338). A third, even more extreme, possibility (which again is mentioned in MIP Chapter 14 but not in KMT) is the inexistence of a wage and price setting corresponding to full employment, which would imply the inconsistency of the system and is accordingly set aside.

But it is not necessary to go to either of these analytical extremes. […] even if monetary policy could definitely restore the economy to full employment, there would still remain crucial question of the length of time it would need. […] Though I am not aware that he expressed himself in this way, this is the essence of Keynes’ position. (MIP, p. 339)

To sum up, for Patinkin the standard Keynesian case would be a long duration of the “classical” competitive adjustment process, not because of rigid money wages (since they adjust to the excess labour supply, although this competitive adjustment process occurs only slowly in order to logically make room for non-clearing intermediate outcomes during the process) but instead because of specific values conferred to the sensibility of both the investment demand and the money demand to the interest rate. An extreme (but however quite plausible) Keynesian case would be for the lack of any competitive adjustment process because of both redistribution and expectations effects, the economy being then trapped at its less-than-full employment position corresponding to the initial external shock. Why favouring the scenario of a too long competitive adjustment process at the expense of a de-emphasising of the instability case (with which Patinkin was seriously concerned in 1948)¹⁶ ? The answer could be fairly simple if one consider that Occam's razor is probably at work here. That is: if a lighter modification of the standard theory is enough to sustain the Keynesian position, why go to such extreme views as instability or equilibrium inexistence?

The first very question that such an account for disequilibrium unemployment raises is whether involuntary unemployment is conflated in Keynes with the issue of a lengthy adjustment process towards the full employment equilibrium. The second question is for the relevance of a significant real balance effect within a liquidity-preference framework.

4.2. The General Theory Chapter 19 as a lengthy adjustment process?

Let us consider the following argument about wage deflation, which appears in the General Theory Chapter 19:

If labour were to respond to conditions of gradually diminishing employment by offering its services at a gradually diminishing money-wage, this would not, as a rule, have the effect of reducing real wages and might have the effect of increasing them, through its adverse influence on the volume of output. (Keynes [1936] 1973a, p. 269; emphasis added)

As this quotation shows, Keynes is very explicit regarding wage deflation: money wage cuts might reduce effective demand, and thus output and employment (and by the way rise the real wage because of the first classical postulate that states a decreasing relationship between real wage and marginal productivity of labour).

Let us briefly summarise Keynes’ argument. First of all, it should be reminded that Keynes disentangles two types of change in money wages, “induced” changes and “spontaneous” ones. The General Theory Chapter 19 deals with spontaneous changes in money wages, namely a cut in wages that is implemented as a way of policy, and not with induced changes. There is no idea of a competitive process in the argument developed. The general cut in money wages is a test, a flexible wage policy tried as a way out to unemployment - it does not correspond to whatever competitive adjustment. The question raised in the General Theory Chapter 19 could be formulated as follows: starting from an underemployment position, what is the effect of a money-wage cut? And Keynes’ answer is definitely dynamic, in the sense that General Theory Chapter 19 aims to show that a deflationary policy is very likely to push the economic system far more astray from the full employment equilibrium. Dynamics means here the study of the (lack of) competitive adjustment forces, i.e. local and global stability.

The fall in money wages has undoubtedly a negative effect on consumption for it involves redistribution effects of revenue unfavourable to the propensity to consume, and thus to the employment level. The only possible positive effect might be found on the side of the investment schedule. Regarding first the marginal efficiency of capital, the money wage cut generates as a matter of principle an indeterminate effect. Indeed, this wage fall is favourable to the marginal efficiency of capital only if accompanied by the expectation of its future increase – because of the expectation of a future price increase. “If, on the other hand, the reduction leads to the expectation, or even the serious possibility, of a further wage-reduction in prospect, it will have precisely the opposite effect” (Keynes [1936] 1973a, p. 263). If expectations are elastic (in Hicks’ sense of the word)¹⁷ , a flexible wage policy reduces the marginal efficiency of capital and by this way worsens unemployment. Regarding next the interest rate, the cut in money wages has also an indeterminate effect, but with an expectation effect symmetric to the one applying to the marginal efficiency of capital. If the wage fall is accompanied by the expectation of their future decrease (expectations are then elastic), then the liquidity preference, and thus the rate of interest, will diminish, which involves a rise in the investment level. If the expectations are in favour of a future increase in money wages (expectations are then inelastic), wage deflation will on the contrary worsen investment. Hence, as a consequence of a general wage fall both the aggregate demand price and the aggregate supply price change; and it is quite possible that they vary in an opposite way. The efficacy of a wage cut policy depends to a great extent on the expectations concomitant to this policy.

Keynes’ contention mentioned above that cuts in money wages are, as a rule, accompanied by a rise in real wages (which means in the analytical framework of the General Theory a fall in the employment level) rests on two kinds of argument: first the expectations case that is the most likely to occur, second the relative sensitivity of the marginal efficiency of capital compared to the sensitivity of the interest rate. Regarding first the most plausible expectation scenario, Keynes insists that in a decentralised economy wage cuts cannot be simply imposed but are achieved “only as a result of a sort of civil war or guerrilla warfare carried on, industry by industry” (Keynes [1930] 1971, p. 419). Hence wage cuts are only obtained progressively, which inevitably lead to elastic expectations regarding wages and prices in the periods ahead. As we have seen, this case is unfavourable to the marginal efficiency of capital but favourable to the interest rate. The very issue is therefore to know which one of these two effects will dominate. Actually, the difficulty of the Keynes-effect does not originate in the interest rate inelasticity of investment but rather in the relative rigidity of the interest rate itself. And this downward inflexibility of the interest rate can apply at any rate, depending on the expectations context faced by private agents. That is, beyond pessimism regarding the economic perspectives in the periods ahead, it is for Keynes quite probable that wealth-owners hold their expectations regarding what the future might bring forth with a very low weight - to borrow the terminology of Keynes’ Treatise on Probability (1921). Consequently, wealth-owners are reluctant to ask for more newly produced non-monetary assets, that is, they hold a low demand-price for capital goods. While the most probable expectation scenario is for elastic expectations, the fall in the marginal efficiency of capital is very likely to dominate the fall in the interest rate. This clearly contradicts Patinkin's argument that the continual fall of money wages increases investment and thus employment during the competitive adjustment process¹⁸ . As an aside, Patinkin appears here rather as belonging to the Wicksellian tradition rather than as a true heir of Keynes.

The crucial argument of the General Theory Chapter 19 is that nothing can be expected of a cut in money wages that would be implemented as a policy device in a decentralised market economy where adjustment cannot be obtained “once-for-all”. Much worse, because of the decentralised character of a monetary economy a progressive, gradual, money-wage fall is very likely to lead to an employment equilibrium inferior to the starting one, mainly because of the expectations and the redistribution effects. To this extent, “the essence of Keynes’ argument” is not the length of the competitive adjustment process ensuing a demand shock, assuming that such a competitive process exists and is a convergent one. In Keynes, the very problem faced by a monetary economy is a too low price of capital goods as compared to money-wages¹⁹ . So lower wages might be an issue with regard to a marginal efficiency of capital severely depressed. But the process of implementing this wage cuts, the effect of falling wages, is very likely to move the system towards a worse equilibrium. To put it differently, the problem in Keynes is not that competitive forces might be too weak to operate in an acceptable period of time, because of “intolerably long period of dynamic adjustment” (MIP, p. 339), but that these equilibrating forces might simply not exist. To put it differently, Keynes’ matter of concern was for suboptimal equilibrium together with the lack of competitive adjustment forces rather than time-consuming competitive dynamics.

Besides, Keynes acknowledges in the General Theory Chapter 18 that the relative rigid nature of money wages in a monetary economy (in which factors of production compete for their relative position in the remuneration scale) helps to provide stability to the system. That is, more flexible wages “will make employment more variable – that depressions will be deepened or prolonged by the expectation that they will cause wage deflation” (Howitt 1986, p. 238). If the labour force was to reply to excess supply by large wage cuts, this would undoubtedly enlarge the fluctuations of the system: “there is, therefore, no ground for the belief that a flexible wage policy is capable of maintaining a state of continuous full employment. […] The economic system cannot be made self-adjusting along these lines” (Keynes [1936] 1973a, p. 267)²⁰ .

Regarding our appraisal of the General Theory Chapter 19, two remarks are in order. First, Keynes’ analysis is for the dynamics of an economy in which prices and wages are falling, and in which accordingly expectations regarding the tendency of the system in the periods ahead prove crucial. Along the lines of Leijonhufvud's (1973) argument for the existence of a “corridor” of stability in a decentralised market-economy, the system might be able to absorb by itself “small” shocks. In that case private agents, and crucially investors and entrepreneurs, are expecting the end of the deflationary process; the fall in wages and prices is viewed as definitive. But the problem becomes much more serious in case of large and protracted shocks. In that case, falling prices and wages trigger a deflationary process that might worsen the initial disequilibrium (Tobin 1993). By contrast, Patinkin's account for the adjustment process is actually for lower wages and prices with no concern for lowering values. In MIP Patinkin assumes unit elastic expectations. Thus, from a formal point of view, expectations in MIP cannot induce a deflationary bias, for these expectations do not incorporate the effect of the deflationary process in the dynamics of a moving system.

This leads us to our second remark, which is related to the equilibrium and disequilibrium issue. Patinkin himself formulates properly the question at stake:

But how can I interpret the General Theory in this way [as a situation of disequilibrium unemployment] in the face of Keynes repeated statements that one of his major accomplishments in his book was to have demonstrated the possible existence of “unemployment equilibrium”? There are two – not mutually exclusive answers. (KMT, p. 114)

The first explanation for this strangeness in Keynes offered by Patinkin deals with style and rhetoric: the upholding of equilibrium unemployment rather than disequilibrium unemployment was a much more frontal attack upon the classical theory. The second answer is for a confused terminology unfortunately used in the General Theory: Keynes’ conception of equilibrium and disequilibrium would be blurred²¹ . But Keynes’ appraisal of involuntary unemployment does not appear as strange once one reminds his Marshallian lineage (De Vroey 1999, 2002). As Davidson (1967) or Asimakopoulos (1973) make clear, Patinkin wrongly conflates equilibrium with market clearing, whereas Keynes the Marshallian understood equilibrium as a position of rest, a state of the system with no tendency to change despite the existence of some non-market clearing outcomes²² . Keynes’ theoretical apparatus definitively corresponds to the theory of unemployment equilibrium, with no competitive forces at work to escape the sub-optimal issue and with no way-out to expect from a flexible wage policy.

4.3. Real balance effect within liquidity-preference framework

Regarding Patinkin's appraisal of the General Theory Chapter 19, there is a point that deserves particular attention, namely the real balance effect²³ . Remind that this competitive mechanism which operates on the goods market to restore aggregate demand to its full employment level only applies for consumption-goods and that it implies a “general price level” effect. As Leijonhufvud (1968) argues:

The Pigou–effect is an effect on real consumption expenditures. It is due to an increase in real balances which, in turn, has been brought about by a proportional fall in all money prices (except of “bonds”) […]. The “Keynes–effect" is an effect on aggregate demand (i.e. on both consumption and investment) due to a fall in the rate of interest which, in turn, has been brought about specifically by an increase in real balances – and the increase in the real balances, finally, should be due to all-around deflation. (Leijonhufvud 1968, pp. 324-5)

As mentioned above, in MIP as well as in KMT but mostly in his New Palgrave article precisely dedicated to the real-balance effect, Patinkin easily acknowledges that the integration of the Pigou-effect in the adjustment process mechanism does not radically undermines the bulk of Keynes’ message for it leaves open the question of the time required for the adjustment to fully operate. That allows Patinkin to argue that this issue is worth discussing at a purely theoretical level, as a strict matter of internal consistency, but that it looses all relevance (even if for the anti-Keynesians) at the policy level: “no one has ever advocated dealing with the problem of unemployment by waiting for wages and prices to decline and thereby generate a positive real balance effect that will increase aggregate demand” (Patinkin 1987, p. 100).

It seems to us that, from a strictly theoretical point of view as well, the “disastrous” character of the Pigou-effect for Keynes’ theoretical apparatus can been questioned. The first way of questioning the relevance of Pigou's critique, which was initially elaborated by Kalecki (1944) in his reply to Pigou (1943), consists in questioning its magnitude. The Pigou–effect, even if relevant against Keynes’ theory, would not be of a sufficiently great magnitude to be significant. Kalecki's (1944) argument is that the real balance effect only applies to outside money (i.e. the monetary base), which restrains significantly its impact on aggregate demand²⁴ . Most importantly, Keynes himself sketched out in his correspondence with Kalecki in 1944 what would become the “Ricardian Equivalence Hypothesis” later argued by Barro (1974), an argument that Keynes put forward to oppose the Pigou-effect. The government debt should also be excluded from the net wealth of the economy, as it represents future taxes that will repay the public debt: “thus, it seems […] that Pigou is in reality depending entirely on the increase in the value of gold” (Keynes’ letter to Kalecki 1944, reproduced in Patinkin 1982, p. 103)²⁵ . The conclusion is obvious: “the whole thing […] is too fantastic for words and scarcely worth discussing” (Keynes’ letter to Kalecki 1944, reproduced in Patinkin 1982, p. 103).

Apart from this critique about the size of the Pigou-effet, there is another line of questioning, more radical, which consists in discussing the way this real balance effect could easily fit (or not) in the theoretical framework of the General Theory. This line of answer to Pigou's critique, which was initially offered by Leijonhufvud (1968), rests on the full recognition of the Keynes–effect and implies a reappraisal of the meaning of “the” interest rate in the General Theory. Leijonhufvud argues that, contrary to Keynes, Patinkin does not disentangle consumer goods from capital goods but only considers a “general price level”. Patinkin's model contains four goods: a “composite good” representing both consumption and capital goods, labour services, money and bonds, whereas Keynes actually distinguishes consumption-goods from non-monetary assets (including capital goods and bonds taken together). In a monetary economy à la Keynes, once the long-term state of expectations is considered as given (as it is the case in the General Theory except in Chapter 12 precisely dedicated to this issue), the interest rate can be viewed as an (inverse) index of the price of the non-monetary asset aggregate. This means that in Keynes (and contrary to Patinkin's reconstruction) the demand price for newly produced capital goods is elastic to the interest rate so that the Keynes–effect is actually as direct as the Pigou-effect. This Keynes-effect operates as follows:

Given the State of Long Term Expectation, a decline in the rate of interest (on which the reliance of the Keynes–effect is placed) implies a rise in the price of capital goods in term of wage units […]. Investment will increase with further “multiplier effects” on aggregate demand, given the initial marginal propensity to consume. But the propensity to consume will also be directly affected – it will increase through the wealth effect of the rise of “real net worth” […]. General deflation, then, will help – if, at some point, the decline in money asset prices starts to lag significantly behind the fall in money wages and consumer goods prices. (Leijonhufvud 1968, pp. 327-8)

In a monetary economy à la Keynes, the interest rate is not simply the price of credit but it incorporates the commonly accepted valuation of the whole stock of non-monetary assets. And in a world in which the future is largely undetermined, the value conferred to the interest rate is mainly an affair of convention. Hence the downward rigidity in the long-term interest rate. This kind of behaviour sets a floor to the equilibrium interest rate required to coordinate savers’ and investors’ plans at the existing state of long-term expectations. This peculiar role played by the interest rate explains why there might simply be no competitive adjustment process and why Keynes held a theory of unemployment equilibrium. If for a given marginal efficiency of capital the interest rate could fall sufficiently, there is no doubt that the investment would increase. But a general deflationary process through a proportionate fall in all prices would not solve unemployment since the very problem faced by a monetary economy in case of involuntary unemployment is that the relative price of non-monetary assets with respect to money wages does not correspond to the full employment one. An overall cut in all prices, in exactly the same proportions, would in the best be of no help²⁶ .

5. Conclusion

Regarding Keynes’ concept of involuntary unemployment, Patinkin's ambition was to account for this phenomenon in a general equilibrium perspective. This programme implied to find causes to excess labour supply other than wage rigidities and to adopt the Walrasian perspective on both equilibrium and equilibrating process. In view of this ambition, the reading of the General Theory Chapter 19 was a key-element for Patinkin's account for unemployment as a disequilibrium phenomenon, i.e. as a temporary process that exists only during the adjustment dynamics towards full employment equilibrium.

Did Patinkin succeed? In our view, it is not only that Patinkin failed in his goal to account for involuntary unemployment in a general equilibrium perspective (because the trade technology he used to account for sluggish adjustment process hardly git in the Walrasian world headed by a centralised auctioneer, to take one but significant example)²⁷ . The point is that this important and influential contributor to the neo-classical synthesis paved the way, largely in spite of himself, for further significant departures, which leave contemporary economists far more astray from Keynes’ initial matters of concern.

A first insight for this claim is Patinkin's definition of involuntary unemployment. His conceptual discussions about voluntariness and involuntariness straightaway put the issue in terms of individual volition. Implicitly, Patinkin leant against Wicksell's distinction between voluntary and involuntary unemployment. Involuntary unemployment “simply” means being off curve, the counterpart of this claim being that voluntary unemployment amounts to nothing else than “false” unemployed who choose not to work. In his preliminary definitions of unemployment and full employment, Patinkin hastily closed the door of the moral aspects of the issue and properly centred the debate on a purely economic ground. But much harm was already done: Patinkin paved the way for the contemporary hazardous discussions about involuntary behaviour, coerced volition and other fuzzy issues that forget that one should deal with the labour force (and not with the individual) within a market-economy (which implies to escape moral debates).

Another misconception concerns the issue of nominal rigidities. Patinkin repeatedly argued that involuntary unemployment does not originate in money wage rigidity but in the specific elasticity of the money demand function and of the investment schedule to the interest rate. Yet, he easily acknowledged that nominal rigidities aggravate involuntary unemployment. Patinkin particularly argued in MIP Chapter 14 that the nominal rigidities involved were not postulated but were due to the behaviour of individuals (both entrepreneurs and employees) who need time to adjust to a demand shock. But again, much harm was done. Ironically, the contemporary research programme held by the New Keynesians basically aims to endogenise the nominal rigidities that were postulated by “old” Keynesians such as Patinkin, this programme being based on the postulate that involuntary unemployment originates in these nominal rigidities (Tobin 1993, Leijonhufvud 1998).

A third significant deviation from Keynes’ original concerns is the understanding of involuntary unemployment as a disequilibrium, thus transitory, phenomenon that can only exist during the competitive adjustment process. Here again, Patinkin appears much more faithful to the Wicksellian lineage than a true heir to Keynes. Such an appraisal of involuntary unemployment implies the existence of a stable equilibrium, which is unique and corresponds to full employment, and accordingly the existence of equilibrating forces bringing back the economic system to its full employment position even after severe and protracted external shocks. In this regard, economic policy is viewed in Patinkin as a device that directly speed the adjustment process, in sustaining the “right” level of aggregate demand (mainly through the budgetary weapon), while today economic policy is rather viewed as a device that dampens cycles (mainly through the monetary weapon), for forward-looking policy helps to anchor rational expectations.

Regarding the first deviation (individual volition and involuntary behaviour), in the General Theory Keynes himself made it absolutely clear that the choice set faced by the individual was not involved. Otherwise, it would be simply impossible to highlight systematic, i.e. macroeconomic, effects of a fall in the wage level as the General Theory Chapter 19 precisely aims to investigate.

Regarding the second deviation about nominal rigidities, the issue of money wage pre-determinacy (which corresponds in the General Theory to an expository device used only in the first 18 Chapters) should be clearly disentangled from the issue of money wage rigidity (which corresponds to a slow speed of adjustment to excess labour supply). Keynes distinguished “spontaneous” changes in money wages (i.e. exogenous changes in the sense of external shock, policy device, etc.) from their “induced” (i.e. endogenous) movements. The General Theory Chapter 19 precisely aims to discuss the efficiency of a wage deflation policy, i.e. the effects of ‘spontaneous’ changes. And the relative rigid character of money wages is for Keynes a condition for the stability of the economic system for sluggish movements in monetary aggregates dampen the dynamic adjustment following an exogenous shock.

Let us conclude with the third deviation about equilibrium and disequilibrium. The very problem being addressed by Keynes in this Chapter 19 is the dynamics of a decentralised system submitted to external shocks of varying degrees of intensity. For small shocks, competitive forces associated to lower prices and wages might help the economy to recover. But the problem becomes much more serious when the system enters in the economics of depression: the deflationary effects of lowering prices and wages, especially implemented through deflationary policies, are very likely to worsen the initial disequilibrium. The topicality of the General Theory Chapter 19 lies in the proposal that a decentralised market economy might lack the required equilibrating forces to ensure its intertemporal stability at full employment. Such an idea was not necessarily perceived as a very extreme view for those who lived the experience of the Great Depression that followed the long recession of the 20s in Great-Britain. But we modern economists should consider again that unemployment might be “inflicted by deflation” (Keynes [1935] 1982, p. 360).

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1 A preliminary version of the paper was presented at the Patinkin conference (Lausanne, 21-22 september 2001). Since then, I benefited from critiques and comments by Ingo Barens, Pascal Bridel, Michel de Vroey, Goulven Rubin and Hans-Michael Trautwein. Usual disclaimers apply.

2 On the genesis of Patinkin's views on involuntary unemployment and disequilibrium economics, see Rubin (2002) and Boianovsky (2006).

3 The first footnote of MIP Chapter 13 is worth quoting regarding Patinkin's conceptual way of framing the issue: “I cannot help citing here the Talmudic dictum that – in certain cases of private law where the formal consent of an individual is required - the court is permitted to ‘coerce him until he says ‘I am willing’” (MIP, p. 313 footnote 1). While Patinkin was highly conscious that this kind of discussions is very far apart economic issues, contemporary economists seem to have forgotten what the whole debate is about. For instance, Lindbeck (1993)' p. takes the example of a woman facing a robber, the latter asking her “your money or your life” to support his two definitions of involuntary unemployment. No doubt that such a choice set is artificially constrained for the person concerned who obeys nevertheless voluntarily to his robber (Lindbeck 1993, pp. 48-9). But this “metaphor” – to borrow Lindbeck's terminology – should not seem so worthy in the economic space.

4 But yet, as Keynes himself made clear in his 1939 reply (“Relative Movements of Real Wages and Output”, reproduced in Keynes (1973a) pp. 394–412) to Dunlop (1938) and Tarshis (1939) investigations, far from being a limitation to the General Theory Chapter 2 argument, a procyclical behaviour of real wages should be considered as an extension to the conventional case of an anti-cyclical trend. Indeed, after a protracted slump, the marginal productivity of labour might be increasing during the recovery so that real wages might be pro-cyclical. But, as shown below, the dynamics at work involved in Keynes is highly dissimilar to Patinkin's (Walrasian) one.

5 See, for example, the following quotation when, looking back at the Thirties, Keynes argues: “It is one thing to say that substantial structural unemployment continued all those years, quite another thing to suggest that, except in 1931/3, there was no deficiency of aggregate demand. I should have said that in almost every year of the pre-war decade there was a deficiency in aggregate demand, the actual level of unemployment being the result of this and of structural unemployment” (Keynes [1942] 1980, p. 305).

6 “It is usually considered as one of the most important achievements of the Keynesian theory that it explains the consistency of economic equilibrium with the presence of involuntary unemployment. It is, however, not sufficiently recognized that, except in a limiting case to be considered later, this result entirely to the assumption of ‘rigid wages’ and not to the Keynesian liquidity preference” (Modigliani 1944, p. 65).

7 Both Lange and Modigliani are mentioned in MIP (p. 341, footnote 14).

8 This is long-standing claim. See for example the following statement: “Now, if the whole purpose of Keynes is to say that with rigid wages we can have unemployment ‘equilibrium’, I really do not see his contribution. This is a point that would have been admitted by classical economists themselves, but Keynes (on page 12, line 9 and following) seems to argue that the classical position on this point was wrong: that there could be unemployment for other reasons” (Patinkin's letter to Modigliani in April 1948 quoted in Rubin 2002, p. 208).

9 Rubin (2002) shows that, at the time of his PhD, Patinkin wrongly conflated the two ideas, the wage rigidity and the inverse L labour supply curve (see also De Vroey 2004, pp. 95-6). This confusion still persists in MIP, especially p. 342 where the issue of money wage rigidity is discussed just after the inverse-L supply curve.

10 “For although the struggle for money-wages is […] essentially a struggle to maintain a high relative wage, this struggle is likely, as employment increases, to be intensified in each individual case both because the bargaining position of the worker is improved and because the diminished marginal utility of his wage and his improved financial margin make him readier to run risks.” (Keynes [1936] 1973a, p. 252–3).

11 “The Walrasian firm equates the announced real wage with its marginal physical product of labour to calculate its demand for labor and supply of output; planning is this way implies the belief that this volume of output can be sold at the announced price. If one were now to add an independently specified ‘sales-expectations’ to this conceptual experiment, it falls apart – the firm is supposed to have two different beliefs at the same time” (Leijonhufvud 1974, p. 167).

12 The justifications suggested by Patinkin – such as uncertainty with respect to the size of the market or cash problems – did not really convince commentators of the time (for example Davidson 1967 or Ott 1978), and this point was the object of several debates. Patinkin acknowledged in footnote 9 of MIP Chapter 13 to be puzzled by this inconsistency. Now, the primary purpose of this paper is not to come back on these controversies regarding the internal consistency of Patinkin's approach but rather to gauge Patinkin's account for disequilibrium unemployment with regard Keynes’ original concern.

13 See, for example, the following statement in MIP Chapter 14: “This is not to say that money wage rigidities do not aggravate the depth and duration of involuntary unemployment. Clearly – as the analysis at the end of Chapter XIII:3 shows – they do.” (MIP, p. 342)

14 “For, by definition, any system which fails to respond quickly and smoothly to equilibrating market forces is suffering from rigidities” (MIP, p. 343).

15 “Let me now return to the dynamic process described in Chapter 19 of the General Theory and note that in principle it is possible that this process will generate adverse expectations that will just offset the otherwise stimulating effect on investment of the decline in interest. That is, there may be a special combination of circumstances which will prevent the decline of money wages from having any net effect on the level of aggregate demand. Under these circumstances, the equilibrium level of aggregate real output, hence the level of input of labour, hence the marginal product of labour, and hence the real wage rate will all remain unchanged.” (KMT, p. 105; emphasis added)

16 On this issue see Rubin (2005).

17 See Hicks (1946), p. 205.

18 On the liquidity-preference and on the issue of the interest rate inelasticity in Keynes, see Rivot (2013). On the issue of probability and liquidity, see Hayes (2006).

19 In Leijonhufvud's words: “The essence of Keynes's diagnosis of depression is this: the actual disequilibrium price vector initiating the contraction differs from the appropriate, hypothetical equilibrium vector in one major respect – the general level of long-term asset prices is lower than warranted” (Leijonhufvud 1968, pp. 335-6; emphasis in the original).

20 On this issue, see Dos Santos Ferreira (2000, 2014) and Leijonhufvud (1968).

21 Patinkin pointed out “Keynes’ imprecise use of the term ‘equilibrium. [He did] not think that Keynes drew a sharp distinction in his own mind between static equilibrium, one the one hand, and protracted dynamic disequilibrium, on the other” (KMT, pp. 115-6).

22 “For Keynes, involuntary unemployment has both a meaning and a place in static equilibrium analysis – it can continue to exist indefinitely in the absence of exogenous changes in the parameters determining the level of employment. For Patinkin, on the other hand, ‘… involuntary unemployment … can have no meaning within the confines of static equilibrium analysis’ (Patinkin, 1965, p. 323) because he has a very narrow interpretation of this type of analysis.” (Asimakopoulos 1973, p. 185; emphasis added)

23 In his New Palgrave article Patinkin presented the real balance effect in the following way: “by the term ‘real balances’ is meant the real value of the money balances held by an individual or the economy as a whole […]. Pigou (1943, 1947) pointed out that the increase in the real value of money holdings generated by the wage and price decline increased the aggregate demand for goods directly, and not only indirectly through its downward effect on the rate of interest” (Patinkin 1987, pp. 98-9; emphasis added). Whereas he made no reference to this point in the first edition of Money, Interest, and Prices (1956), Patinkin specified in the second edition that the analysis is restricted to pure outside money: “For simplicity, we shall deal with a pure outside-money economy; the argument can, however, readily be generalized to an economy with both outside and inside money, as well as interest-bearing government debt” (MIP, p.317).

24 The conclusion of Kalecki's (1944) paper is particularly ironic: “The adjustment required would increase catastrophically the real value of debts, and would consequently lead to wholesale bankruptcy and a ‘confidence crisis’. The ‘adjustment’ would probably never be carried to the end: if the workers persist in their game of unrestricted competition, the Government would introduce a wage stop under the pressure of employers” (Kalecki 1944, p. 132).

25 On this point, see Kalecki's correspondence with Keynes, reprinted in Patinkin 1982, pp. 102–3.

26 Leijonhufvud probably exaggerated somewhat when he argued the real balance effect was “the cornerstone of Patinkin's theoretical work”, for Patinkin repeatedly argued that “recognition of the real-balance effect in no way controverts the central message of the General Theory [because] employment would increase within an acceptable period of time” (Patinkin 1987, pp. 100–1).

27 De Vroey (1998) makes clear that Patinkin's failure to achieve his stated objective does not only concern involuntary unemployment itself: “It follows from the fact that, to date, its prerequisite, i.e. a general equilibrium theory of disequilibrium behaviour of agents and disequilibrium states of the economy, is still lacking. […] Were such a general theory existing, the analysis of involuntary unemployment could be derived as a particular case. Thus, Patinkin's interpretation falls within a line of research which, a priori, looks consistent yet which, for technical reasons, has failed to be implemented” (De Vroey 1998, p. 198).