1. As we know, in the development of John Maynard Keynes’s economics two main courses can be identified: (i) the post-Keynesian, tending to unfold the innovative aspects of his theory; (ii) the new-Keynesian, trying to circumscribe the Keynesian revolution to an exception of the neoclassical theory.

The latter strand has become the maximum of progressism tolerable within the dictates of the massive neoliberal counter revolution started with Reagan’s and Thatcher’s administrations and supported by ultra neoliberal economists like Friedrich August von Hayek and Milton Friedman. On that account, the phenomenon of stagflation typical of that period was generally interpreted as a failure of the Keynesian theory. In fact, it is generally attributed to Keynes the idea that a moderate rate of inflation can help stimulate the economy and reduce unemployment. However, this policy* is considered by him only as a transient and partial remedy for improving – in a situation of economic depression and through a reduction of real wages (and hence with an argument more neoclassical than Keynesian!) – the propensity to invest of entrepreneurs. As also emerges from the reported quotations, he considered the stability of prices central for the development of the system.

We now propose some remarks on the unrealisticness of the new-Keynesian theories (in reality, neoclassic with rigidities). Let us start from their typical assumptions, which can be so summarized: (I) if prices and wages were perfectly flexible, no unemployment would exist; (II) an addition of public spending (beyond a minimum level held strictly necessary for the working of the system) can increase GDP in the short run, but in the long run will crowd out private investments, reduce GDP and increase prices.

Such ideas are more or less explicitly related to the general equilibrium model (GEM) elaborated  by Léon Walras. However, what mainstream economists forget is that Walras, in his Studies in Social Economics, expounded the notion that only in very simple markets, like that of bricolage, GEM can apply,  (and, in our view, GEM and the related neoclassical approach, as resting on very simplistic and unrealistic postulates, are wholly inadequate also in these instances). In all other cases**, including monopoly, oligopoly and public ownership of the land (which he strongly advocated as a way to realise a democratic socialism) an active public intervention was required.

Some more comments on the unrealisticness of the points (i) and (ii).

As for (I), the reason why prices are not flexible is simply because, normally, for firms is more profitable to apply sticky prices. One central reason for this strategy lies in the phenomenon of satiation for a large category of products which, by lowering the price elasticity of demand, makes it unprofitable for firms to cut down prices. For instance, if we need for a given period one smart phone, two PC and three hats, it is rather unlikely that we will buy the double amount if the prices halve. For the same reason, it becomes even more unlikely that a decrease of prices of, say, 90%, would induce to buy nine times more the initial quantity.

The same reasoning can be applied to wages. Fully flexible wages (especially downward), by further weakening the contractual power of the workers, would not spur firms to hire more workers. Rather, such course would induce firms to further reduce wages and prolong the working hours. More generally, if prices and wages were wildly flexible, no reliable social life would be possible. Another central and related issue is whether it is fair or expedient that wages should be equal to the marginal revenue product of labour (MRPL). This comes about because, for a given amount of fixed capital, MRPL will in general decrease beyond a certain value of the “production function” (however defined).  The result is the widening for every additional worker of the gap between MRPL and the average revenue product of labour (ARPL). Orthodox economists would say that the MRPL criterion should anyway be applied to all the workers. And that, if workers do not accept these conditions, this means that they prefer voluntary unemployment. However, it is also true that the choice of moving along a decreasing path of marginal product is usually taken by the firm’s management, without any involvement of the workers. For instance, if a firm chooses to hire an additional worker at the MRPL of 1 penny per day ─ perhaps as a strategy for lessening all wages ─ is it fair to reduce accordingly the wages of all the workers? For this reason, it would be much fairer that workers be remunerated according to the ARPL. In this sense, while it is true that wages (and profits) cannot be considered as an independent variable, it is also true that there are no necessary and efficient laws of wage determination. This is much more so when, under an appearance of “perfect market”, firms have a much stronger contractual power over the single worker. Hence, all these matters find their settlement in the institutional, cultural, political and psychological dimensions of socio-economic relations.

Also the hypothesis (II) is very unrealistic. In particular, the orthodox tenet of crowding out effect does not hold true in real economies. In fact, a reduction of public spending (even if deemed useful) is rarely replaced by a corresponding increase of private spending. This is one the reason why the ratio of public spending on GDP has increased among the OECD Countries in the long period: from around 10% of the 1910s, to 20%-30% of the 1950s-1960s to 40%-50% of the latest decades.

The same applies to credit creation as a central means to finance consumption and investment and then to create effective demand. This takes place especially when ─ as it is very often the case ─ the process of debt repayment is slow and imperfect. Also in this case, the ratio of private debt on GDP (see also later) has sharply increased in the long run, ranging now in the various OECD Countries from 150% to 400% of GDP (with the highest values tending to occur in the most developed Countries).

2. Other aspects on which heterodox economics can cast a better light can be found in the policies of “inflation-targeting” of the early 1980s, which led to a sharp increase*** of the real interest rates. Now, while it is highly doubtful that these policies were effective and relevant for curbing inflation, what more realistically took place was that the sharp increase of real interest rates depressed real economies and fueled the widespread financialisation of the system. On that account, high real interest rates have a negative effect on GDP, because the cost of borrowing for firms increases, and the Keynesian marginal efficiency of capital shrinks (the difference between expected rate of profit and real interest rate). This comes about also because high real interest rates are often accompanied by “credit rationing”. A phenomenon that, by favouring the stronger companies and putting at a disadvantage small and medium-sized firms, has pushed the concentration of economic activities in few dominant groups. And, last but not least, high real interest rates have contributed to disseminating the “psychology of financial rent” to all social classes.

For these reasons, then, lowering real interest rates would be beneficial for promoting investment. To this it can be added the idea ─ put forward by Keynes in the final chapter of the “General Theory” ─ that the diminution of the real interest rate (that he associated with the “euthanasia of the rentier”) would also lessen the rate of profit. Hence, a parallel reduction of inequalities would ensue. This kind of approach will shift attention, in the analysis of investments’ incentives, from the all-important role attributed to profits to the ways to enliven ‘animal spirits’; namely, a tendency to start initiatives not strictly related to the ‘economic motive’. Hence, in order to foster positive behavior in economic and social spheres, measures aimed at improving motivation and participation will play a relevant role. These measures, besides their intrinsic worthiness, would foster a virtuous circle in the wider social context. As a matter of fact, a better participation, by improving the process of social valuing ─ namely, a better understanding of the motivations related to the various policy options ─ would also help overcome its most conflicting aspects.

Arturo Hermann


* These ideas appear also from the following passages,

“Of the two (inflation and deflation) perhaps Deflation is, if we rule out exaggerated inflations such as that of Germany, the worse; because it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier. But it is not necessary that we should weigh one evil against the other. It is easier to agree that both are evils to be shunned. The Individualistic capitalism of to-day, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient—perhaps cannot survive—without one. For these grave causes we must free ourselves from the deep distrust which exists against allowing the regulation of the standard of value to be the subject of deliberate decision.”, (J.M.Keynes, Essays in Persuasion, New York, Norton, 1963: 103-104,  first edition 1931).

“I am now of the opinion that a maintenance of a stable of general level of money-wages is, on a balance of considerations, the most advisable policy for a closed system….This policy will result in a fair degree of stability of price level;─greater stability, at least, then with a flexible wage policy.”, (J.M.Keynes, The General Theory of Employment, Interest and Money, Edison Martin Imprint, 2013: 121-122, first edition 1936).

** We have addressed these aspects in A.Hermann, “The Studies in Social Economics of Léon Walras and His Far-Reaching Critique of Laissez Faire”, International Journal of Pluralism and Economics Education, vol. 7(1): 59-76, 2016, Link https://www.academia.edu/28757791/The_Studies_in_Social_Economics_of_L%C3%A9on_Walras_and_his_far-reaching_critique_of_laissez_faire

*** Another related and negative effect of high real interest rates has been the massive increase of public (and private) debt, whose ratios on GDP has approximately doubled from the early 1980s−with the advent of the neo-liberal oriented policies on the two sides of the Atlantic. In fact, such policies were often accompanied in most OEDC Countries – perhaps to give them a semblance of Keynesism – by large public budgets’ deficits. For more details on the data for public spending, and public and private debt, refer to the following links,