It is completely right to say that modern Keynesian economics should not be about who is more “faithful” to Keynes. Keynes made mistakes. He was not always right, and a proper Keynesian economic science must move beyond Keynes. I agree.
I was also wrong to imply that Daniel just self-identifies as a strict New Keynesian. Sorry about that!
Nor, when I cited an article in a previous post that happened to be called “Bastard Keynesianism,” did I mean to insult New Keynesians. On reflection, the term “Bastard Keynesianism” that was coined by Joan Robinson in 1962 to refer to the neoclassical synthesis (in addition to being rude!) gives the unfortunate impression that Keynesian economics is just about blindly following Keynes, which it certainly should not be.
And, yet, when it comes to the other issues I fear we may be talking past one another. Obviously, there is a flow of money into banks that represents funds people want to save, and in return they get an asset: either (1) the credit money we call demand deposits (or checking accounts or saving accounts) or (2) financial assets called time deposits.
But surely classical loanable funds theory is, fundamentally, a theory of interest rates, saving and investment. It makes many more claims than the simple observation that there is an annual flow and stock of savings.
Now I am sure Daniel is perfectly familiar with Keynes’s critique of loanable funds.
So the remarks that follow are really more for my benefit and other readers of this post.
Keynes’s critique of the loanable funds theory is summed up by Bill Mitchell:
“… the Classical belief [sc. was] that the household decision to save was determined by the preferences for current and future consumption mediated by the interest rate (the price that consumers traded current consumption for future consumption). Instead, … [sc. Keynes] considered aggregate saving was a positive function of national income.There is also the question of what information, if anything reliable, is communicated to businesses through interest rates about time preference.
So when national output and income rises, aggregate saving will rise. The amount of extra saving per dollar of additional disposable income is called the Marginal Propensity to Save (MPC). If the MPC = 0.20, then households will save 20 cents of every extra dollar of disposable income they receive.
The interest rate might have some influence on saving but Keynes considered the influence of changes in national income to the dominant factor determining the aggregate level of savings in any period.
The other consideration is that investment spending is a component of aggregate demand, which in turn, drives total national income in each period.
Taken together, these insights undermines the concept of a loanable funds market in the way conceived by the Classical economists. There could not be independent saving and investment functions brought together by movements in the interest rate as required by the loanable funds doctrine because investment drove income which influenced saving.
In Chapter 14 … of his General Theory of Employment, Interest and Money, he produced a diagram to illustrate his contention that this interdependency meant the loanable funds doctrine was a ‘nonsense theory.’”
Bill Mitchell, “Keynes and the Classics Part 6,” Billy Blog, January 24, 2013.
And then we have more complicated issues about money and banking, such as endogenous money theory, relevant to the classical loanable funds.
Money saved adds to a bank’s reserves. But even at this point the standard story is flawed. Bank lending is not constrained in the way the standard theory requires. Loans create deposits (or new money), and most of the broad money stock is bank money held in the form of demand deposits. Prior monetary saving is not strictly necessary for investment. Then there is the issue of the mythical money multiplier.
At this point, however, we are simply revisiting some of the issues of the Krugman versus Keen debate on endogenous money from about a year ago, which I discussed here:
“Keynes and the Classics Part 6,” January 24, 2013.
“Scott Fullwiler: Krugman’s Flashing Neon Sign,” Naked Capitalism, April 2, 2012.