Keynes on Economic Calculation

At the conclusion of Chapter 19 of The General Theory, Keynes pointed out that rapid and significant wage and price flexibility, and especially downwards nominal wage movements and price deflation, can wreak havoc in a market economy where many contracts are fixed in nominal terms and subjective expectations play a major role:

“It follows, therefore, that 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 even have the effect of increasing them, through its adverse influence on the volume of output. The chief result of this policy would be to cause a great instability of prices, so violent perhaps as to make business calculations futile in an economic society functioning after the manner of that in which we live. To suppose that a flexible wage policy is a right and proper adjunct of a system which on the whole is one of laissez-faire, is the opposite of the truth. It is only in a highly authoritarian society, where sudden, substantial, all-round changes could be decreed that a flexible wage policy could function with success.” (Keynes 1964 [1936]: 269).

In other words, a system in which rapid and unexpected deflation occurs will cause serious problems in a market economy and to the plans and calculations of business people.

In fact, one of the main purposes of Keynes’ A Tract on Monetary Reform (1923) was to advocate polices to ensure a relatively stable purchasing power for money, given the violent hyperinflations of post-World War I Europe and the destabilising deflation in the UK induced by the return to the gold standard. (At this time of course, Keynes was a quantity theorist, so his polices were then based on the quantity theory of money.)

These points about Keynes are of interest, because the internet is filled with vulgar Austrians and libertarians who seem to think that only the Austrian school has ever understood the truths that

(1) money prices are necessary to calculate profit and loss, and
(2) that business requires a relatively stable purchasing power for money to make these calculations meaningful,

when of course mainstream neoclassical economists and heterodox economists understand this perfectly well (e.g., see Ingham 2011: 45).

Of course, as Keynes thought, steady and low inflation is compatible with effective business calculation, and better than deflation for many reasons, especially if the business community, as they do now, expect a low inflation environment as the normal state of affairs.

Even Mises’ condition for the attainment of effective economic calculation is only a relatively stable purchasing power for money, though he expressed this in the general terms of the quantity theory,* as the need to prevent great changes in the money stock:

“For the sake of economic calculation all that is needed is to avoid great and abrupt fluctuations in the supply of money. Gold and, up to the middle of the nineteenth century, silver served very well all the purposes of economic calculation. Changes in the relation between the supply of and the demand for the precious metals and the resulting alterations in purchasing power went on so slowly that the entrepreneur’s economic calculation could disregard them without going too far afield. Precision is unattainable in economic calculation quite apart from the shortcomings emanating from not paying due consideration to monetary changes. The planning businessman cannot help employing data concerning the unknown future; he deals with future prices and future costs of production. Accounting and bookkeeping in their endeavors to establish the result of past action are in the same position as far as they rely upon the estimation of fixed equipment, inventories, and receivables. In spite of all these uncertainties economic calculation can achieve its tasks. For these uncertainties do not stem from deficiencies of the system of calculation. They are inherent in the essence of acting that always deals with the uncertain future.” (Mises 1998: 225).

Mises was right on this one point, and Keynes would have agreed. But naturally Keynes and Mises would have disagreed on how best to achieve this aim, and on many other points of economic theory. I have shown here how Mises’ other comments about economic calculation can be subject to a Post Keynesian critique, particularly his unrealistic model, on the basis of flexible wages and prices, of how a modern market economy achieves economic coordination.

But, in conclusion, it is true that violent, rapid and unexpected changes in money’s purchasing power – whether it is high inflation, hyperinflation or severe deflation – are to be avoided, so that monetary calculations of businesses about investment, costs of production and profit and loss can be meaningful: pretty much every economist understands this, and the vulgar internet Austrians have no idea what they are talking about.

Note
* I am well aware that Mises and the Austrians do not wholly subscribe to the quantity theory, but have their own criticisms of it, because of the issue of Cantillon effects and how they make the quantity theory’s assumption of a proportional relationship between money supply and price level problematic. So please don’t bother pointing this out to me!

BIBLIOGRAPHY
Ingham, Geoffrey. 2011. Capitalism. Polity, Cambridge.

Keynes, John Maynard. 1923. A Tract on Monetary Reform. Macmillan, London.

Keynes, J. M. 1964 [1936]. The General Theory of Employment, Interest, and Money. Harvest/HBJ Book, New York and London.

Mises, L. 1998. Human Action: A Treatise on Economics. The Scholar’s Edition. Ludwig von Mises Institute, Auburn, Ala.