{"id":402,"date":"2021-12-18T19:22:40","date_gmt":"2021-12-18T19:22:40","guid":{"rendered":"https:\/\/www.economic-instability.com\/?p=402"},"modified":"2021-12-18T19:27:12","modified_gmt":"2021-12-18T19:27:12","slug":"waiting-for-the-judgment-day-hansen-samuelson-pigou-and-klein-on-the-classical-stationary-state","status":"publish","type":"post","link":"https:\/\/www.economic-instability.com\/?p=402","title":{"rendered":"Waiting for the judgment day: Hansen, Samuelson, Pigou and Klein on the classical stationary state"},"content":{"rendered":"
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Stefan Lochner, Last Judgement, c. 1435. Wallraf-Richartz Museum, Cologne. Source: https:\/\/commons.wikimedia.org\/wiki\/File:Stefan_Lochner_-_Last_Judgement_-_circa_1435.jpg<\/a><\/figcaption><\/figure>\n

This post is based on parts of an article accessible here<\/a>. All comments are welcomed.<\/p>\n

The multiplier-accelerator model (see this post<\/a> on Samuelson\u2019s multiplier-accelerator model) conveyed a gloomy vision of the world in which economies running out of net private investment or public expenditures were doomed to stabilize in a stationary state below full employment. Once there, nothing guaranteed that full employment could be reached through price flexibility, a problem referred to by Samuelson, as \u201cKeynes\u2019s gloomy Day of Judgment\u201d (1941: 549).<\/p>\n

Unlike his American colleagues, the Cambridge (UK) Professor Arthur Cecil Pigou (1941) did not share that pessimism. As he argued in his 1941 book Employment and Equilibrium<\/em>, if the economy came to stabilize in such a stationary state, unemployment would eventually cause cuts in money wages followed by falls in prices and interest rates and rises in investment. Samuelson doubted that such a mechanism could do the job. This is because, as he made it clear in his 1941 review of Pigou\u2019s book – there may not exist a positive rate of interest at which saving out of full employment income would be zero. So, Samuelson concluded, averting \u201cthe Day of Judgment\u201d necessarily involved \u201cto hope for the appearance of dynamic new investment outlets and broad institutional changes in saving habits brought about by changes in the age distribution, changes in public and private finance, etc., rather than rely upon the slender reed of the interest rate’s effects on motivation\u201d (Samuelson, 1941: 549).<\/p>\n

Pigou was not unsympathetic to the argument but as he argued in his 1943 article on \u201cThe classical stationary state,\u201d even if the fall of the rate of interest proved insufficient to restore full employment through new investments, the fall in the price level would be sufficient by encouraging consumption. For Samuelson, this \u201crosy theory of long-run equilibrium\u201d (Samuelson, 1941: 549) could work only as long as expectations did not play a destabilizing role.<\/p>\n

When Lawrence Klein worked on his PhD dissertation under the supervision of Samuelson in the early 1940s, he came up with a graphical representation of the arguments raised in the debate, when he drew investment and savings schedules that did not meet for a positive rate of interest at full employment levels of income.<\/p>\n

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Two sets of investment and savings curve for two different levels of income; at the full employment level of income, the solid lines of investment and savings do not cross for a positive rate of interest. For a lower income level, an equilibrium is found (dashed lines) but there is some unemployment. Source: Klein (1944: 97).<\/figcaption><\/figure>\n

One thus gets a decreasing investment curve showing that as the interest rate diminishes investment increases, and an increasing savings curve showing that as the interest rate increases, savings increase. For a specific shape of both curves, it is perfectly possible that they may intersect at a negative and thus unreachable rate of interest. Now, if one assumes that the amount of savings depends positively on the level of prices, when prices fall, the savings curve will shift leftward. Since there are less savings and more consumption, full employment equilibrium can be reached for a lower level of investment, because less investment outlets are needed to offset the aggregate savings. Eventually, prices will fall enough so that the level of investment necessary to maintain an equilibrium of full employment can be reached for a positive rate of interest.<\/p>\n

The following application reproduces the issues at stake in the debate: Klein’s graphical representation of the investment and savings curves, and the effect of prices which impact the position of the savings curve. A level of full employment income can be specified, and one can change parameters to see how best to obtain this level. An IS curve representing the points where the goods market is in equilibrium is shown on the right panel: when prices are falling this curve will shift upward and full employment can be reached, as per Pigou’s theory; one should note that since there are no dynamic considerations that are introduced here, nothing can be said on the stability of this equilibrium with shifting prices.<\/p>\n