Keynes Tried to Do the Impossible: Reconciling Money and Equilibrium

Multiplier-accelerator models had trouble dealing with money. The analysis of the cycle in terms of multiplier-accelerator interaction could be conducted entirely in real terms. Thus the role of money often came in as an afterthought. In order to accomplish that link the LM-curve had to be accounted for and that could be done by assuming that it was horizontal. As Laidler (1999) stresses, in that way one cut out any feedback from the monetary system that might disturb the smooth operation of whatever linear-difference-equation dynamics were to be analyzed. Thus even with explicit dynamics it appeared that the role of money was not so fundamental as Keynes had claimed it to be.

Kohn (1986) attributes this failure of the Keynesian revolution to a basic error in Keynes’s thinking. In his view, Keynes had tried to do what was undoable, namely to reconcile money and equilibrium. In order to explain the role of money, one needs to introduce uncertainty or specific market failures, assumptions that are incompatible with the conditions of equilibrium, which requires perfect knowledge, plan coordination or market clearing on all markets et cetera. This internal inconsistency of the GT [Keynes's General Theory] was quickly resolved by those who further developed Keynesian economics. They dropped the monetary factor and retained the assumption of equilibrium as the foundation of their work.

—Bert Tieben, The Concept of Equilibrium in Different Economic Traditions: An Historical Investigation (Cheltenham, UK: Edward Elgar Publishing, 2012), 391-392.