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.

Human Action Implies a Rejection of the Notion of Economic Equilibrium as an End-State

There is a close relationship between the Austrian conception of economic equilibrium and the key methodological aspect of this school. This is the notion that economics is a science of human action.

Mises (1949) defined human action as ‘conscious or purposeful behaviour’. He rejected the notion that economic individuals are ‘automatons’ who passively react to given means and given ends. Take the example of a rational agent who maximizes utility subject to constraints. The outcome of this maximization process is completely determinate given that one knows the objective function and the constraining conditions. The Austrians do not consider this type of choice-making meaningful, purposeful behaviour because it lacks a distinctive human element. Anyone facing the same objective function and constraints would make the same decision, a rare condition for people of flesh and blood. The notion of human action gives a much richer portrait of human existence. It assumes that people select their own ends and choose means to attain those ends. For an individual to act is a personal affair and touches the heart of being human. In the words of Mises: ‘Action is the essence of his nature and existence, his means of preserving his life and raising himself above the level of animals and plants’ (ibid., 18). What makes action human is the fact that it is goal-oriented or purposeful behaviour. People are conscious beings and they use their brain to imagine a future in which life is better. Their actions are directed at making that dream become reality and although they know that disappointments are a fact of life, they will not stop trying. Man ‘is not only homo sapiens, but no less homo agens’ (ibid., 14) which is governed by the lifelong quest to improve his living conditions, whatever disappointments and setbacks he may find on his path.

One of the key tenets of the Austrian tradition is that human action implies a rejection of the notion of economic equilibrium as an end-state. When equilibrium means that every participant in a market realizes his plans, or in neoclassical terminology ‘maximizes utility’, no one has an incentive to change his or her behaviour. This is the end of economic activity and the negation of human action. ‘A man perfectly content with the state of affairs would have no incentive to change things. He would have neither wishes nor desires; he would be perfectly happy. He would not act; he would simple live free from care’ (Mises 1949, 13).

—Bert Tieben, The Concept of Equilibrium in Different Economic Traditions: An Historical Investigation (Cheltenham, UK: Edward Elgar Publishing, 2012), 302-303.