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History of Political Economy 32.3 (2000) 693-694
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Fabricating the Keynesian Revolution:
Studies of the Inter-war Literature on Money, the Cycle, and Unemployment
Fabricating the Keynesian Revolution: Studies of the Inter-war Literature on Money, the Cycle, and Unemployment. By David Laidler. Cambridge: Cambridge University Press, 1999. xvi; 380 pp. $74.95.
When the author of one great book, The Golden Age of the Quantity Theory (1991), writes another, it really is too much, and such is the case with the one before us. As every historian of economic thought knows, pre-Keynesian macroeconomics was the quantity theory of money, and this is a book about interwar macroeconomics before, during, and just after the publication of Keynes’s General Theory. What is great about this book is not its thesis—that the IS-LM interpretation of Keynes was less than what Keynes had wrought and to that extent J. R. Hicks’s “Mr. Keynes and the Classics” was a fabrication of the Keynesian Revolution. This is a thesis too well known, argued at first by Joan Robinson and then even by Hicks himself, to require applause in 1999. It is a great book, not because of its familiar central message, but because of the rich detail with which it embroiders this message. Rarely have the ideas of Mises and Hayek in Austria, Myrdal, Lindahl, and Ohlin in Sweden, Lavington, Robertson, Pigou, and Hawtrey in England, and Fisher, Mitchell, Hansen, Douglas, and Viner in the United States been better expounded.
If this story has a hero, it surely is Knut Wicksell and his “cumulative process.” The idea that a gap between the “natural rate” and the “market rate” of interest, between the yield of capital invested in production and the loan rate that must be paid to borrow that capital from banks, is capable in a fractional reserve banking system of generating an unstable credit boom, appears first in the writings of the Austrians and the Stockholm school but then in various muted forms in the works of practically all interwar monetary economists, showing up at last in IS-LM analysis itself. The quantity theory was a theory about the relationship of the money supply to the price level, and that theory had always consisted of both a direct “transmission mechanism” from money to price via the level of spending, and an indirect “transmission mechanism” that works by way of the effect of the rate of interest on [End Page 693] the demand for real balances. Wicksell threw new emphasis on the latter and hence on saving and investment as the central relationship in monetary theory.
The quantity theory as far back as John Stuart Mill and even David Hume had always been more than a theory of the price level. Money was said to be neutral in the long run but nonneutral in the short run, and that short-run nonneutrality of money provided Mill, and certainly Alfred Marshall, with a starting point for theorizing about fluctuations in output and employment even before Wicksell had set pen to paper. It is that emphasis on the short run—an emphasis that virtually ignored the long-run neutrality of money that is the shibboleth of every modern textbook statement of the quantity theory—that became the very hallmark of interwar macroeconomics. This is what Axel Leijonhufvud rightly called “the Wicksell connection,” the crucial role of bank credit in the coordination failure of saving and investment decisions. Elements of that Wicksell connection are preserved in the IS part of IS-LM analysis, just as elements of the quantity theory are enshrined in the LM part. In other words, as David Laidler puts it, “there was no intellectual vacuum in monetary economics when the General Theory was published. There existed no monolithic and atrophied orthodoxy detached from economic reality and therefore ripe for overthrow…. There was no substance whatever to those old myths about the nature of macroeconomics before 1936. Rather, the General Theory must be seen as a contribution to...