Reflections on the Pure Theory of Money of Mr. J.M. Keynes
Introduction by Joseph T. Salerno
Friedrich A. Hayek was only thirty-two years old when he published this two-part article in Economica, at the time, the world’s leading English-language economics journal. The article is a review essay of John Maynard Keynes’s two-volume book, A Treatise on Money, published the previous year. Keynes, a generation senior to Hayek, was at the time the leading economist of the British Cambridge School and had already achieved world renown as a public intellectual. Keynes worked hard and long on his treatise, having written the first page six years before it was published. Keynes clearly intended the work to be his magnum opus, a dazzling leap forward in the theory of money based on “a novel means of approach to the fundamental problems of monetary theory.”
But Keynes’s reach was much, much longer than his grasp given his parochial and stunted training in economic theory—one course in economics and the study of Alfred Marshall’s clunky and disjointed textbook. Keynes’s Treatise never stood a chance. For the brilliant and courageous young Hayek was waiting, having already fully absorbed and integrated in his own work Mises’s monetary and business cycle theories, Böhm-Bawerkian-Wicksellian capital theory, and the general analytical approach of the broad Austrian school from Menger onward that maintained an unwavering focus on the interrelationship among all economic phenomena.
Hayek’s article is a positive thrill to read. Hayek relentlessly scrutinizes and exposes the weak and patchwork structure of Keynes’s theoretical arguments and then dismantles it brick by brick, leaving nothing standing. Keynes’s reaction reveals just how deeply Hayek’s review cut as well as Keynes’s cavalier attitude toward intellectual pursuits. Keynes’s reply to the first part of Hayek’s article, which dealt with the first, purely theoretical volume of the Treatise, was not properly a reply at all but a critique of Hayek’s book Prices and Production. Upon publication six months later of the second part of Hayek’s article, which focused on the second, applied volume of the Treatise and in which Hayek was a bit more complimentary, Keynes remarked to Hayek, “Oh never mind, I no longer believe all that.”
Yet Keynes was not done. A month later, Keynes, as chief editor of the Economic Journal published a nasty review of Hayek’s Prices and Production written by one of Keynes’s more uncomprehending and rabid disciples, Piero Sraffa. Keynes’s fellow Cambridge economist, Arthur C. Pigou, was aghast at this behavior. Without naming names, Pigou wrote, “A year or two ago, after the publication of an important book, there appeared an elaborate and careful critique of a number of passages in it. The author’s answer was, not to rebut the criticism, but to attack with violence another book, which the critic had himself written several years before. Body-line bowling. The methods of the duello. That kind of thing is surely a mistake.”
Keynes’s response to his painstaking review of the Treatise was very discouraging for Hayek. In later years, Hayek often said that the reason he did not undertake a similar review of Keynes’s later and more influential General Theory was because Keynes so easily changed his mind and that he could not be sure that Keynes would have not done so again, once more rendering Hayek’s efforts for naught. Whether a scholarly review by Hayek of such a shrewdly designed tract for the times like the General Theory would have altered the course of economic theory and policy is problematic in any case.
The article you are about to read demonstrates that Hayek was a formidable economic disputant even at a relatively young age. But it also signifies a broader point about Hayek’s early work that has been sorely neglected by the continuing outpouring of works from the cottage industry of Hayek commentators, interpreters, and biographers. Hayek’s amazing burst of creativity from the late 1920s through the late 1930s was a product of his participation in the great theoretical controversies of the time. His opponents were some of the great (and not so great) figures in interwar economics: Keynes, W.T. Foster and W. Catchings, Ralph Hawtrey, Irving Fisher, Frank Knight, Josef Schumpeter, Gustav Cassel, Alvin Hansen, A.C. Pigou, Arthur Spiethoff to name a few.
Perhaps the greatest economic controversialist of the twentieth century by the age of forty, Hayek took on all comers without fear or favor and in a series of brilliant books and articles, notably Monetary Theory and the Trade Cycle, Prices and Production, Monetary Nationalism and International Stability, “The Paradox of Saving,” “The Mythology of Capital,” and the present article he had synthesized and elaborated the first positive statement of modern Austrian “macroeconomics.”
The appearance of any work by Mr. J.M. Keynes must always be a matter of importance: and the publication of the Treatise on Money1 has long been awaited with intense interest by all economists. Nonetheless, in the event, the Treatise proves to be so obviously—and, I think, admittedly—the expression of a transitory phase in a process of rapid intellectual development that its appearance cannot be said to have that definitive significance which at one time was expected of it. Indeed, so strongly does it bear the marks of the effect of the recent discovery of certain lines of thought hitherto unfamiliar to the school to which Mr. Keynes belongs, that it would be decidedly unfair to regard it as anything else but experimental—a first attempt to amalgamate those new ideas with the monetary teaching traditional in Cambridge and pervading Mr. Keynes’s own earlier contributions. That the new approach, which Mr. Keynes has adopted, which makes the rate of interest and its relation to saving and investing the central problem of monetary theory, is an enormous advance on this earlier position, and that it directs the attention to what is really essential, seems to me to be beyond doubt. And even if, to a Continental economist, this way of approach does not seem so novel as it does to the author, it must be admitted that he has made a more ambitious attempt to carry the analysis into the details and complications of the problem than any that has been attempted hitherto. Whether he has been successful here, whether he has not been seriously hampered by the fact that he has not devoted the same amount of effort to understanding those fundamental theorems of “real” economics on which alone any monetary explanation can be successfully built, as he has to subsidiary embellishments, are questions which will have to be examined later.
That such a book is theoretically stimulating goes without saying. At the same time, it is difficult to suppress some concern as regards the immediate effect which its publication in its present form may have on the development of monetary theory. It was, no doubt, the urgency which he attributes to the practical proposals which he holds to be justified by his theoretical reasoning, which led Mr. Keynes to publish the work in what is avowedly an unfinished state. The proposals are indeed revolutionary, and cannot fail to attract the widest attention: they come from a writer who has established an almost unique and well-deserved reputation for courage and practical insight; they are expounded in passages in which the author displays all his astonishing qualities of learning, erudition and realistic knowledge, and in which every possible effort is made to verify the theoretical reasoning by reference to available statistical data. Moreover, most of the practical conclusions seem to harmonize with what seems to the man in the street to be the dictates of common sense, and the favorable impression thus created will probably not be diminished at all by the fact that they are based on a part of the work (Books III and IV) which is so highly technical and complicated that it must forever remain entirely unintelligible to those who are not experts. But it is this part on which everything else depends. It is here that all the force and all the weakness of the argument are concentrated, and it is here that the really original work is set forth. And here, unfortunately, the exposition is so difficult, unsystematic, and obscure, that it is extremely difficult for the fellow economist who disagrees with the conclusions to demonstrate the exact point of disagreement and to state his objections. There are passages in which the inconsistent use of terms produces a degree of obscurity which, to anyone acquainted with Mr. Keynes’s earlier work, is almost unbelievable. It is only with extreme caution and the greatest reserve that one can attempt to criticize, because one can never be sure whether one has understood Mr. Keynes aright.
For this reason, I propose in these reflections to neglect for the present the applications, which fill almost the whole of Volume II, and to concentrate entirely on the imperative task of examining these central difficulties. I address myself expressly to expert readers who have read the book in its entirety.2
Book I gives a description and classification of the different kinds of money which in many respects is excellent. Where it gives rise to doubts or objections, the points of difference are not of sufficient consequence to make it necessary to give them space which will be much more urgently needed later on. The most interesting and important parts consist in the analysis of the factors which determine the amounts of money which are held by different members of the community, and the division of the total money in circulation into “income deposits” and “business deposits” according to the purpose for which it is held. This distinction, by the way, has turned up again and again in writings on money since the time of Adam Smith (whom Mr. Keynes quotes), but so far it has not proved of much value.
Book II is a highly interesting digression into the problem of the measurement of the value of money, and forms in itself a systematic and excellent treatise on that controversial subject. Here it must be sufficient to say that it deals with the problem in the most up-to-date manner, treating index-numbers on the lines developed chiefly by Dr. Haberler in his Sinn der Indexzahlen, as expressions of the changes in the price-sum of definite collections of commodities—its main addition to the existing knowledge of this subject being an excellent and very much needed criticism of certain attempts to base the method of index numbers on the theory of probability. For an understanding of what follows, I need only mention that Mr. Keynes distinguishes as relatively less important for the purposes of monetary theory the Currency Standard in its two forms, the Cash Transactions Standard and the Cash Balances Standard (and the infinite number of possible secondary price levels corresponding, not to the general purchasing power of money as a whole, but to its purchasing power for special purposes), from the “Labor Power” of Money and the Purchasing Power of Money proper, which are fundamental in a sense in which price levels based on other types of expenditure are not, because “human effort and human consumption are the ultimate matters from which alone economic transactions are capable of deriving any significance” (Vol. I, p. 134).
III. Keynes’s Analysis of Profit
It is in Books III and IV that Mr. Keynes proposes “a novel means of approach to the fundamental problem of monetary theory” (Preface). He begins with an elaborate catalogue of the terms and concepts he wants to use. And here, right at the beginning, we encounter a peculiarity which is likely to prove a stumbling block to most readers, the concept of entrepreneur’s profits. These are expressly excluded from the category of money income, and form a separate category of their own. I have no fundamental objection to this somewhat irritating distinction, and I agree perfectly when he defines profits by saying that “when profits are positive (or negative) entrepreneurs will—in so far as their freedom of action is not fettered by existing bargains with the factors of production which are for the time being irrevocable—seek to expand (or curtail) their scale of operations” and hence depicts profits as the mainspring of change in the existing economic system. But I cannot agree with his explanation of why profits arise, nor with his implication that only changes in “total profits” in his sense can lead to an expansion or curtailment of output. For profits in his view are considered as a “purely monetary phenomenon” in the narrowest sense of that expression. The cause of the emergence of those profits which are “the mainspring of change” is not a “real” factor, not some maladjustment in the relative demand for and supply of cost goods and their respective products (i.e., of the relative supply of intermediate products in the successive stages of production) and, therefore, something which could arise also in a barter economy, but simply and solely spontaneous changes in the quantity and direction of the flow of money. Indeed, throughout the whole of his argument the flow of money is treated as if it were the only independent variable which could cause a positive or negative difference between the prices of the products and their respective costs. The structure of goods on which this flow impinges is assumed to be relatively rigid. In fact, of course, the original cause may just as well be a change in the relative supply of these classes of goods, which then, in turn, will affect the quantities of money expended on them.3
But though many readers will feel that Mr. Keynes’s analysis of profit leaves out essential things, it is not at all easy to detect the flaw in his argument. His explanation seems to flow necessarily from the truism that profits can arise only if more money is received from the sale of goods than has been expended on their production. But, obvious as this is, the conclusion drawn from it becomes a fallacy if only the prices of finished consumption goods and the prices paid for the factors of production are contrasted. And, with the quite insufficient exception of new investment goods, this is exactly what Mr. Keynes does. As I shall repeatedly have occasion to point out, he treats the process of the current output of consumption goods as an integral whole in which only the prices obtained at the end for the final products and the prices paid at the beginning for the factors of production have any bearing on its profitableness. He seems to think that sufficient account of any change in the relative supply (and therefore in the value) of intermediate products in the successive stages of that process is provided for by his concept of (positive or negative) investment, i.e., the net addition to (or diminution from) the capital of the community. But this is by no means sufficient if only the total or net increment (or decrement) of investment goods in all stages is considered and treated as a whole, and the possibility of fluctuations between these stages is neglected; yet this is just what Mr. Keynes does. The fact that his whole concept of investment is ambiguous, and that its meaning is constantly shifting between the idea of any surplus beyond the reproduction of the identical capital goods which have been used up in current production and the idea of any addition to the total value of the capital goods, renders it still less adequate to account for that phenomenon.
When I come to the concept of investment I shall quote evidence of this confusion. For the present, however, let us assume that the concept of investment includes, as, in spite of some clearly contradictory statements of Mr. Keynes it probably should include, only the net addition to the value of all the existing capital goods. If we take a situation where, according to that criterion, no investment takes place, and therefore the total expenditure on the factors of production is to be counted as being directed towards the current production of consumers’ goods, it is quite conceivable that—to take an extreme case—there may be no net difference between the total receipts for the output and the total payments for the factors of production, and no net profits for the entrepreneurs as a whole, because profits in the lower stages of production are exactly compensated by the losses in the higher stages. Yet, in that case, it will not be profitable for a time for entrepreneurs as a whole to continue to employ the same quantity of factors of production as before. We need only consider the quite conceivable case that in each of the successive stages of production there are more intermediate products than are needed for the reproduction of the intermediate products existing at the same moment in the following stage, so that, in the lower stages (i.e., those nearer consumption) there is a shortage, and in the higher stages there is an abundance, as compared with the current demand for consumers’ goods. In this case, all the entrepreneurs in the higher stages of production will probably make losses; but even if these losses were exactly compensated, or more than compensated, by the profits made in the lower stages, in a large part of the complete process necessary for the continuous supply of consumption goods it will not pay to employ all the factors of production available. And while the losses of the producers of those stages are balanced by the profits of those finishing consumption goods, the diminution of their demand for the factors of production cannot be made up by the increased demand from the latter because these need mainly semi-finished goods and can use labor only in proportion to the quantities of such goods which are available in the respective stages. In such a case, profits and losses are originally not the effect of a discrepancy between the receipts for consumption goods and the expenditure on the factors of production, and therefore they are not explained by Mr. Keynes’s analysis. Or, rather, there are no total profits in Mr. Keynes’s sense in this case, and yet there occur those very effects which he regards as only conceivable as the consequence of the emergence of net total profits or losses. The explanation of this is that while the definition of profits which I have quoted before serves very well when it is applied to individual profits, it becomes misleading when it is applied to entrepreneurs as a whole. The entrepreneurs making profits need not necessarily employ more original factors of production to expand their production, but may draw mainly on the existing stocks of intermediate products of the preceding stages while entrepreneurs suffering losses dismiss workmen.
But this is not all. Not only is it possible for the changes which Mr. Keynes attributes only to changes in “total profits”) to occur when “total profits” in his sense are absent: it is also possible for “total profits” to emerge for causes other than those contemplated in his analysis. It is by no means necessary for “total profits” to be the effect of a difference between current receipts and current expenditure. Nor need every difference between current receipts and current expenditure lead to the emergence of “total profits.” For even if there is neither positive nor negative investment, yet entrepreneurs may gain or lose in the aggregate because of changes in the value of capital which existed before—changes due to new additions to or subtractions from existing capital.4 It is such changes in the value of existing intermediate products (or “investment,” or capital, or whatever one likes to call it) which act as a balancing factor between current receipts and current expenditure. Or to put the same thing another way, profits cannot be explained as the difference between expenditure in one period and receipts in the same period or a period of equal length because the result of the expenditure in one period will very often have to be sold in a period which is either longer or shorter than the first period. It is indeed the essential characteristic of positive or negative investment that this must be the case.
It is not possible at this stage to show that a divergence between current expenditure and current receipts will always tend to cause changes in the value of existing capital which are by no means constituted by that difference, and that because of this, the effects of a difference between current receipts and current expenditure (i.e., profits in Mr. Keynes’s sense), may lead to a change in the value of existing capital which may more than balance the money profits. We shall have to deal with this matter in detail when we come to Mr. Keynes’s explanation of the trade cycle, but before we can do that, we shall have to analyze his concept of investment very closely. It should, however, already be clear that even if his concept of investment does not refer, as has been assumed, to changes in the value of existing capital but to changes in the physical quantities of capital goods—and there can be no doubt that in many parts of his book Mr. Keynes uses it in this sense—this would not remedy the deficiencies of his analysis. At the same time there can be no doubt that it is the lack of a clear concept of investment—and of capital—which is the cause of this unsatisfactory account of profits.
There are other very mischievous peculiarities of this concept of profits which may be noted at this point. The derivation of profits from the difference between receipts for the total output and the expenditure on the factors of production implies that there exists some normal rate of remuneration of invested capital which is more stable than profits. Mr. Keynes does not explicitly state this, but he includes the remuneration of invested capital in his more comprehensive concept of the “money rate of efficiency earnings of the factors of production” in general, a concept on which I shall have more to say later on. But even if it be true, as it probably is, that the rate of remuneration of the original factors of production is relatively more rigid than profits, it is certainly not true in regard to the remuneration of invested capital. Mr. Keynes obviously arrives at this view by an artificial separation of the function of the entrepreneurs as owners of capital and their function as entrepreneurs in the narrow sense. But these two functions cannot be absolutely separated even in theory, because the essential function of the entrepreneurs, that of assuming risks, necessarily implies the ownership of capital. Moreover, any new chance to make entrepreneurs’ profits is identical with a change in the opportunities to invest capital, and will always be reflected in the earnings (and value) of capital invested. (For similar reasons it seems to me also impossible to mark off entrepreneurs’ profits as something fundamentally different from, say, the extra gain of a workman who moves first to a place where a scarcity of labor makes itself felt and, therefore, for some time obtains wages higher than the normal rate.)
Now this artificial separation of entrepreneurs’ profits from the earnings of existing capital has very serious consequences for the further analysis of investment: it leads not to an explanation of the changes in the demand price offered by the entrepreneurs for new capital, but only to an explanation of changes in their aggregate demand for “factors of production” in general. But, surely, an explanation of the causes which make investment more or less attractive should form the basis of any analysis of investment. Such an explanation can, however, only be reached by a close analysis of the factors determining the relative prices of capital goods in the different successive stages of production—for the difference between these prices is the only source of interest. But this is excluded from the outset if only total profits are made the aim of the investigation. Mr. Keynes’s aggregates conceal the most fundamental mechanisms of change.
I pass now to the central and most obscure theme of the book, the description and explanation of the processes of investment. It seems to me that most of the difficulties which arise here are a consequence of the peculiar method of approach adopted by Mr. Keynes, who, from the outset, analyses complex dynamic processes without laying the necessary foundations by adequate static analysis of the fundamental process. Not only does he fail to concern himself with the conditions which must be given to secure the continuation of the existing capitalistic (i.e., roundabout) organization of production—the conditions creating an equilibrium between the depreciation and the renewal of existing capital—not only does he take the maintenance of the existing capital stock more or less as a matter of course (which it certainly is not—it requires quite definite relationships between the prices of consumption goods and the prices of capital goods to make it profitable to keep capital intact): he does not even explain the conditions of equilibrium at any given rate of saving, nor the effects of any change in the rate of saving. Only when money comes in as a disturbing factor by making the rate at which additional capital goods are produced different from the rate at which saving is taking place does he begin to be interested.
All this would do no harm if his analysis of this complicating moment were based on a clear and definite theory of capital and saving developed elsewhere, either by himself or by others. But this is obviously not the case. Moreover, he makes a satisfactory analysis of the whole process of investment still more difficult for himself by another peculiarity of his analysis, namely by completely separating the process of the reproduction of the old capital from the addition of new capital, and treating the former simply as a part of current production of consumption goods, in defiance of the obvious fact that the production of the same goods, whether they are destined for the replacement of or as additions to the old stock of capital, must be determined by the same set of conditions. New savings and new investment are treated as if they were something entirely different from the reinvestment of the quota of amortization of old capital, and as if it were not the same market where the prices of capital goods needed for the current production of consumption goods and of additional capital goods are determined. Instead of a “horizontal” division between capital goods (or goods of higher stages or orders) and consumption goods (or goods of lower stages)—which one would have thought would have recommended itself on the ground that in each of these groups and sub-groups production will be regulated by similar conditions—Mr. Keynes attempts a kind of vertical division, counting that part of the production of capital goods which is necessary for the continuation of the current production of consumption goods as a part of the process of producing consumption goods, and only that part of the production of capital goods which adds to the existing stock of capital as production of investment goods. But this procedure involves him, as we shall see, in serious difficulties when he has to determine what is to be considered as additional capital—difficulties which he has not clearly solved. The question is whether any increase of the value of the existing capital is to be considered as such an addition-in this case, of course, such an addition could be brought about without any new production of such goods—or whether only additions to the physical quantities of capital goods are counted as such an addition—a method of computation which becomes clearly impossible when the old capital goods are not replaced by goods of exactly the same kind, but when a transition to more capitalistic methods brings it about that other goods are produced in place of those used up in production.
This continual attempt to elucidate special complications without first providing a sufficient basis in the form of an explanation of the more simple equilibrium relations becomes particularly noticeable in a later stage of the investigation when Mr. Keynes tries to incorporate into his system the ideas of Wicksell. In Wicksell’s system these are necessary outgrowths of the most elaborate theory of capital we possess, that of Böhm-Bawerk. It is a priori unlikely that an attempt to utilize the conclusions drawn from a certain theory without accepting that theory itself should be successful. But, in the case of an author of Mr. Keynes’s intellectual caliber, the attempt produces results which are truly remarkable.
Mr. Keynes ignores completely the general theoretical basis of Wicksell’s theory. But, nonetheless, he seems to have felt that such a theoretical basis is wanting, and accordingly he has sat down to work one out for himself. But for all this, it still seems to him somewhat out of place in a treatise on money, so instead of presenting his theory of capital here, in the forefront of his exposition, where it would have figured to most advantage, he relegates it to a position in Volume II and apologizes for inserting it (Vol. 11, p. 95). But the most remarkable feature of these chapters (27–29) is not that he supplies at least a part of the required theoretical foundation, but that he discovers anew certain essential elements of Böhm-Bawerk’s theory of capital, especially what he calls (as has been done before in many discussions of Böhm-Bawerk’s theory—I mention only Taussig’s Wages and Capital as one of the earliest and best known instances) the “true wages fund” (Vol. 11, pp. 127–129) and earlier (Vol. I, p. 308) Böhm-Bawerk’s formula for the relation between the average length of the roundabout process of production and the amount of capital.5 Would not Mr. Keynes have made his task easier if he had not only accepted one of the descendants of Böhm-Bawerk’s theory, but had also made himself acquainted with the substance of that theory itself?
V. The Process of Investment
We must now consider in more detail Mr. Keynes’s analysis of the process of investment. Not the least difficult part of this task is to find out what is really meant by the expression investment as it is used here. It is certainly no accident that the inconsistencies of terminology, to which I have alluded before, become particularly frequent as soon as investment is referred to. I must mention here some of the most disturbing instances, as they will illustrate the difficulties in which every serious student of Mr. Keynes’s book finds himself involved.
Perhaps the clearest expression of what Mr. Keynes thinks when he uses the term investment is to be found where he defines it as “the act of the entrepreneur whose function it is to make the decisions which determine the amount of the non-available output” consisting “in the positive act of starting or maintaining some process of production or of withholding liquid goods. It is measured by the net addition to wealth whether in the form of fixed capital, working capital or liquid capital” (Vol. I, p. 172).
It is perhaps somewhat misleading to use the term investment for the act as well as the result, and it might have been more appropriate to use in the former sense the term “investing.” But that would not matter if Mr. Keynes would confine himself to these two senses, for it would not be difficult to keep them apart. But while the expression “net addition to wealth” in the passage just quoted clearly indicates that investment means the increment of the value of existing capital—since wealth cannot be measured otherwise than as value—somewhat earlier, when the term “value of investment” occurs for the first time (Vol. I, p. 126), it is expressly defined as “not the increment of value of the total capital, but the value of the increment of capital during any period.” Now, in any case, this would be difficult as, if it is not assumed that the old capital is always replaced by goods of exactly the same kind so that it can be measured as a physical magnitude, it is impossible to see how the increment of capital can be determined otherwise than as an increment of the value of the total. But, to make the confusion complete, side by side with these two definitions of investment as the increment of the value of existing capital and the value of the increment, four pages after the passage just quoted, he defines the “Value of the Investment” (should the capital V or the second “the” explain the different definition?) not as an increment at all but as the “value of the aggregate of Real and Loan Capital” and contrasts it with the increment of investment which he now defines as “the net increase of the items belonging to the various categories which make up the aggregate of Real and Loan Capital” while “the value of the increment of investment” is now “the sum of the values of the additional items.”
These obscurities are not a matter of minor importance. It is because he has allowed them to arise that Mr. Keynes fails to realize the necessity of dealing with the all-important problem of changes in the value of existing capital; and this failure, as we have already seen, is the main cause of his unsatisfactory treatment of profit. It is also partly responsible for the deficiencies of his concept of capital. I have tried hard to discover what Mr. Keynes means by investment by examining the use he makes of it, but all in vain. It might be hoped to get a clearer definition by exclusion from the way in which he defines the “current output of consumption goods” for, as we shall see later, the amount of investment stands in a definite relation to the current output of consumers’ goods so that their aggregate cost is equal to the total money income of the community. But here the obscurities which obstruct the way are as great as elsewhere. While on page 135, the cost of production of the current output of consumption goods is defined as total earnings minus that part of it which has been earned by the production of investment goods (which a few pages earlier (p. 130) has been defined as “non-available output plus the increment of hoards”), there occurs on page 130 a definition of the “output of consumption goods during any period” as “the flow of available output plus the increment of Working Capital which will emerge as available output,” i.e., as including part of the as yet non-available output which, in the passage quoted before, has been included in investment goods and therefore excluded from the current output of consumption goods. And still a few pages earlier (Vol. I, p. 127) a “flow of consumers’ goods” appears as part of the available output, while on the same page “the excess of the flow of increment to unfinished goods in process over the flow of finished goods emerging from the productive prices” (which, obviously, includes “the increment of Working Capital which will emerge as available output” which, in the passage quoted before, is part of the output of consumption goods) is now classed as non-available output. I am afraid it is not altogether my fault if at times I feel altogether helpless in this jungle of differing definitions.
VI. A Picture of the Process Itself
In the preceding sections we have made the acquaintance of the fundamental concepts which Mr. Keynes uses as tools in his analysis of the process of the circulation of money. Now we must turn to his picture of the process itself. The skeleton of his exposition is given in a few pages (Vol. I, pp. 135–40) in a series of algebraic equations which, however, are not only very difficult, but can only be correctly understood in connection with the whole of Book III. In the adjoining diagram, I have made an attempt to give a synoptic view of the process as Mr. Keynes depicts it, which I hope will give an adequate idea of the essential elements of his exposition.
Diagrammatic Version of Mr. Keynes’s Theory of the Circulation of Money
Community’s Earnings Or Money Income
(The numbers in brackets denote Mr. Keynes’s first and second fundamental equations respectively.)
There is a disturbing lack of method in Mr. Keynes’s choice of symbols, which makes it particularly difficult to follow his algebra. The reader should especially remember that while profits on the production of consumption goods, investment goods, and total profits are denoted by Q1, Q2, and Q respectively, the symbols for the corresponding price levels are chosen without any parallelism as P, P’, and II. On the other hand, there is a misleading parallelism between P and P’ and I and I’, where the dash does not stand for a similar relation, but in the former case serves to mark off the price level of investment goods from that of consumption goods, and in the second case to distinguish the cost of production of the increment of new investment goods (I’) from its value (I).
* This formula is not given by Mr. Keynes.
E, which stands at the top and again at the bottom of the diagram, represents (according to the definition which opens Book III) the total earnings of the factors of production. These are to be considered as identically one and the same thing as (a) the community’s money income (which includes all wages in the widest sense of the word, the normal remuneration of the entrepreneurs, interest on capital, regular monopoly gains, rents and the like) and (b) “the cost of production.” Though the definition does not expressly say so, the use Mr. Keynes makes of the symbol E clearly shows that that “cost of production” refers
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