On Keynes’s August 27th and 30th, 1935 Exchanges with Harrod, Who Acknowledged That Keynes Had Discovered the Missing LM Equation Needed to Complete the Classical –Neo Classical Theory of the Rate of Interest: The Ignorance of This Exchange, in Volume 13 of the CWJMK, Explains Why Economists, Who Have Written on Keynes, Have Overlooked His IS-LM Model in Section Four of Chapter 21 of the General Theory
45 Pages Posted: 25 Nov 2019
Date Written: November 13, 2019
Economists who have been writing on Keynes’s General Theory since 1936 have been unable to understand, grasp or comprehend Keynes’s clear statements in chapter 21 of the General Theory that ”… if we have all the facts before us, we shall have enough simultaneous equations to give us a determinate result” on p.299 of the General Theory and/or Keynes’s statement that “the quantitative effect could be derived from the three elements” on page 298 of the General Theory.
This failure to grasp that Keynes is analyzing his IS-LM(LP) model in chapter 21,as he said he would do in greater detail than he did in section 4 of Chapter 15 in a footnote on page 209, has led to the false conclusion for the last 81 years that there was no IS-LM(LP) analysis provided by Keynes in the General Theory, when, in fact, this analysis, which is central to the entire General Theory, is provided in explicit fashion.
The question of why no economist in the 20th or 21st century ,who has written on Keynes’s General Theory, has demonstrated any inkling about what Keynes was doing in chapter 21 of the General Theory, requires an analysis involving cognitive dissonance, group think, and the Benthamite Utilitarian orientation of the economics profession. Harrod’s clear admission, in his letter to Keynes of August 30th, 1935, that Keynes had incorporated his LM equation, missing from classical and neoclassical theories of the rate of interest, as specified on page 199 of the General Theory, to create a complete theory of the rate of interest, requires a complete revision of the history of economic thought regarding Keynes and the General Theory. Keynes’s discovery was a major theoretical achievement because Keynes had demonstrated to Harrod in his letter of August 27th that the classical and Neoclassical theory was simply a single downward sloping IS curve in (Y,R) space that intersected nothing.
Keynes, exhibiting great patience and care with Harrod in their correspondence of 1935, gradually walked Harrod through the construction of Keynes’s IS-LM(LP) model .It is in Keynes’s letter of August 27th, 1935, where Keynes demonstrated to Harrod in a post script that the classical and neoclassical theory of the rate of interest was indeterminate because there was only a single , downward sloping IS curve in Keynes’s (r,Y) space. Harrod showed that he had finally understood the IS-LM model in his letter to Keynes of August 30th,1935, when he acknowledged that Keynes had made a major contribution and had reconstituted the theory of the rate of interest by having discovered the missing LM equation that made the previous theory determinate: “…has to be determined by some new equation not provided for in the classical system. Thus the way is clear for a radical reconstruction. Your new equation is the liquidity preference schedule…”. (Harrod, 1973, CWJMK, Vol. 13,p.550).
The point made by Keynes to Harrod in his letter of August 27th, 1935 was carefully incorporated by Keynes in chapter 14 of the General Theory on pages 179-182 concerning the” missing data” provided by the LM equation, in Keynes‘s 1937 QJE article in his reply to Viner about the need to emphasize the completely elastic range of the LM curve, and in his two point summary on pp.222-223 of his conclusion of the 1937 QJE article, in which he identified what was missing from the neoclassical theory of the rate of interest that dealt only with the IS(mec) curve –the LM curve.
It is quite impossible for Hicks to have first developed the IS-LM model in his April,1937 Econometrica article, as asserted by Krugman. This erroneous claim also represents the major error in Colin Champion’s recent 2019 work on the General Theory, which is partially based on a mistaken assessment by B. DeLong of the 1937 QJE article that overlooks the first point made in Keynes’s summary on pp.222-223, which was that the fundamental error of classical and neoclassical economics was a mistaken theory of the rate of interest, which was caused by their having overlooked the existence of uncertainty, as opposed to risk, in decision making.
Keywords: IS-LM, IS-LP(LM), Harrod, Hawtrey, Keynes, chapter 21, pages 179-182 of GT, letter of August 30, 1935
JEL Classification: B10, B12, B14, B16, B20, B22
Suggested Citation: Suggested Citation