In my post on the Austrian Business Cycle Theory Jan, a regular commenter on Lord Keynes’ blog, once again brought up the Stockholm School of economics. He has been doing this on Lord Keynes’ blog for as long as I can remember and there has so far never been a proper discussion.

What was the Stockholm School? They were a group of economists working in Sweden in the first half of the 20th century who, like Keynes, were followers of the Swedish economist Knut Wicksell who had expanded the latter’s theories to take into account shortfalls in aggregate demand. The two main figures were Bertil Ohlin and Gunnar Myrdal.

I am only really familiar with the work of the latter — and even then, only in a highly abridged edition entitled The Essential Gunnar Myrdal from which I derive all the quotes in the following post. It seems to me that the purely economic work of Myrdal and Ohlin is very hard to come by in English.

In what follows we will focus on what Myrdal considered to be his main contribution to Keynesian theory; that is, the distinction between ex post and ex ante in the analysis of savings and investment.

This distinction, which came from a book called Monetary Equilibrium which the Post-Keynesian economist G.L.S. Shackle called “the most undervalued work of economic theory ever written”, strikes me as being extremely useful in discussing the equilibrium/disequilibrium of savings and investment. Many Post-Keynesians would later come to realise this.

In Monetary Equilibrium Myrdal writes that:

A criticism of Keynes and Hayek would have to begin by pointing out the fact that in their theoretical systems there is no place for the uncertainty factor and anticipations. (Pp32)

This may strike Post-Keynesians as being a rather unusual statement. After all, doesn’t the General Theory contain an extensive discussion of “animal spirits” and action undertaken in the face of uncertainty? Yes, it does but what Myrdal is complaining about is that the actual theoretical framework of the General Theory, which is static, cannot really accommodate these observations. He writes:

It is good proof of Keynes’ intuitive genius that he reaches practical results that in many respects are very much superior to his deficient statements of certain theoretical problems. (ibid)

Myrdal goes on to say that if we introduce the distinction between ex post and ex ante we can avoid much theoretical confusion. Before we turn to this statement let us allow Myrdal to define what he means by these terms:

Quantities defined in terms of measurements made at the end of the period in question are referred to as ex post; quantities defined in terms of action planned at the beginning of the period in question are referred to as ex ante. (Pp34)

He then goes on to make the salient point that it is only by keeping this in mind that the Keynesian framework can fruitfully be applied to the analysis of savings and investment in real historical time:

Looking backward on a period which is finished, we are looking at actually realized returns, costs, etc., as those items are registered in the bookkeeping of business. In such an ex post calculation there is, as we will show later, an exact balance between the invested waiting and the value of gross investment [Phil: he appears to mean savings and investment]. Looking forward there is no such balance except under certain conditions which remain to be ascertained. In the ex ante calculus it is a question not of realized results but of anticipations, calculations, and plans driving the dynamic process forward. Had this distinction been kept in mind, much confusion about “saving and investment” would have been avoided. There is in fact no contradiction at all between the statement of an exact bookkeeping balance ex post and the obvious inference that in a situation in which saving is increasing without a corresponding increase in investment, or perhaps with an adverse movement in investment, there must be a tendency ex ante to disparity. (ibid)

Let us not doubt the importance of this distinction. Myrdal is perfectly correct that it is not to be found properly articulated in the General Theory which was indeed embedded in a static framework rather than one suited to the analysis of economic processes embedded in actual historical time. Indeed, it was the role of uncertainty and expectations that Keynes had to stress in the follow-up 1937 article to the book that attempted to clarify the central argument, The General Theory of Employment.

It is also now widely realised by Post-Keynesians that a failure to properly recognise this problem led to the misrepresentation of Keynes’ central argument in the ISLM diagram; indeed, it was for this reason that John Hicks, the inventor of the ISLM, abandoned the framework in his mea culpa 1980 article ISLM: An Explanation.

With all that in mind I will leave the reader with a quote from Joan Robinson and John Eatwell’s excellent classroom book An Introduction to Modern Economics in which they clearly realise the problem that the idea of a static equilibrium between savings and investment has caused in the minds of economists since Keynes put it forward in his General Theory. What’s more, they also realise this problem in properly Myrdalian terms:

In the early days of the exposition of Keynes’ General Theory it was usual to argue as follows:

Y = C + I

Y = C + S

Therefore, I = S

But, since net investment and net saving are accounting identities, this was not a legitimate argument; it allowed hostile critics to create confusion. An ex-post accounting identity, which records what happened over, say, the past year, cannot explain causality; rather, it shows what has to be explained. Keynes’ theory did not demonstrate that the rate of saving is equal to the rate of investment, but explained through what mechanism this is brought about. (Pp216-217, my emphasis)

Alas, however, it was too late. Such classroom texts soon fell out of print and into oblivion and the ISLM came to reign supreme. It might be interesting to note that Paul Samuelson thought Myrdal’s work to be “anti-climactic”; a sure sign that Post-Keynesians should pay close attention!