PKSG SEMINARJUNE, 5TH 2012

SHORT PERIOD AND LONG PERIOD IN MACROECONOMICS: AN AWKWARD

DISTINCTION

ELEONORA SANFILIPPO(UNIVERSITY OF CASSINO, ITALY)

Robinson College, Cambridge

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Introduction2

I was kindly invited here by Dr. Hayes to present my paper on the use of the notions of Short Period and Long Period in Macroeconomics – a paper which has recently been published in the Review of Political Economy (Vol. 23, n. 3, pp. 371-388, July 2011).

This publication represents a further development of a research that I started many years ago, at the time when I wrote my PhD thesis (in 2000) on the notion of equilibrium in Keynes’s General Theory.

The aim of the paper3

The aim of the paper is to show that the meaning of the concepts of short period and long period is often unclear and may be seriously misleading when applied to macroeconomic analysis.

What seems particularly difficult to grasp is

the exact content to be given to them, as well as the analytical assumptions underlying them.

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One of the main problems seems to

lie in the fact that the meanings attributed to these methodological tools change accordingly to the different macroeconomic models and approaches, making comparison between them very difficult.

Short and long period in microeconomics:

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As is well-known, in microeconomic analysis both concepts refer to the equilibrium position of a firm or industry. To put it in a very simple manner, the short period is defined as a context in which the productive capacity is given and what can vary with the fluctuations in demand is the intensity of the use of this given capacity;

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while the long period is a framework in which the productive capacity can change to adjust to variations in the level of demand. This distinction (as originally conceived by Marshall) was essentially linked to the ‘length’ of time necessary for the adjustment of supply to demand conditions in each specific market.

No confusion arises in microeconomic analysis

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In microeconomics the meaning of short period and long period is clearly identified and any scholar can refer to these concepts with enough confidence that no misunderstandings can arise.

My fundamental point is that these definitions become much less clear and more controversial when we move to macroeconomics.

The confusion in macroeconomics: two evidences8

To show the ambiguities arising when the concepts of short period and long period are employed in an aggregate framework, I provide two main evidences:

(i) one is given by the interpretative debate (which took place in the 1980s and 1990s) aiming at establishing whether Keynes’s General Theory should be considered as a short- or long-period analysis of the aggregate level of output;

(ii) the other by the different uses (or misuses) of these concepts that are currently made in macroeconomics textbooks (see for example Stiglitz 1997, Krugman-Wells 2005, Lipsey-Crystal 2006, Blanchard 2009).

The 1980s and 1990s debate

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Let me start with a brief recollection of the debate.

Although Keynes’s General Theory has

been widely considered as a ‘short-period’ analysis, it is easy to detect in the literature two different types of short-period interpretations, which refer to two different contents (or definitions) of ‘short period’:

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(1) The ‘Neoclassical’ interpretations of Keynes’s model - which are, by far, the best known (e.g. Modigliani 1944, Klein 1947, Meade 1978). They impinge on what has been called by Leijhonhufvud (1968) the ‘imperfectionist view’, which is based on the assumption that, once given enough time to change variables, like the wage level, kept ‘in the pound’ in the short period, the economic system necessarily tends in historical time towards an optimal long-period equilibrium, by means of automatic mechanisms.

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From the perspective of the present paper we include under this group the New Keynesian interpretations of Keynes’s model (Lindbeck and Snower, 1986, Shapiro and Stiglitz 1984) but also those interpretations that define Keynes’s unemployment equilibrium as a ‘disequilibrium’ position (Clower 1965, Barro and Grossman 1976, Malinvaud 1977).

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Indeed all these contributions share the idea that unemployment emerges as a short-period phenomenon due to the existence of various rigidities in the economic system and they also share the implicit or explicit assumption that in the long period these rigidities will disappear and the economy will naturally tend to a full employment level of output.

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(2) The Post-Keynesian interpretations which, referring to Marshall’s original framework, consider the General Theory as an application, or extension, of the Marshallian ‘short-period’ to an aggregate framework (see for example Davidson 1978, Asimakopoulous 1989, Lim 1990). Differently from the Neoclassical ones, these interpretations do not adhere to the view that unemployment will be necessarily re-absorbed in the long period. On the whole, the Post-Keynesians do not attribute so much importance to the concept of long period.

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Beside the short period interpretations of Keynes’s model we find in the debate also a different interpretative approach (taken by Eatwell and Milgate 1983), which associates Keynes’s equilibrium with ‘a long-period position of classical type’ (contra see Garegnani, 1983).

And finally we should also mention other interpretations (for example by Nell 1983, Bhattacharjea 1987, Carvalho 1990, Amadeo 1992, Park 1994), which extend the relevance of Keynes’s theory to the long period, all grounding on textual and/or analytical elements that are present in the General Theory.

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The debate just recalled is, according to me, a particularly telling example (and proof) of the ambiguous meanings attributed to short and long period in macroeconomics and of the difficulties of communication among different theoretical approaches in macroeconomics, due to the lack of a common ground even at a purely semantic level.

Short period in macroeconomics 16

Looking also at the macroeconomics textbooks, it emerges that:

The short period is usually associated to a given quantity of capital (as in microeconomic analysis) and/or to a rigidity of prices and wages.

Very often it is also identified with a situation in which a differential exists between actual and potential output (the latter being understood as a full employment and stable position).

Sometimes but not always the short period is also meant to describe simply a situation of short duration in calendar time.

Long period in macroeconomics

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The long period is sometimes associated with the full flexibility of prices and wages but – strangely enough – also with the assumption of an unchanging capital (differently from the definition of the long period in microeconomics), and refers to a context in which there is equality between the actual output and a given potential output (Think for example to the AS-AD model).

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Sometimes it refers to a context of growth of potential GDP and changes in productive capacity (growth models).

Very often but not always the long period is identified with the achievement of a full employment position (in which change is ruled out), provided that a ‘sufficient’ – but not univocally specified - length of time is given to the self-adjusting mechanisms to operate.

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The list is not complete because we can also consider the Neoricardian models of growth, wherein the long period positions are not conceived as full employment positions but simply as situations in which the productive capacity is adjusted to the level and composition of demand.

It is possible, in my view, to reduce this variety of meanings basically to two different ways of conceiving the long period:

Two different ways of conceiving the long period

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(i) one as a dynamic context

characterized by changing capital, where some fundamental forces are at work and some fundamental tendencies can be detected;

(ii) the other as a final position, possessing some specific characteristics, where there are no incentives to change or where opposite forces counterbalance.

The problem of a ‘given capital’

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It seems quite evident, therefore, that one possible source of ambiguity derives from the use of the same wording to refer to two different things: the gravitation process towards a final position and the final position itself.

Obviously in the former, the capital cannot be conceived as given neither in quantity nor in form during the gravitation process, while in the latter it is possible to assume a condition of given capital stock, since all changes have already happened.

The main source of ambiguity

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My opinion is that, beside what can be considered as a terminological confusion, there is also a conceptual ambiguity which relates to the distinction itself.

Two uses of these concepts in fact seem to me to be juxtaposed:

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(i) One in which the distinction is purely logical and some analytical characteristics are supposed to distinguish the short from the long period, without necessarily referring to a particular duration in historical time.

(ii) The other in which the distinction is, instead, chronological in the sense that a specific length in terms of calendar time is attributed respectively to the short and long period and that it is with the mere passing of time that the system goes from the former to the latter.

Possibles explanations24

The paper also suggests two possible explanations for the ambiguities arising when the distinction between short run and long run is employed in macroeconomics:

one has to do with the fact that these tools were originally introduced by Marshall at a micro level and cannot easily be extended to a macroeconomic context of the analysis

another seems to derive from the habit – which Keynes firstly criticized (Collected Writings of JMK, vol. XXIX: 54-55) – of identifying the long period with an ‘optimal’ position.

Difficulties in adapting the Marshallian distinction at a macro level25

Let me examine first the difficulties arising in the application to aggregate models of methodological tools ‘invented’ for the partial equilibrium analysis.

In the case of a single firm or industry the assumption of a given productive capacity takes on a definite and concrete meaning, and the short period as a logical device can also have a definite chronological duration.

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On the aggregate level instead you can still apply a logical short period but it is far more difficult to give it a content in terms of historical time. One year can be a ‘short period’ for some industries and a ‘very long period’ for some others, in which the physical capital can be far more easily adjusted over a span of the year.

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As far as the second explanation is concerned, it was Keynes himself who, in the preparatory works of the GT, criticized – as a source of confusion - the erroneous identification between the long period and optimal positions:

‘…there is no reason to suppose that positions of long-period equilibrium have an inherent tendency or likelihood to be positions of optimum output’ (CWK, vol. XXIX: 55).

Keynes’s ‘ceteris paribus’ method

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  Let me now clarify Keynes’s method by recalling this fundamental and well-known passage of the GT:

“We take as given the existing skill and quantity of available labour, the existing quality and quantity of available equipment, the existing technique, the degree of competition, the tastes and habits of the consumer, the disutility of different intensities of labour and of the activities of supervision and organisation, as well as the social structure including the forces, other than our variables set forth below, which determine the distribution of the national income” (GT: 245).

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It is fundamentally on the basis of this passage that the General Theory has been interpreted as a short-period model.

My claim is that applying the distinction between short and long period to the interpretation of Keynes’s method of analysis proves not particularly useful and, on the contrary, a source of misunderstanding.

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I do not deny that the hypothesis of a given productive capacity is used by Keynes, nor that the General Theory is mostly built on this assumption. The idea suggested here is that this assumption should not be linked to the traditional distinction between short- and long-period analysis at a disaggregate level but should be considered simply as an application of the ceteris paribus method, as a logical device to cope with continuous changes taking place in economic reality.

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This is why in Keynes’s model the assumption of fixed plants does not seem linked in any significant way to the length in historical time of the period considered in the analysis. The lack of this link can be attributed to the awareness by Keynes of the crucial role played by ‘fundamental uncertainty’ in the economy, and to the need to take this element into account at both the analytical and methodological levels.

An awkward distinction in macroeconomics

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The difficulties related to the existence of several meanings attributed to the long period (and to its distinction from the short period) are still there in modern macroeconomics literature.

In the Neoclassical interpretations of Keynes’s model the long period is simply a context in which the rigidities are relaxed, and unemployment absorbed, while the level of capital is still given in the economic system.

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In the neoclassical theory of growth, on the other hand, the long period is a position of full equilibrium both of labor and capital, towards which the system tends, if enough time is given to the adjustment mechanisms to operate.

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In the Post-Keynesian approach the traditional concept of long-period intended as a gravitation centre is rejected in favor of an analysis of structural dynamics, in which the effects of changes in the level of capital are fully considered but the introduction of the uncertainty à la Keynes makes indeterminate ‘the final point’ the system will reach in its evolution through time.

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In the Sraffian or Neo-Ricardian approach the long-period position is derived from the classical theory and considered as a point of attraction for the system in real time, even though full employment is not guaranteed.

Finally, we can just mention the ‘rational expectations’ approach à la Lucas, where the short period is simply identified with a context in which people do not revise their expectations, while the long period is a context in which, thanks to the revision process, economic agents are able to capture the underlying structure of the economy, which basically coincides with the walrasian equilibrium framework.

Conclusions36

My provocative suggestion is: do not apply this distinction in macroeconomics

– where it is a source of confusion and misunderstanding – but use the ‘ceteris paribus method’, where the given factors, independent and dependent variables are made explicit in each model in use, according to the specific quaesitum of the analysis.

This is exactly what Keynes did in his General Theory (Ch. 18), where he never made reference to the distinction ‘invented’ by his Master, we may guess because he was fully aware of the difficulties arising when it is applied to models and contexts other than those assumed by Marshall himself.

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In his biographical essay on Marshall, Keynes referring to short and long period concepts wrote:

‘All these are path breaking ideas which no one who wants to think clearly can do without. Nevertheless this is the quarter in which, in my opinion, the Marshall analysis is least complete and satisfactory, and where there remains most to do’ (Keynes 1924: 351).

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I hope that my discussion reveals just how well-founded this observation by Keynes eventually proved to be.

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THANKS