Sunday, February 01, 2009

Leijonhufvud's Corridor

The ideas of a number of economists have been cited in popular accounts of the current economic crisis.

Some have been calling this a "Minsky moment" and have been exploring the Post Keynesian economist Hyman Minsky. In building on this trend, Michael Perelman sees connections to Marx's views on fictious capital. I have pointed out Hugh Townshend basically describing (in 1937) the housing crisis as part of his account of

Another popular interpretation points to erroneous Austrian Business Cycle Theory. For some reason - probably political, although I'm willing to accept ignorance also - very few who go on about the ABCT bring up the Austrian concept of the "secondary depression". Yet this epicycle would seem to be precisely relevant as the crisis becomes a general downturn, instead of being more restricted to financial institutions.

Another interesting idea, although one I am not sure I agree with, is Axel Leijonhufvud's corridor. Leijonhufvud became famous for arguing "Keynesians" had misinterpretated Keynes. As I understand it, his interpretation is closely related to that offered by Robert Clower in his 1965 paper, "The Keynesian Counter-Revolution: A Theoretical Appraisal". Clower argues that households, in making consumption and savings decisions, are constrained by realized income, not by the income they would receive at a point of full-employment equilibrium. Clower and Leijonhufvud end up with thinking of Keynes as describing a disequilibrium. I think Keynes claimed to have described an equilibrium that could be consistent with the presence of involuntary unemployment.

I think Leijonhufvud developed his notion of the corridor later. The corridor constitutes time paths near enough to full employment. If the economy falls outside the corridor, agents no longer have well-developed norms and expectations about what happens that are mutually consistent and likely to quickly lead the economy back to full employment.

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