Sraffa, Keynes and'The Years of High Theory'

Review of Political Economy, Volume 13, Number 3, 2001 Sraffa, Keynes and ‘The Years of High Theory’ MATIAS VERNENGO Center for Economic Policy Analysis, New School for Social Research, 80 Fifth Avenue, New York 10011, USA This paper argues that Shackle’s interpretation of ‘the years of high theory’ is  awed. Shackle (1967) sees Sraffa’s critique of the Marshallian theory of value only as a step in the development of the theory of imperfect competition. In the same vein, Shackle reduces the message of Keynes’s General Theory to the claim that unemployment results from the existence of uncertainty and irrational expectations. Thus, Shackle leaves open the possibility that both Sraffa’s critique of Marshall and Keynes’s theory of effective demand do not question the internal coherence of neoclassical theory, but instead merely assert that market imperfections render it irrelevant for the analysis of the real world. This paper argues, in contrast, that the theories of Sraffa and Keynes should be interpreted as radical departures from marginalism, and represent a return to the surplus approach of classical political economy. 1. Introduction G. L. S. Shackle argues in The Years of High Theory that ‘there began in the mid-1920s an immense creative spasm, lasting for fourteen years until the Second World War, and yielding six or seven major innovation s of theory, which together have completely altered the orientation and character of econom- ics’ (Shackle, 1967, p. 5). However, by 1967, the two most important develop - ments of this period—Keynes’s principle of effective demand and Sraffa’s criticism of the Marshallian theory of value—were rapidly fading from the main corpus of mainstream theory. The relative ease with which neoclassical economics reasserted its main conclusions is, in fact, explained by Shackle’s account of those years. First, Sraffa’s critique of the Marshallian theory of value is seen only as a step in the development of the theories of imperfect competition by Joan Robinson and Edward Chamberlin.1 Second, Keynes’s General Theory is seen as stating that unemployment results from the existence of uncertainty and irrational expecta- tions (Shackle, 1967, p. 129). Both developments can be interpreted as asserting The author would like to thank, without implicating, Edward Nell, Massimo Pivetti, Louis-Philippe Rochon and an anonymous referee for their valuable comments. 1 In fact, there is no reference in Shackle’s book to the relation between Sraffa’s 1926 ‘manifesto’ and his later work. ISSN 0953-825 9 print/ISSN 1465-3982 online/01/030343-1 2 Ó 2001 Taylor & Francis Ltd DOI: 10.1080/0953825012005518 6 344 Matias Vernengo that market imperfections render neoclassical theory, although internally coher- ent, irrelevant for the analysis of the real world. Shackle’s position has been in uential among post-Keynesians , who also believe that Keynes’s main contribution was to show that, in the real world, true uncertainty might lead to persistent unemployment (see Asimakopulos, 1990; Minsky, 1990). The emphasis on uncertainty has also contributed to the view that Sraffa’s and Keynes’s contribution s are incompatible. This essay is con- cerned with the misinterpretatio n of Sraffa’s and Keynes’s ideas in post-Keyne- sian thought. It argues that their contribution s are compatible, and that both authors thought that monetary factors are crucial for understandin g the working of the capitalist economy. 2. The Years of High Theory I: Sraffa on in ation and distribution Piero Sraffa came to economics via monetary economics, a route that he shared with Ricardo and Keynes. His dissertation for the Law Degree, L’In azione Monetaria in Italia Durante e Dopo la Guerra (Sraffa, 1920), dealt with postwar in ation and the return to the Gold Standard, the same topic of Keynes’s Tract on Monetary Reform (Keynes, 1923). In many respects, his analysis seems conventional , since its explanation of in ation is ultimately based on the Quantity Theory of Money. According to the Quantity Theory, the origins of any in ationary process are to be found in irresponsibl e Ž scal policies of governments. Budget deŽ cits lead to an increase in the supply of money, and, consequently, to higher prices. Sraffa was in the camp of monetary orthodoxy, that is, he accepted the Quantity Theory of Money. His concern was with the question of the desirability for the Italian economy of returning to the pre-war gold parity. In this respect, his work resembles that of Keynes in the Tract, which Sraffa translated into Italian. In accordance with the Quantity Theory, Sraffa (1920, p. 16) argues that the privilege of seignorage allows governments to Ž nance themselves through the in ation tax, and that the solution to the in ationary problem is to restore sound money either by reducing expenditure or raising revenues. Up to this point, his analysis is completely conventional. It is in the solutions to restore the value of a depreciated currency that his alternative views on income distributio n appear. Sraffa (1920, p. 17) notes that there are two alternative routes to restore the convertibilit y of a depreciated currency into gold: a de ationary policy of withdrawing circulating money until the previous purchasing power is re-established, or accepting the new purchasing power. In oppositio n to his thesis director, Luigi Einaudi, he favored the latter course of action. The basis of his argument resides in the asymmetric effects of in ation and de ation, and the negative effects of de ationary policies. Accord- ing to Eatwell & Panico (1987, p. 447), in the analysis of the asymmetric effects of in ation and de ation Sraffa reveals the heterodox character of his position, more akin with the works of the classical authors and Marx than the conven- tional marginalist analysis. Sraffa (1920, p. 22) emphasizes that ‘it is generally acknowledged that such abundance [of money], by making exchanges easier and by making industrial  Sraffa, Keynes and ‘The Years of High Theory’ 345 and commercial proŽ ts grow through the price increase, is a strong stimulus to industria l growth.’ The opposite would be the case in a monetary contraction. In addition, he argues that a gradual de ation would cause more damage than a sudden decrease in prices: the gradual withdrawal of the notes issued during the war would produce severe damage to the economy. Not only would a gradual de ation have a negative impact on the level of activity, but its effects on the distributio n of income between debtors and creditors would not restore the previous situation, since ‘the creditors damaged by in ation are not the same as those who would beneŽ t from the contraction’ (Sraffa, 1920, p. 23). Not only would creditors receive an unexpected premium, but also de ation would affect the real wage. Initially, real wages would increase with the fall in prices. However, with the rise in the real burden of debt, some debtors become insolvent, and eventually some factories would close, increasing unemployment, unless wages fall (Sraffa, 1920, pp. 23–24). In that case, en- trepreneurs have an incentive to reduce wages. By contrast, in an in ationary situation, when real wages are falling, ‘the initiative must be taken by workers in the battle for wage increases’ (Sraffa, 1920, p. 24). In Sraffa’s framework, monetary policy can affect the equilibrium or normal real wage (Panico, 1988a, p. 12). Class con ict determines the normal real wage, and monetary policy affects the distributiv e variables through its effect on prices. After a change in monetary policy, changes in the price level affect the real wage. Once the forces that in uence the value of money cease to operate, a normal value of money is established. However, this normal or equilibrium value of money is entirely conventional , and can be at any level (Sraffa, 1920, p. 24). Hence, a priori, there was no reason for the Italian government to re-establish convertibility at the pre-war parity.2 The notion that social con icts and monetary factors determine the normal real wage was part of Sraffa’s analysis, although several elements of his analysis were still conventional , e.g. the acceptance of the Quantity Theory and of the Purchasing Power Parity theory. Sraffa’s criticism of the Marshallian theory of supply represents an anal- ogous situation, in the sense that some elements of the conventiona l marginalist views were still present. His critique can be summarized in the following way. First, rising costs derive from diminishing returns to substitution , and, therefore, in the general case where there are no Ž xed factors, increasing costs do not seem to exist. Secondly, increasing returns are incompatible with perfect competition. In the long period, when the Ž rm cannot experience marginal costs arising from the existence of some Ž xed input, there can be no diminishin g returns. Replica- tion is always possible, except for the case of indivisibilities . In addition, Sraffa showed that increasing returns to scale are inconsisten t with the notion of perfect 2 Another, often neglected, indication of Sraffa’s alternative view on distribution can be found in his debate with Angelo Tasca on the revaluation of the lira (Sraffa, 1927, pp. 180–191). Sraffa notes that the revaluation of the lira must be seen as an attempt by the Fascist government to obtain the support of the working class, since the real wage is favored by such a measure (Sraffa, 1927, p. 181; Potier, 1991, p. 53). The external value of the currency affects, as it were, domestic income distribution. 346 Matias Vernengo competition. 3 In the case of increasing returns, the average cost is decreasing, implying that the marginal cost is below average variable cost, and, hence, there is no Ž nite, non-zero solution for the proŽ t maximization problem. In other words, there is a tendency for the Ž rm to expand to inŽ nite size. Sraffa’s argument proves the failure of perfectly competitive assumptions to determine any equilibrium of the individual Ž rm. Two alternatives are opened by Sraffa’s critique of Marshallian theory. If it is not legitimate to treat average cost as either increasing or decreasing within the framework of perfect competition, we are left with the result that the only satisfactory assumption is that of constant returns. On the other hand, ‘everyday experience shows that a very large number of undertakings work under condi- tions of individual diminishing costs’ (Sraffa, 1926, p. 543), which suggests that we should instead abandon the notion of perfect competition.4 The fact that increasing returns and imperfect competition are present in his 1926 article suggests that ‘at least up to 1926, Sraffa was not yet prepared to abandon completely the supply-and-demand framework’ (Mongiovi, 1996, p. 216). It also seems reasonable to assume that Sraffa was not aware in 1926 that the classical theory was not developed in terms of constant returns, since he argues that ‘in normal cases the cost of production of commodities produced competitively … must be regarded as constant in respect of small variations in the quantity produced’ (Sraffa, 1926, p. 540–541).5 Sraffa considered the imperfect competition approach to be the only logical way to develop the theory of value along Marshallian lines. However, he showed no inclination to pursue this solution, and he appears to have already been working toward the revival of the classical approach. The origins of this project can be traced back to his early draft of the opening propositions of the Production of Commodities, which he asked Keynes to read in 1928 (Sraffa, 1960, p. vi).6 In Production of Commodities, Sraffa indicates that the money rate of interest might regulate the real rate of proŽ t (Sraffa, 1960, p. 33). This prop- osition is important in itself, since it implies that monetary policy has an effect on income distribution . Yet, even more important, is the effect of the monetary explanation of distributio n for the theory of employment developed by Keynes in the 1930s. As we will discuss in the following section, the deŽ ciencies of the Keynesian theory of interest can be re-interpreted under the light of Sraffa’s contribution. 3 The only case in which increasing returns would be compatible with perfect competition would be generated by ‘those economies which are external from the point of view of the individual Ž rm, but internal as regards the industry in its aggregate.’ However, this type of scale economies ‘constitute precisely the class which is most seldom to be met with’ (Sraffa, 1926, p. 186). 4 The original Italian version of Sraffa’s article referred just to the Ž rst alternative (Sraffa, 1925, p. 88). 5 Sraffa’s last attempt to argue in terms of constant returns was made in 1926 (Panico & Salvadori, 1994, pp. 324–325). The method of ‘given quantities’, used in the Production of Commodities, was introduced shortly after his 1926 article. 6 In fact, as early as 1932, Maurice Dobb presented the ‘corn model’ interpretation of Ricardo. Dobb (1932, p. 35) acknowledges his debt to Sraffa for that interpretation of the classical system.  Sraffa, Keynes and ‘The Years of High Theory’ 347 Shackle’s failure in 1967—well after the publication of Production of Commodities—to acknowledge the importance of the revival of classical politi - cal economy to the debates of the 1930s represents a serious inadequacy of his interpretation of ‘the years of high theory’. 3. The Years of High Theory II: Keynes on in ation and employment Keynes’s views on monetary issues in the early 1920s were far more conven- tional than those of Sraffa, although both shared the view that a return to the Gold Standard was an error. As Milgate (1983, p. 44) argues, in his debate with Pigou on the Gold Standard Keynes criticizes the latter’s views on policy, but not his theoretical position. Keynes’s criticism of the Cunliffe Report’s recom- mendation in favor of a return to gold at the pre-war parity—a recommendation strongly favored by Pigou, the only academic member of the Committee—was based on the short-run effects of such a measure. Keynes maintained in ‘The economic consequences of Mr. Churchill’ (Keynes, 1925) the same two alterna- tives foreseen in the Tract (Keynes, 1923, p. 116): de ation or devaluation. Both alternative policy prescriptions—price stability and exchange rate stability—are based on the Quantity Theory of Money and the Purchasing Power Parity theory. The monetary authority can choose to restore the pre-war parity, opting for exchange rate stability, and, as a result, the price level should fall. War Ž nance led to unbalanced budgets, and this, in turn, led to higher in ation in Britain than abroad. The only way to restore the purchasing power of sterling was a domestic de ation. De ation is not desirable, argues Keynes, because its short-term effects are harmful. The arguments against de ation fall into two camps. In the Ž rst place, ‘de ation which causes falling prices means impoverishment to labour and to enterprise by leading entrepreneurs to restrict production, in their endeavour to avoid loss to themselves; and is therefore disastrous to employment’ (Keynes, 1923, pp. 35–36). However, in 1923, Keynes did not consider unemployment to be the worst consequence of de ationary policies. In his view, ‘the most cogent reason for permanent depreciation, that is to say devaluation, … is generally to be found in the fact that a restoration of the currency to its former value would raise the current annual burden of Ž xed charges of the National Debt to an insupportabl e level’ (Keynes, 1923, p. 53).7 By 1925, however, Keynes’s concerns had shifted to the effects of the return to gold on employment. The only way to avoid the unemployment that followed ‘Mr. Churchill’s policy of improving the exchange rate by 10 per cent was … a policy of reducing every one’s wages’ (Keynes, 1925, p. 245). Accord- ing to Keynes, the experts of the Cunliffe Committee committed two serious 7 Keynes cites the case of Germany, where ‘the National Debt has been by those means [in ation] practically obliterated’ (Keynes, 1923, p. 54). But the fact that Keynes was in favor of a permanent depreciation should not be interpreted as an advocacy of  exible exchange rates. The objective, as noted by Smithin & Wolf (1993, p. 369), was the management of the exchange rate to achieve domestic goals. 348 Matias Vernengo mistakes. 8 In the Ž rst place, they miscalculated the value of the necessary revaluation of sterling. In the second place, and more importantly, they ‘misun- derstood and underrated the technical difŽ culty of bringing about a general reduction of internal money values’ (Keynes, 1925, p. 250). The working class would not agree to a reduction in money wages without guarantees that the cost of living would also fall. Moreover, de ation would have negative distributiv e effects, and a great amount of money would be transferred ‘into the pockets of the rentiers out of the pockets of the rest [of society]’ (Keynes, 1925, p. 250). As a result, the working class would resist, and social con ict would continue ‘until those who are economically weakest are beaten to the ground’ (Keynes, 1925, p. 248). Faced with rising unemployment, Keynes changed the emphasis of his analysis. It is true that he still thought of unemployment as a short-term phenomenon, in line with marginalist analysis.9 Yet Keynes was departing from the traditional policy prescriptions of the marginalist analysis. He no longer saw the Gold Standard, free trade, and balanced budgets as adequate policies for the economy. The rupture with these policies, and the necessity to Ž nd theoretical foundations for the new policies demanded by the new institutiona l environment, paved the way for the analytical revolution of The General Theory. According to Peter Clarke, Keynes’s policy views have to be placed in the context of his political views, which were related to the New Liberalism of Asquith and Lloyd George: If the Old Liberalism of the nineteenth century had been associated with the achievement of political democracy … the New Liberalism of the twentieth should identify with social democracy. The end of laissez faire was pro- nounced; the politics of collectivism, state intervention, and redistributive taxation were enunciated. Just as there was no necessary antithesis in theory between liberalism and socialism, so, it was claimed, there was no need for con ict in practice between the Liberal party and Labour. (Clarke, 1988, p. 13) Not surprisingly , Keynes proclaims ‘The end of laissez faire’, and argues that ‘it is not a correct deduction from the Principles of Economics that enlightened self-interest always operates in the public interest’ (Keynes, 1926, p. 312). The fact that the economic system was unable to lead to the best possible outcome means that government intervention has a role to play. In line with this view, Keynes (1929) argued in favor of public works in the pamphlet entitled ‘Can Lloyd George do it?’10 The defeat of his policy prescriptions appears to have led Keynes to believe that only an intellectual victory, in the dominion of ideas, and not vested 8 Pigou was the expert Keynes had in mind. Milgate (1983, p. 40) notes that Keynes held Pigou, the only academic economist on the Committee, responsible for the return to gold at the pre-war parity. 9 This is the context of Keynes’s famous remark that ‘economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is  at again’ (Keynes, 1923, p. 65). 10 Keynes’s argument was a response to the Treasury view, according to which no permanent additional employment could be created by government expenditure. Richard Kahn’s development of the multiplier was, in fact, partly inspired by the political critique of the Treasury view. See Kahn (1984, p. 91).  Sraffa, Keynes and ‘The Years of High Theory’ 349 interests, would permit a reversal of misguided policies. In his 1932 lectures at Cambridge, he embraced the idea that the economy could settle into a position of long-run equilibrium with unemployment.11 The development of this prop- osition is contained in the principle of effective demand. The principle of effective demand contends that the level of expenditure determines the level of income. In a draft of the General Theory, Keynes writes that his aim is to replace Say’s Law, ‘[t]he propositio n that supply creates its own demand … [with] the proposition that expenditure creates its own income, i.e. an income just sufŽ cient to meet the expenditure’ (Kenyes, 1971–82, (henceforth JMK) Vol. XXIX, p. 81). In The General Theory, he conŽ rms that the main conclusion of his theory is that the economy ‘oscillate[s], avoiding the gravest extremes of  uctuation in employment and in prices in both directions, round an intermediate position appreciably below full employment’ (Keynes, 1936, p. 254). Investment expenditure and the multiplier determine the level of output, and variations in the level of output bring about the adjustment of savings to investment. Therefore, the rate of interest must be determined in a different fashion from what is claimed by orthodox theory. Keynes Ž rst developed the theory of output, and then elaborated his monetary theory of interest as an afterthought. 12 However, the theory of interest proved to be the Achilles heel of Keynes’s theory of unemployment equilibrium . There are two different theories of the rate of interest in The General Theory (Shackle, 1967, p. 130). The Ž rst, based on the marginal efŽ ciency of capital is found in Chapter 11; the second, rooted in the animal spirits of entrepreneurs in an environment of fundamental uncertainty, is contained in Chapter 12. Keynes’s theory of output and employment is seriously weakened by the inclusion, in both versions, of an inverse relation between investment expenditure and the rate of interest. If investment is an elastic function of the rate of interest, then there must be some rate of interest corresponding to a full-employment volume of investment. This interest rate that corresponds to the full-employment level of invest- ment is equivalent to the Wicksellian natural rate of interest, and its existence in The General Theory ‘gave strength to most of the views against which Keynes had directed his work in those years’ (Panico, 1988b, p. 138).13 Milgate (1977, 11 Keynes’s Treatise on Money was still grounded in the traditional orthodox analysis, in which unemployment is only a temporary phenomenon. It is generally assumed that Keynes changed his views under the in uence of the discussions of the Cambridge Circus. Yet, interestingly enough, it was Pigou who pointed out that Keynes’s fundamental equations implied that the level of prices, and not the level of output, adjusted for changes in investment and savings (Milgate, 1983, p. 47). 12 Keynes tells us that ‘the initial novelty lies in my maintaining that it is not the rate of interest, but the level of incomes which ensures equality between saving and investment. The arguments which lead up to this initial conclusion are independent of my subsequent theory of the rate of interest, and in fact I reached it before I had reached the latter theory. But the result of it was to leave the rate of interest in the air’ (Keynes, 1937, p. 212). For a discussion of the role of liquidity preference in The General Theory see Milgate (1977). 13 Panico (1988b, p. 140) is essentially correct in afŽ rming that Keynes’s ‘intention … was to present a theory of the rate of interest, in opposition to the dominant one, which determined the “natural” rate of interest independently of monetary considerations.’ In fact Keynes (1936, p. 242) argues that 350 Matias Vernengo p. 313) argues that ‘Keynes had attempted to portray the internal problems of the “classical” theory of interest as part of the more general problem of orthodox capital theory.’ However, under the in uence of Roy Harrod ‘the criticisms concerning the internal logic of the “classical” position are considerably wa- tered-down.’ In fact, in the critique of the classical theory of interest in Chapter 14 of The General Theory, Keynes leaves room for the interpretation that if the level of income were given then the classical theory of interest would apply (Milgate, 1977, p. 314); that is, for the view that the classical theory and Keynes’s theory are special cases of a more general theory. Arguably, the synthesis of the Liquidity Preference (Keynes) and Loanable Funds (classics) theories in the 1950s was the result of the belief that both theories are special cases of a more general theory. According to Panico (1987, p. 215) the development of the ISLM model ‘established what Hicks had hinted in his reviews of the General Theory, that is, that in a general equilibrium analysis to attribute the determination of a price or of a distributiv e variable to the attainment of equilibrium in one speciŽ c market makes no sense.’ The responsibilit y for resolving the inconsistenc y in the theory of interest as developed by Keynes fell on his closest collaborators, Joan Robinson and Richard Kahn. Their contributio n was based on Keynes’s argument that ‘the rate of interest is a highly conventiona l … phenomenon. For its actual value is largely governed by the prevailing view as to what its value is expected to be’ (Keynes, 1936, p. 203). As Pivetti (1996, p. 77) notes, Robinson and Kahn defended ‘Keynes’ interpretation of the rate of interest as a monetary phenom- enon susceptible to policy determination—provided the authoritie s act with a sufŽ cient measure of ‘persistence and consistency’. In Robinson’s Accumulation of Capital (Robinson, 1956) and Kahn’s Memorandum to the Radcliffe Com- mittee (Kahn, 1958), the monetary authority exogenously determines the rate of interest. In the view of Robinson and Kahn, the monetary authority can, to a great extent, in uence the prevailing view as to what the rate of interest is expected to be. More importantly, there is no necessary inverse relation between the conventional rate of interest and investment. Another member of the Cambridge Circus, Sraffa, undermined the foundations of the factor substitutio n mechanism upon which the notion of an inverse relation between the interest rate and the volume of investment rests.14 In this sense, Sraffa’s work is crucial for the development of Keynes’s theory of employment. Once the inverse relation between interest rates and investment spending is rejected, the fundamental proposition of The General Theory—the possibility of equilibrium with unemployment in the long run—is established. The interpret - Footnote 13 continued ‘it was a mistake to speak of the natural rate of interest or to suggest that the above deŽ nition would yield a unique value for the rate of interest irrespective of the level of employment.’ 14 Sraffa (1960, p. 33), it should be mentioned, suggested that ‘the rate of proŽ ts … is accordingly susceptible of being determined from outside the system of production, in particular by the level of the money rates of interest.’ Sraffa’s view of the money rate of interest as an exogenous variable of the system is analogous to Keynes’s treatment of the conventional level of the interest rate.  Sraffa, Keynes and ‘The Years of High Theory’ 351 ation of the development of Keynes’s thought proposed here, emphasizes his rupture with the marginalist approach. On this reading, the Marshallian remnants in his book are to be seen as weaknesses of his argument, which represent the difŽ culties of shedding habitual modes of thought and expression. It is also true that, although Keynes never embraced the heritage of classical political economy and Marx, as Sraffa did, his analysis is compatible with that of the classical authors; in fact, the radical conclusion that unemployment can be a long-run phenomenon can only be established within the limits of the surplus approach. 4. On the Compatibility between Keynes and Sraffa In the previous sections, we established that the work of Sraffa and Keynes should be understood as breaks with the marginalist analysis. This appears to be the opposite of the view defended by Shackle (1967, p. 294), who argues that Sraffa … honoured the language of Marshall and of much of the earlier writers, but [he] plainly felt that there was something wrong. … Keynes in the Treatise felt himself to be treading old ground in a somewhat different way; in the General Theory he felt himself to be breaking quite new ground. … Yet reconstruction must inevitably use much of the old material. … Invention is helpless without tradition. What Shackle means by tradition is certainly not the intellectual heritage of the classical political economists and Marx. Shackle’s position is that both Sraffa and Keynes were critical of Marshall, but developed their theories along Marshallian lines: Sraffa helped to develop the theory of imperfect competition, and Keynes showed that, in a world of fundamental uncertainty, unemployment would prevail. Post-Keynesian authors share Shackle’s view that the main contributio n of The General Theory is the formulation of a theory of the operation of the market economy in the face of uncertainty. Irreversible time and uncertainty are the real causes of persistent unemployment. The surplus approach is seen as irrelevant for Keynesian economics, given its incapacity to deal with historical time. Asimakopulos (1990, p. 331) argues that ‘attempts to “marry” the Sraffa and Keynes approaches to economic theory overlook the fundamental differences between them—the difference in the role of time and the visions of the operations of the capitalist economies implicit in these theories.’15 However, Sraffa’s theory, as developed in Production of Commodities, assumes a given level of output, and is therefore compatible with a number of possible theories of output, including the principle of effective demand. Further, 15 This is essentially the argument in Carvalho (1983–84, pp. 278–279): ‘in SrafŽ an theory … there is no place given to historical time. … The problem of analyzing time is in fact the problem of adopting a philosophy of history. … It is essential to consider the limits to action imposed by the social structure’. While it is true that Sraffa’s analysis is not dynamic, in the sense that there is no treatment of accumulation in his book, it is difŽ cult to see how it can be argued that there is no room for historical time. That is, if by historical time it is understood that institutions, and the social structure impose restrictions to the working of the economy in an irreversible way. The fact that prices of production act as centers of gravitation for market prices does not in any sense imply that economic processes are reversible in time. 352 Matias Vernengo as we have seen, the validity of Keynes’s theory depends upon the abandonment of marginalist principles. In that sense, Keynes and Sraffa are complementary to each other (Eatwell, 1979). In addition to the analytical complementarity, it is possible to notice another similarity between Keynes and Sraffa. Both held a vision of the capitalist system in which monetary factors are crucial for the long-term equilibrium of the economy. For Keynes, monetary factors are crucial for the determination of the level of output, whereas for Sraffa monetary factors are important for income distribution. As is well known, Keynes was clear that monetary policy could affect the long-run equilibrium of the economy. Furthermore, the absence of a natural rate of interest means that there is more than one long-run equilibrium . Keynes argues that ‘there is no unique long-period position of equilibrium equally valid regardless of the character of the policy of the monetary authority. On the contrary there are a number of such positions corresponding to different policies’ (JMK, Vol. XXIX, pp. 54–55). Thus, Keynes understood that the possibility of long-run unemployment equilibrium rests on the denial of the existence of a natural rate of interest, that is, a unique level of the rate of interest compatible with full employment. As argued in the previous section, however, the only coherent way of getting rid of the notion of a natural rate is to abandon the marginalist theory of distribution . Thus, the attainment of Keynesian long-run unemployment equilibrium depends on the SrafŽ an rehabilitatio n of the classical surplus approach. Abandoning the marginalist theory of distribution implies that there is no inverse relation between the interest rate and the level of investment. This is crucial to prove that the Keynes and Pigou effects are not operative.16 But this does not mean that changes in the interest rate do no not have any impact on the level of activity. Lavoie & Seccareccia (1988, p. 151) argue that Keynes’s advocacy of low interest rate policies was related to his income distribution concerns: ‘much of this concern with the problem of distributio n arises out of his monetary theory. This is because changes in the rate of interest have both a direct and indirect impact on the distributio n of income between rentiers and the “active earning class” of workers and entrepreneurs.’ For Keynes monetary policy has a direct effect on income distribution , as in Sraffa. Pivetti (1985, p. 100) observes that ‘if money plays an important role in determining income distribution , it will also play an important role in the determination of the level and composition of output’. Keynes was perfectly aware of the effects of income distributio n on the level of output. For him The transfer from wage-earners to other factors is likely to diminish the propensity to consume. The effect of the transfer from entrepreneurs to rentiers is more open to doubt. But if rentiers represent on the whole the richer section 16 In a situation of unemployment, if wages and prices fall, real balances would rise, reducing the interest rate. If a fall of the interest rate does not lead to higher spending, then the self-adjusting character of the economy is not re-established.  Sraffa, Keynes and ‘The Years of High Theory’ 353 of the community and those whose standard of life is least  exible, then the effect of this will also be unfavourable. (Keynes, 1936, p. 262) Keynes envisaged the euthanasia of the rentier by cheap money policies that would arise from the political necessity of solving the two ‘outstandin g faults’ of the capitalist system, namely: ‘its failure to provide full employment and its arbitrary and inequitable distributio n of wealth and incomes’ (Keynes, 1936, p. 372).17 In sum, my interpretation differs from the post-Keynesian rendition of the Sraffa–Keynes relation in two essential respects: it emphasizes the analytical compatibility of Sraffa’s and Keynes’s theories, and it recognizes that both regarded monetary factors as crucial for the determination of output and income distribution . Moreover, for both authors, the understanding of the rate of interest as determined by the monetary authority was part of a struggle of escape from the Quantity Theory of Money, which both authors had accepted in the early 1920s. 5. Concluding Remarks In contrast to the post-Keynesia n view that the theoretical frameworks of Keynes and Sraffa are incompatible, I contend that Sraffa’s work is essential for the full development of the Keynesian Revolution. In particular, the Shacklean interpret - ation of the ‘years of high theory’ is misleading. Shackle interprets the theories of Sraffa and Keynes as saying that the imperfections of the real world render an essentially coherent neoclassical theory irrelevant for the analysis of the real world. Against this view, I argue that the theories of Sraffa and Keynes constitute a radical departure from marginalism. In particular, it seems that the possibilit y of a long-run position of unemployment equilibrium , crucial to Keynes, is only possible with a return to the long forgotten theories of the classical political economy authors associated with the surplus approach. 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