Managing the Loss: How Pigou Arrived at the Pigou Effect

The Pigou effect was conceived to counter Keynes’s argument that a competitive economy could remain in the state of high unemployment. Before he introduced this idea, Pigou had debated with Keynes the same question of whether an economy has the tendency to recover full employment. He lost in this controversy. A few years later came Pigou’s renewed attempt with the Pigou effect. This study points to two oddities in the way he presented the effect. One is that Pigou had used an almost identical framework he used for the Pigou effect several years before but that at that time, he did not mention the effect. This suggests that Pigou discussed the real balance effect to recover his denied conclusion. The other oddity is that Pigou did not mention real situations as an example in the discussion of the Pigou effect while he did at the time of the controversy. It is probable that he recognized the relevancy of the effect to the reality was limited. I conclude that his sole aim in the discussion of the effect was to recover his loss without damaging the Keynesian framework in the policy field, which he came to appreciate after the controversy.