We conclude by observing that the nature of economic problems of more developed economies has changed so much that Keynesian policies alone are not so much relevant. Keynes argues that there is a paradox between the object of liquidity for the individual and the illiquidity of investment for the community (this is also where Keynes mentions “time and ignorance” [p. 155]). This considerably simplified his work. This is the aspect of the slump which bankers and business men have been right in emphasising, and which the economists who have put their faith in a ‘purely monetary’ remedy have underestimated.”. 180 crores, planned saving is more than planned investment so that income falls to correct the disequilibrium. And then what do we do? But the money-wage level as a whole should be maintained as stable as possible, at any rate in the short period.”. The first half of this book will be dedicated to prying it open. Modern equity markets undermine the necessity for long-term, stable investment. And while workers are obviously not all equivalent the way dollar bills are, we can take an hour of unskilled labor as our standard and count people with special skills as multiples of an hour of unskilled labor. Content Guidelines 2. Its main tools are government spending on infrastructure, unemployment benefits, and education. The points on this line fulfill the equilibrium condition in the economy: i.e. That is, if management decides to pay people $4 an hour instead of $5, people might go on strike, but nobody ever goes on strike demanding a raise because the cost of milk has gone up. At the same time we must recognise that only experience can show how far the common will, embodied in the policy of the State, ought to be directed to increasing and supplementing the inducement to invest; and how far it is safe to stimulate the average propensity to consume, without foregoing our aim of depriving capital of its scarcity-value within one or two generations. If, however, it should prove easy to secure an approximation to full employment with a rate of accumulation not much greater than at present, an outstanding problem will at least have been solved. Keynes’s work has left a deep mark on modern macro-economics. At various levels of income and employment, there will be different levels of aggregate demand, but all the levels of demand are not effective. Column 3 in the table shows that at the level of income of 50 crores, saving is negative, that is, minus 10 crores. But the actual course of events is more complicated still. Keynesian economics was founded by economist John Maynard Keynes. Let us consider what the various commodity-rates of interest over a period of (say) a year are likely to be for different types of assets. Consumption depends upon the size of income and the propensity to consume while investment depends upon marginal efficiency of capital and the rate of interest. Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. The classical view is that we are kept poor by our impatience — we insist on spending money now instead of saving it for later, when it will grow into more. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. Keynes begins the General Theory with a summary of the classical theory of employment, which he encapsulates in his formulation of Say's Law as the dictum "Supply creates its own demand". stimulus — in mind here, although he never really comes out and says it.] And the process of adjusting can have some odd effects: if you need to quickly ramp up production, you might keep hiring until you have more employees than you really need in the long-run. Use of the Wage Unit 4. 10. Thus decreased consumption leads to decreased employment. For in such matters it is rash to predict how the average man will react to a changed environment. So how does printing money affect prices? So why should the government promote investment instead of demand? As such it is called Consumption Function. The remaining chapters of Keynes's book contain amplifications of various sorts and are described later in this article. Inequality has been addressed somewhat by government redistribution, but some are hesitant to go further because they believe that growth is promoted by savings and so taking away the savings of the rich will retard growth. The point £ where the aggregate expenditure line intersects the 45° line shows that income is equal to total expenditure, Y= C + I. Perhaps the government should start buying and selling long-term bonds to address this. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism — which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object. Summary. He observed that public works need to be undertaken only as long as private investment is deficient. The C +I line lies parallel to and above C, the vertical distance between them showing investment For determining the equilibrium level of income we need the total expenditure (C + 7) line and the 45° line (Y= C+S). Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. If we expect interest rates to go up, we might want to hold on to our cash and use it to buy higher-yield bonds later. In ease of disequilibrium, planned or intended or ex-ante saving is more than or less than planned investment. But it was found that Keynes’s policies tended to create inflationary pressures to control which the government had to reduce aggregate spending. The values of income, consumption and saving shown in Table 3.1 have been plotted in Figure 3.1. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. Share Your Word File
Keynes’ economic thinking and economic policy at once became popular. [AS: I’ve been saying businesses because I find it clearer, but Keynes actually says entrepreneurs. 70 crores while their income is only Rs. The government lowers interest rates so that there’s full employment. Prices in Keynes’s model use only after full employment. Otherwise, our only relief comes from printing more money. If the national income is increased by an amount of say Rs. A shorter account will be found in the article on Keynesian economics. He writes: ”This simple yet powerful point doesn’t get the attention it ought to. Disclaimer Copyright, Share Your Knowledge
With the publication of the General Theory in February 1936, the scene shifted somewhat to new matters of defence, exposition and further development. But there’s two kinds of overinvestment: disappointing investments, where the investment would have made sense except the economy collapsed, and genuine overinvestment, where the investment could never have made money. Another thing the classical economists long mocked were laws against usury. And even if they were willing to wait, why should they trust you? In the Keynesian model, a change in money supply only affects national income through its effect on the rate of interest. “One of the chief social justifications of great inequality of wealth is, therefore, removed.”. If consumption fell at the same rate as income, we’d fall into a downward spiral: lower consumption would mean lower income, which in turn would mean lower consumption, and soon we’d all be out of a job. So business is booming and everyone’s optimistic — even though costs of production (and maybe interest rates) are rising, sales are too, so expected profits are looking good. There is no remedy but to persuade the public that green cheese is practically the same thing and to have a green cheese factory (i.e. Not much, Keynes argues. Lerner, a disciple of Keynes, called it the policy of Functional Finance. We can’t measure net output, but we can count the number of people employed. His theory is built up on the basic idea that ‘Effective Demand’ determines employment. I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work. If interest rates go up, it no longer becomes possible for them to make money, even though the machine remains unchanged. [emphasis added], 11: Imagine you get a new widget-making machine. If venture capitalists are spending all their money on useless cable, the solution is to take their money away. The straight line through the origin (Y = C + S) makes an angle of 45′ with the two axes. 4. If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary. Thus, even though we actually have no clue what the yield might be, we all agree that the current stock price is our best guess and instead of worrying about the fact we actually have no clue what the “right” stock price is whatsoever, we only have to worry about those things which will affect it (the stock price). So it’s how much people spend that determines employment. Or if there is some monopoly clement somewhere, then its degree remains unchanged. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The extraordinary achievement of the classical theory was to overcome the beliefs of the ‘natural man’ and, at the same time, to be wrong. But I think this is entirely due to a difference in philosophies: the General Theory was the first book on economics I could really understand. Simple Income Determination 7. Certain definite points on which the writer diverges from previous theories, 212. etc. And there are some, I believe, who practise the fourth, fifth and higher degrees. THE POSTULATES OF THE CLASSICAL ECONOMICS 3. In the analysis of trade cycle, theory of multiplier is an important tool Keynes’s policy of public works was based on his belief in the working of the multiplier vigorously in the depression phase. We’ll define net income as just income minus supplementary costs, since people can’t really be blamed for the unforeseen events. and measured them in wage units to be able to ignore the questions arising out of changes in relative prices of resources. Keynes in his general theory dealt with aggregates like the national income, saving, investment, etc. No, the interest rate is the “price” people demand for parting with their cash. 22: Why are there trade cycles, aka business cycles, aka booms and busts? [AS: This is truly brilliant. It was a passion with the young economists and a problem with the traditional economists. They keep doing what they did yesterday unless they have a reason to change. But these all depend on other complicating factors. If the expected rate of profitability (MEC) of an additional unit of capital asset is high, private investors would be prepared to invest, otherwise not. … The insights here have yet to be fully mined.”]. Let’s start by thinking about the end of the boom. The entrepreneur’s income is the value of his output less the prime cost — that’s what he tries to maximize. And if the interest rate falls, the economy will grow and people will need more cash for these sorts of transactions. It’s because investment comes first. Well, recovery can’t come until old equipment is used up and has to be replaced and old stocks of goods that were produced get sold off and have to be replenished. 3) It’s very easy to store — it doesn’t spoil. But since saving is just the amount of income that isn’t consumed and income is just output (output is always output to someone), savings necessarily equals investment. The equilibrium level of income is determined at Rs. Entrepreneurs can also lose capital due to unavoidable events — a market crash, an earthquake, the passage of time. money) is something which cannot be produced and the demand for which cannot be readily choked off. In this way, Keynes reduced the magnitude of employment to wage units and measured the various types of aggregative magnitudes in terms of wage units. As there is disequilibrium, income will have to rise. There are other reasons people might want to hold cash. And when national income falls, a larger proportion gets spent as people dip into savings and governments go into deficit. Most governments were helpless spectators to the deepening economic crisis because the economic advisers would not suggest any economic measures of state intervention in the economy. There are three attributes which different types of assets possess in different degrees; namely, as follows: (i) Some assets produce a yield or output q, measured in terms of themselves, by assisting some process of pro… Such public investment, he said, best achieves the multiplier effects. As I said, that’s the naive view — there are a couple complications. Earlier definitions did not throw any light on the factors which go to determine income or its relation with employment; this purpose was amply achieved in the definition adopted by Keynes. 24: The two great economic problems are unemployment and inequality. An uninterrupted process of transition, such as the above, to a new long-period position can be complicated in detail. at different points on this line total income is equal to total expenditure. Community saving is simply an aggregate of individual saving. ... x The Economics of Keynes: A New Guide to The General Theory Hayes’s subsequent explanations of the analysis and contributions of The General Theory are built on these basic, central, core foundations. they are simply bartered away; Pigou’s definition was of no use. Its importance lies in the fact that in a private enterprise economy investment depends upon it. Why don’t people just invest all their money? There are two obvious problems with this. Like “The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.” “We reach a condition where there is a shortage of houses, but where nevertheless no one can afford to live in the houses that there are.”, Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest! In which case, “a decreased readiness to spend will be looked on in quite a different light.”, [AS: And so this is the famous paradox of thrift. | Keynes’s General Theory. But how much? Finally, with the additional demand equipment and so on will have to be replaced, raising marginal costs. But unfortunately they tended to give rise to the phenomenon known as ‘stop-go’. We have seen that it’s quite the opposite — that redistribution, by increasing effective demand, promotes growth. For a country could only keep its citizens employed if it had gold, and the only way to get gold was by taking it from another country (and thus throwing them out of work). 250 as a result of depreciation. There are a large number of short-run and long-run influences which affect the marginal efficiency of capital. “Moreover, this situation might be reached comparatively soon—say within twenty-five years or less. [AS: This sounds pretty ridiculous, I know, but give it a minute.]. Keynes's main theory (including its dynamic elements) is presented in Chapters 2-15, 18, and 22, which are summarised here. Thus the total amount spent on wages equals the wage-unit times the number of labor-units. A hefty tax on each trade might be the best way to discourage speculation and thus improve the functioning of the market. And businesses choose whether to hire people based on how much they expect to sell. The limitations of Keynes’s theory and policy became obvious when the policies advocated by the Keynesians were implemented after the Second World War. Perhaps this is why it has a reputation for being a very tough book — so difficult that even economists can’t follow it. Effective demand manifests itself in the spending of income. Are the interests which they will thwart stronger and more obvious than those which they will serve? Classical economists always believed that the economy was in equilibrium at full employment level only, but in his general theory Keynes could show successfully that the free enterprise market economy could be in equilibrium at less than full employment-to this, he gave the name of underemployment equilibrium. Before publishing your Articles on this site, please read the following pages: 1. And we return to the problem that many of our economic decisions depend on our “spontaneous optimism,” our “animal spirits,” our “urge to action rather than inaction,” not “the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.” This means not only that slumps get exaggerated (since they depress animal spirits, worsening the slump) but that economic performance depends to a large degree on keeping businessmen happy. 2. 100 + Rs. The General Theory of Employment, Interest and Money Written: 1935; Source: The General Theory of Employment, Interest and Money by John Maynard Keynes, Fellow of the King's College, Cambridge, published by Harcourt, Brace and Company, and printed in the U.S.A. by the Polygraphic Company of America, New York; Not all protectionism promotes the balance of trade, of course — mid-1800s Britain probably would have done best with complete free trade. And that’s because, unlike most economics books, it makes sense — the theories it proposes comport with the real world, instead of taking place in some fantasyland of perfect competition. Therefore, he made the specific assumption of short-period so as to concentrate on the problem at hand. These two combined are the prime cost. Unemployment develops, that is to say, because people want the moon; — men cannot be employed when the object of desire (i.e. If people lose “confidence” because of all the spending, they may decide to hold onto their money. A.C. Pigou has tried to limit down the concept so as to make it practicable. Not only is income equal to expenditure, Y = C +I, but saving also equals investment, S = I. It is an inevitable result of an investment market whose organization encourages these behaviors. In Table 3.1, planned saving at the levels of income of Rs. Keynes. Introduction to Keynesian Theory: Keynes was the first to develop a systematic theory of employment in his book. You might think that this just means someone who actually does sit down and calculate expected yields could make vast profits from all the speculators playing Snap. Indeed, the basic model assumed that wages and prices are fixed as long as the government is reducing unemployment. So stock traders don’t sit down and try to calculate the long-term expected yield; they try to guess the short-term change in the stock price and trade base on that. … Moreover, if such a situation were to arise, it would mean that the public authority itself could borrow through the banking system on an unlimited scale at a nominal rate of interest.” [AS: The US, however, is in this situation right now (2009).]. Keynes seems to suggest this can be modeled as “a rapid liability to change in the supply of labor;” I guess that’s possible. 1) You can’t just go ahead and make it — it can’t be “grown like a crop or manufactured like a motor-car.” 2) You can’t reclaim it from use for other purposes — it doesn’t have any. Because these things go together, they’re sometimes mistaken as the cause, but note that it’s the expected return which falls first, then interest rates rise. It is not always possible to predict the effects of policy changes adopted in the short run. It is very necessary to measure the aggregative quantities like saving, investment, consumption, income output etc. And, if our theory does work and we end up with full employment, then we return to the world of the classical economic theory, whose only flaw was assuming that full employment was the only possible state of affairs. People can either be put to work making things for people to use today or making things for people to use tomorrow, but that tomorrow “cannot be pushed indefinitely into the future.” After all, an hour of labor cannot be “saved” and put into a bank for a rainy day! The General Theory was Keynes’s last major written work. Thus the interest rate depends on people’s desire to hoard cash — their liquidity preference (L) — and the quantity of money (M). 23: Now that Keynes has outlined his revolutionary theory, it’s time to look back at other economists the classical school dismissed. But this doesn’t effect the long-term rates, which depend on people’s expectations of what the government will do to short-term rates. Call that the supply cost. Reading Keynes’ General Theory of Employment, Money, and Interest then is a sobering experience. 900 at the end of the year by incurring a small maintenance cost of Rs. It’s basically been written out of economic history, in part, no doubt, because it was written in the form of a scandalous satirical epic poem. If you can’t increase investment, you have to increase consumption. It was in this type of situation that Keynes was provoked to bring out his ‘General Theory’ (So nicknamed popularly) to justify taking up some new economic measures to tackle the situation. But the classical school ignored the problem, as a consequence of introducing into their premisses conditions which involved its non-existence; with the result of creating a cleavage between the conclusions of economic theory and those of common sense. Saving money for the future is not the same as making things for the future — it’s only the latter that’s useful. Liquidity preference is a new concept used by Keynes. Other traps are hyperinflation (where no one wants to hold onto money) and a financial crisis (where no one trusts the banks enough to let go of money). This gets rid of the most objectionable features of capitalism — people could still become rich by saving money, but there would be nothing left to invest it in, so their money wouldn’t ever grow. Comments on the four discussions in the previous issue of points in the General Theory, 209. (Since running a trade deficit with a country means sending them your precious metals instead of your exports.) For it now seems clear that the disquisitions of the schoolmen were directed towards the elucidation of a formula which should allow the schedule of the marginal efficiency of capital to be high, whilst using rule and custom and the moral law to keep down the rate of interest.” After all, “individual savings may be absorbed either by investment or by debts, and that there is no security that they will find an outlet in the former.” Laws against usury help ensure they do. Saving in that case equals intended or planned investment. There’s no math, but there’s still a lot to chew on. Now in general the interest rate is governed by the quantity of money and “in an age in which substantial foreign loans and the outright ownership of wealth located abroad are scarcely practicable” (not to mention the international gold standard), money equals precious metals which equals the balance of trade. Classical economists believed that saving was a great private and social virtue. But this is good, because otherwise wages would fall to zero in any downturn and the entire economy would shut down. TOS4. Let investment be 20 crores of rupees whatever the level of income. And “it is not so easy to revive the marginal efficiency of capital, determined, as it is, by the uncontrollable and disobedient psychology of the business world. Net income is found by deducting supplementary costs V from the income (A-U). 16 quotes from The General Theory of Employment, Interest, and Money: ... ― John Maynard Keynes, The General Theory of Employment, Interest, and Money. You might think (as Keynes once did) that the best solution is to just force people to hold on to what they buy, so they have to figure out what it’s really worth beforehand, but this will just push people to hold on to their money. These games can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated. In it, he argues vigorously for strong government action to correct the excesses of laissez-faire capitalism. The General Theory of Employment, Interest and Money transformed economics and changed the face of modern macroeconomics. OK, so you promote investment, but how much investment? It’s the best book on the economy I’ve ever read; indeed, it’s one of the best books I’ve ever read. According to him what actually existed in the capitalist society was under-employment and not full employment. The General Theory of Employment, Interest and Money is a highly significant work that marked a turning point in the development of modern economic theory. No doubt Dr. Marshall’s definition was theoretically sound, simple and comprehensive; even then it had serious practical limitations; for example, it is not easy to make statistically correct estimates of the total production of goods and services in a country, besides the difficulties of double counting and the portion of the produce that is retained for personal consumption. They got it in their head that they were going to build a railroad, and by Jove they did. In The General Theory of Employment, Interest and Money, the British economist John Maynard Keynes argues that the belief that markets naturally tend towards full employment is a fallacy, and that state interventionism is therefore necessary to overcome economic slumps. The only thing that could work is a one-time decrease in everyone’s wages to a new level, but that a) is never going to happen in a democracy and b) unfairly penalizes wage-earners over everyone else. It is not the ownership of the instruments of production which it is important for the State to assume. The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. And total consumption is just all the stuff that isn’t sold to other businesses. Again, in Pigou’s definition, one could find the total amount of national dividend because we are to include where most of the goods and services are not exchanged for money. I. It simply lays down that as our incomes increase; consumption will also increase though not in the same proportion as the increase in income. This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; — it can be played by professionals amongst themselves. It forgets that there is no such thing as liquidity of investment for the community as a whole. “A full explanation is complex and must wait for Chapter 15.” But we can see one reason now: uncertainty about the expected [AS: there’s that word again] rate of interest. Only the services, rendered to use during this year by these things are income.”. They’d much rather invest their money so that its valuation keeps going up and up and up. Keynes uses some archaic language and is trying to communicate some complicated ideas. - Uncertainties and fluctuations of investment, 217. Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity. But how much they sell is exactly dependent on how much people spend. The mercantilists perceived the existence of the problem without being able to push their analysis to the point of solving it. are on the right track. That means, Keynesians wanted the government to go on raising aggregate demand to reduce unemployment to the acceptable level. And there must be a similar employment multiplier (k’) where for each person hired for a job, k’ people get hired in total. a central bank) under public control. The big problem is that money is the one thing market processes can’t adjust. The policy recommendations he made were not entirely new but the theoretical justification he gave for them was remarkable. For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs — a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops. “It is in determining the volume, not the direction, of actual employment that the existing system has broken down.”. It may be called ‘Income = Expenditure’ line. Hayek economics was founded by famous economist Friedrich August von Hayek. It is curious how common sense, wriggling for an escape from absurd conclusions, has been apt to reach a preference for wholly “wasteful” forms of loan expenditure rather than for partly wasteful forms, which, because they are not wholly wasteful, tend to be judged on strict “business” principles. Thus they can’t even be approximately estimated. 140. 3. The effective demand in turn depends upon: (2) Investment, which depends upon marginal efficiency of capital and the rate of interest. [Tyler Cowen: “This is the best chapter in the book and one of the most important economics essays of all time. The public can’t control the amount of hoarding, since that’s necessarily equal to the amount of cash. The General Theory of Employment, Interest and Money [full text]. Bonds are for wusses. It conveys the impression that there are several factors on which employment depends. And there’s our trap: if we don’t make things for tomorrow and we don’t make things for today, people are forced out of work since there’s nothing for them to make. “The fundamental psychological law,” he says, is that, on average, the amount people spend increases as the amount they make increases, but not as quickly. The State of Long-Term Expectation I WE have seen in the previous chapter that the scale of investment … Again we have a tradeoff between having a market (and thus volatility) or no market (and thus overcaution). Keynes’ multiplier is investment multiplier in the sense that a small increase in investment (A1) is expected to lead to a much higher increase in income (Ay). Thus, if you ignore direct investment by the government (as people had), these are the two things to be concerned about. John Maynard Keynes' The State of Long‐Term Expectation, From the General Theory Page 3 of 4 months or a year hence. — The theory of interest restated, 215. Under the classical theory, the wage rate is determined by the marginal productivity of labour , and as many people are employed as are willing to work at that rate. And, in practice, people don’t calculate their expectations from scratch each morning. But to assume that it actually does so is to assume our difficulties away. Keynes, the story goes, figured out the causes of the Great Depression and in doing so revolutionized the field of economics. Keynes, the story goes, figured out the causes of the Great Depression and in doing so revolutionized the field of economics. 2.4 Summary 83 APPENDIX TO CHAPTER 2 86 . While each person thinks they’ll do better off by saving money instead of spending it, if a whole country decides to save their money, they’re all worse off, since nobody will have a job. Deflation does the opposite. 3: When people get money, they spend some of it — but not all of it. 12 of Interest Rate Theory) Page 1 John Maynard Keynes The General Theory of Employment, Interest and Money Chapter 12. When most countries of the world were experiencing the gravest depression of the last two hundred years – that is, the so- called Great Depression of 1929-36-economists of the time faced a challenge in the problem of increasing unemployment, shrinking national income, falling prices and failing firms. Therefore, Keynes called his treatise the General Theory Moreover, the necessary measures of socialisation can be introduced gradually and without a break in the general traditions of society. Keynes, however, felt that the concept of income in terms of A-U is of little use when the community has to decide how much to spend on consumption. Thus the government must step in. After all, a bond is just a promise to get some money in the future. (2) net Income (A-U-V) on which Consumption of the community depends. But as interest rates get lower, it becomes profitable to invest in building things with smaller and smaller expected yields. The Saving-Investment Approaches (S=I): The second approach to income determination given in the ‘General Theory’ is based on the Keynesian definitions of Saving and Investment.