John Maynard Keynes The General Theory of Employment, Interest and Money, which I will refer here as the General Theory, revolutionized the way the world thinks about economics. It was published in 1936, seven years in to the Great Depression. He differs from the other economists because it is non-textual. He used the reality to guide his assumptions. The idea of the book is hard to understand unless you have a thorough background in economics but for the sake of discussion I will try to give my own analysis of his work.
I am a History major and the moment I knew that we have to do Adam Smith and Keynes as a project, I was a little hesitant. I have learned of Adam Smith as the father of modern economics and I was always puzzled by the "Keynesian" economics according to my readings. So I decided to give it a shot.
I
The General Theory written by Keynes was generally considered to be his magnum opus. It sought to bring about a revolution, commonly referred to as the "Keynesian Revolution", in the way economists thought - especially in relation a market economy and full employment. . During the 1920's, the U.S. experienced a stock market crash of enormous proportions which crippled the economy for years. Keynes knew that to recover as soon as possible, the government had to intervene and put a decrease on taxes along with an increase in spending. By putting more money into the economy and allowing more Americans to keep what they earned, the economy soon recovered and once again became prosperous.
In The General Theory, Keynes said that the classical economists had believed that "supply creates its own demand," and that therefore unemployment was impossible. This is because every product offered on the market was guaranteed a buyer. But since periods of depression and widespread unemployment had happened in the past (and one was the Great Depression), it clearly showed that the classical economists had been wrong. The "Great Depression" is so named because it is by far the largest sustained decline in industrial production and productivity from the century and a half where economic records have been kept with any regularity, and it reached virtually the entire industrialized world and their trading partners in peripheral nations. It led to massive bank failures, high unemployment, as well as dramatic drops in GDP, industrial production, share prices and virtually every other measure of economic growth.
The economists before Keynes emphasized that as long as men have unsatisfied wants, there is always more work and production to be done. Demand can never too small in comparison with the supply. But they were not able to point out that there can be mismatches between the individual supplies offered on the market and the individual demands for a particular good.
Keynes, or any other sensible theoretical economist, would agree that free-markets are a good idea in principle, which is seldom if ever realized.
II
The General Theory provides the theoretical framework within which temporary measures like the New Deal can be justified. Simply out, the public borrowing simply crowds out private investment. Here, government should always balance its annual budget. Keynes himself placed equal emphasis on taxation and a monetary policy of ‘cheap money. ’
Accordingly, he did not believe governments should run deficits for current consumption, as opposed to public investment. Another concept would be that depression and high unemployment result from insufficient private spending and that to cure these problems the government can always and must do something. And that is to increase its spending. It is the responsibility of the government to maintain full employment. The central theme of the book is that the level of employment is determined, not by the price of labor as what the other economists had in mind but rather by spending money or what we call as the aggregate demand.
Government protectionism (not always bad), monopolies (almost always bad), lack of sufficient incentives and transparency (almost always bad), are a few things that prevent markets from forming and operating efficiently "as if by invisible hand" to use one of the most beat up quotes in all economic literature. . The role of government in the Keynesian system was thus a double one: to improve the conditions of confidence--to give businessmen confidence that the system would last, that property rights would be maintained, and that the demands of workers would be restrained; and at the same time to make sure by fiscal and monetary policy that total spending in the economy would equal full employment output. In practical terms this meant that any increase in businessmen's pessimism about the future must be offset by increased government spending to compensate for an increased propensity to hoard. Keynes was quite aware of a possible conflict between the two roles of government.
III
Another point of discussion is the assumption that the market because it is competitive will deliver full employment. Of course, full employment will be the equilibrium state of a monetary economy. On the contrary, under-employment and under-investment are likely to be the natural state unless active measures are taken. One implication of The General Theory is that a lack of competition is not the lproblem. Keynes does not set out a detailed policy program in The General Theory, but he went on in practice to place great emphasis on the reduction of long-term interest rates and the reform of the international monetary system.
Just as the reception of The General Theory was encouraged by the 1930s experience of mass unemployment, its fall from favour was associated with the ‘stagflation’ of the 1970s. Although Keynes addresses inflation, The General Theory does not treat it as an essentially monetary phenomenon nor suggest that control of the money supply or interest rates is the key remedy for inflation. However, many of the innovations introduced by The General Theory continue to be central to modern macroeconomics.
IV
Keynes does get blamed for failed economic policies of those Keynesians of the sixties and seventies who believed they could tinker the economy into perfection. Mistrust developed in Keynes General Theory. But when I read his book, I came to the conclusion that at some point he is right. Monetary policy can be used to get away with bad times. If I may say, the central conclusion of his work is that government in its involvement in the economy is always necessary. Although difficult to read, it has been essential to my understanding of modern economics.
The key here is the notion that at particular times in the business cycle, an economy can become over-productive and will begin a result in massive lay offs and even cut sin production to balance supply and demand. On the other hand, an economy can sometimes reach underemployment state, something is necessary to boost employment.
The main point of difference of Keynes and the classical economics is that the latter just assumes that a gap is always filled by planned investment (where the economy is at full employment, no less) without even making an argument for it.
V
His famous "in the long-run we are all dead" remark clearly reveals that he was more concerned with the long run in a historical rather than logical sense. Technically, the logical long period can emerge after a short or long amount of time. Indeed, one of the major appeals of Keynes's General Theory was precisely that it seemed to lend theoretical guidance to policy-makers in an era when the Great Depression still had its grip on the industrialized world.
Keynes's theory is simple and practical: firms will hire more labor only if they believe they can sell the extra output; consequently, if demand as a whole declines, they will cut back production and lay workers off. However, by laying workers off, the income of potential customers decreases and thus demand as a whole will be even lower. Thus, as firms do not see demand rise again, they have no incentive to rehire. The economy, in short, is caught in a vicious circle of high unemployment and low demand. This is where an exogenous agency, such as a government, can step in and, by increasing demand, push the economy into a virtuous cycle of high demand and high employment.
Briefly, the "General Theory" argued that the level of aggregate demand in a modern economy was determined by a range of factors including the propensity to consume (the percentage of any increase in their income that people chose to spend on goods and services), the propensity to save (the percentage of any increase in their incomes that they chose to save), the attractiveness of fixed capital investment (dependent on anticipated rates of return) and the level of interest rates. Keynes's key arguments included that in an economy bedevilled by weak demand (e.g. a depression), where in his terminology there was an ignition problem (a difficulty in getting the economy to move forward more vigorously), then the government (more broadly the public sector) could increase aggregate demand by increasing its expenditures, including by borrowing to finance the expenditures, and that the public-sector borrowing would not increase interest rates sufficiently to undermine the effectiveness of such a policy.
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