The effective demand in turn depends upon: (2) Investment, which depends upon marginal efficiency of capital and the rate of interest. According to Prof. Fisher, “…….. the national dividend or income consists solely of services received by ultimate consumers, whether from their material or from their human environment. Policy Recommendations of Keynes’s Theory 9. 9: How does raising interest rates affect consumption? 13: We said before that businesses keep investing until their expected return reaches the interest rate (so lower interest rates mean more investment), but what determines the interest rate? Therefore, Keynes justified state intervention in economic affairs to fight instability. Thirdly, Keynes spelt out the specific form which state intervention has to take to counter economic depression. 180 crores. 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. Whilst, therefore, the enlargement of the functions of government, involved in the task of adjusting to one another the propensity to consume and the inducement to invest, would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism, I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative. the national dividend is that part of the objective income of the community including, of course, income derived from abroad, which can be measured in money.” According to Prof. Pigou, only those goods and services should be included (double counting being avoided) that are actually sold for money. Consumption depends upon propensity to consume and investment is determined by inducement to invest. To mention a detail, the tendency in slumps for the price of gold to rise in terms of labour and materials aids eventual recovery, because it increases the depth at which gold-digging pays and lowers the minimum grade of ore which is payable. my shorter summary of the fundamental ideas, The General Theory of Employment, Interest and Money. As such it is called Consumption Function. 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. Long-term expectations can’t be easily checked, so when they do change, they often change suddenly. 250 as a result of depreciation. People seem to recognize this when it comes to government making stuff. Consumption C and Investment I further depend on a large number of other influences in the economy. THE GENERAL THEORY OF EMPLOYMENT SUMMARY 1. Professor A.P. What will we do when we’ve built all the factories the people of the future can be expected to use? In Keynes’s view, fluctuations in the marginal efficiency of capital are the fundamental cause of the business cycle. 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. If the rate of interest were so governed as to maintain continuous full employment, Virtue would resume her sway; — the rate of capital accumulation would depend on the weakness of the propensity to consume. [AS: Obviously this accounting fiction isn’t particularly realistic since, in reality, the multiples people get paid change as the wage-unit goes up. Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in the volume of capital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus; and at a scheme of direct taxation which allows the intelligence and determination and executive skill of the financier, the entrepreneur et hoc genus omen (who are certainly so fond of their craft that their labour could be obtained much cheaper than at present), to be harnessed to the service of the community on reasonable terms of reward. Limitations of the Keynesian Theory. Liquidity preference means preference for liquidity or cash. He observed that public works need to be undertaken only as long as private investment is deficient. According to Prof. Hansen, Consumption Function is the most important contribution of J.M. And, Keynes points out, it’s largely about the paradox of thrift — centuries before Keynes! Thus gold-mines are of the greatest value and importance to civilisation. 16 quotes from The General Theory of Employment, Interest, and Money: ... ― John Maynard Keynes, The General Theory of Employment, Interest, and Money. To say that net output to-day is greater, but the price-level lower, than ten years ago or one year ago, is a proposition of a similar character to the statement that Queen Victoria was a better queen but not a happier woman than Queen Elizabeth — a proposition not without meaning and not without interest, but unsuitable as material for the differential calculus. 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. Thus, net income = A – U – V. In other words, both user costs (U) and supplementary costs (V) have to be subtracted from Gross National Product (A) to obtain the net national income. The horizontal axis of Figure 4.1 shows the levels of income and the vertical axis shows the levels of consumption, saving and investment in the economy. Further, the amount of wages received by ordinary labour for an hour’s work, Keynes called-wage unit. “But whilst this limiting case might become practically important in future, I know of no example of it hitherto. Yet he has scarcely established an equal claim to rank — a private, perhaps, but not a major in the brave army of heretics — with Mandeville, Malthus, Gesell and Hobson, who, following their intuitions, have preferred to see the truth obscurely and imperfectly rather than to maintain error, reached indeed with clearness and consistency and by easy logic, but on hypotheses inappropriate to the facts. But spending can have negative effects as well. The big problem is that money is the one thing market processes can’t adjust. “Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better.”. It seemed clear that there was something seriously wrong with the capitalist way of economic organisation. 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. The total income of the community is just the amount sold minus the user cost. And some of the money can “leak” out to other countries. I must not be taken to deny this, because I assert that a state of full investment in the strict sense has never yet occurred, not even momentarily.”. I do not attempt an answer in this place. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Even if you hire people for investment, the money those people get paid in turn gets spent on additional consumption, increasing employment indirectly as well. 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. I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work. But we could increase investment: “the wisest course is to advance on both fronts at once.” Not just so that the people we give money to can buy the new products investment creates, but so that they have enough money to buy even more, and thus spark growth themselves! Keynes, the story goes, figured out the causes of the Great Depression and in doing so revolutionized the field of economics. if the reward for parting with cash were diminished, the aggregate amount of cash which the public would wish to hold would exceed the available supply, and that if the rate of interest were raised, there would be a surplus of cash which no one would be willing to hold.” And if that’s true then the quantity of money is the other factor that determines interest rates. But this is totally consistent with there being unemployment — if people aren’t buying, businesses aren’t selling, so they fire people (who then buy less). When recovery picks up, it feeds on itself in the opposite way. Are the interests which they will thwart stronger and more obvious than those which they will serve? They keep doing what they did yesterday unless they have a reason to change. The straight line through the origin (Y = C + S) makes an angle of 45′ with the two axes. In particular, he was unaware that money was not unique” — if people didn’t hoard it, there’s lots of other things they could hoard. 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. - I. Keynes’ argument is based on the idea that the level of employment is not determined by the price of labour, but by the spending of money. 9, 1972), and served once more in the Treasury as an all-purpose adviser. But Pigou’s definition made an artificial distinction between goods that are exchanged for money and goods that are not so exchanged. It shows the simple process of income determination in an economy. I. As a result, the theory supports the expansionary fiscal policy. Thus the interest rate depends on people’s desire to hoard cash — their liquidity preference (L) — and the quantity of money (M). [AS: I think he only ends up in making things more confusing, but maybe I’m missing something. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The game of hazard which he plays is furnished with many zeros, so that the players as a whole will lose if they have the energy and hope to deal all the cards. Column 1 in the table shows the various levels of income while column 2 shows the levels of consumption associated with it. Otherwise, our only relief comes from printing more money. The limitations of Keynes’s theory and policy became obvious when the policies advocated by the Keynesians were implemented after the Second World War. Keynes wanted to choose the most suitable definition for this particular purpose. But it is more difficult to have an idea of net consumption than net production. But if effective demand is adequate, average skill and average good fortune will be enough. “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! The ‘General Theory’ does not trace out the effect of the future on the present economic events clearly. This is because people spend on consumption to the extent of Rs. Still, the book isn’t exactly a smooth read. Before we do so, it will help us to know the general framework or apparatus of Keynes’s theory. Keynes expressed employment in terms of labour units. His theory is built up on the basic idea that ‘Effective Demand’ determines employment. 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. And then those factories hire people to work there, who spend their wages on other things. Therefore, Keynes called his treatise the General Theory Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York. Dr. Marshall in his Principles of Economics had defined national income as follows: “The labour and capital of a country, acting on its natural resources, produce annually a certain net aggregate of commodities, material and immaterial, including services of all kinds… and net income due on account of foreign investments must be added in this is the true net annual income or revenue of the country, or the national dividend.”. Moreover, this behavior is not the outcome of a wrong‐headed propensity. The entrepreneur’s income is the value of his output less the prime cost — that’s what he tries to maximize. Since consumption expenditures in the short run remain stable, Keynes’s theory stated in simple terms maintains that employment depends upon investment. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. Such costs have to be deducted from gross income to get net income on which the consumption of the community depends. [emphasis added], 11: Imagine you get a new widget-making machine. And with the disappearance of its rentier aspect much else in it besides will suffer a sea-change. But unfortunately they tended to give rise to the phenomenon known as ‘stop-go’. In it, he argues vigorously for strong government action to correct the excesses of laissez-faire capitalism. 2 (Feb, 1937), pp.209-223.. Back [Note on HET version: Page numbers in bold square brackets, e.g. It conveys the impression that there are several factors on which employment depends. 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. We have to accept them as an inevitable result of applying to the conduct of the State the maxims which are best calculated to “enrich” an individual by enabling him to pile up claims to enjoyment which he does not intend to exercise at any definite time. Saving money for the future is not the same as making things for the future — it’s only the latter that’s useful. There are two obvious problems with this. Having discussed the factors which determine the level of economic activity (income, output and employment) in the economy, Keynes went on to build a simple model of income determination at a particular time. The concept of underemployment equilibrium is the most revolutionary idea put forth by Keynes. Keynes was writing about the short-period problem of depression. If we don’t ever spend it, it becomes worthless. 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). In the short period, employment, income and aggregate output are interrelated. Summary. It is interesting to notice that the characteristic which has been traditionally supposed to render gold especially suitable for use as the standard of value, namely, its inelasticity of supply, turns out to be precisely the characteristic which is at the bottom of the trouble. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. 4. The analogy between this expedient and the goldmines of the real world is complete. Thus decreased consumption leads to decreased employment. That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. A man’s saving is that part of his money income that is not spent on consumption goods. A Summary/Explanation of John Maynard Keynes’ General Theory With the recent economic crisis, there has been much talk of John Maynard Keynes and his economics. Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of “liquid” securities. So their solution was simple: to end unemployment, people just needed to be willing to work for less. Instead, you can give it to poor people, who will use it to buy useful things like food and clothing. 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. It’s a long book, so if you’re in a hurry, you might prefer my shorter summary of the fundamental ideas. It forgets that there is no such thing as liquidity of investment for the community as a whole. | Keynes’s General Theory. ], 8: We return now to our main argument. Share Your Word File An important fact about the consumption function is that it is stable in the short run because the consumption habits of the community remain more or less stable in the short run. 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. He gave practically useful policy. 16: OK, so we’re in a liquidity trap. 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. THE POSTULATES OF THE CLASSICAL ECONOMICS 3. A shorter account will be found in the article on Keynesian economics. Thus, through his theoretical contribution Keynes not only shook the Classical Theory in its roots but also demolished its policy implications completely. 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. 12 of Interest Rate Theory) Page 1 John Maynard Keynes The General Theory of Employment, Interest and Money Chapter 12. 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.” Generally speaking, saving is done in the form of cash or in buying shares and stocks, bonds etc. It’s only the second kind that’s an actual waste of resources, and the solution to it isn’t raising interest rates “which would probably deter some useful investments and might further diminish the propensity to consume, but in taking drastic steps, by redistributing incomes or otherwise, to stimulate the propensity to consume.”. The result is “a gradual crescendo in the level of employment, rising to a peak and then declining to the new long-period level.” This can happen even if you don’t expect to sell more things, but just a slightly different thing: you “overhire” to get up to speed on the new model, but then fire people until you’re back down to your previous level. Prof. Fisher’s definition was better than both Dr. Marshall’s and Prof. Pigou’s in as much as it was nearer the concept of economic welfare because welfare depends upon the goods and services made available to the individuals of the community. These propositions contain the essentials of the general theory’ of employment. Except during the war, I doubt if we have any recent experience of a boom so strong that it led to full employment. Presumably this means that interest rates will become very low (although you don’t want them so low that nobody’s making things to sell today). Modern equity markets undermine the necessity for long-term, stable investment. Use of the Wage Unit 4. “I was brought up to believe that the attitude of the Medieval Church to the rate of interest was inherently absurd, and that the subtle discussions aimed at distinguishing the return on money-loans from the return to active investment were merely Jesuitical attempts to find a practical escape from a foolish theory. 15 crores then investment multiplier is 15/5 = 3. Keynes does not deduct the whole of depreciation from the Gross National Product, he subtracts a little less than the whole amount of depreciation called ‘User Cost’. At income levels less than this, planned saving is much less than planned investment. “Never in history was there a method devised of such efficacy for setting each country’s advantage at variance with its neighbours’!”. 2. Propensity to consume, also called the consumption function, is a key concept to Keynesian theory of employment. Such public investment, he said, best achieves the multiplier effects. “In this event the monetary authority would have lost effective control over the rate of interest.” [AS: This, I presume, is the liquidity trap.] The General Theory of Employment, Interest, and Money By John Maynard Keynes Feburary 1936 Table of Contents • PREFACE • PREFACE TO THE GERMAN EDITION • PREFACE TO THE JAPANESE EDITION • PREFACE TO THE FRENCH EDITION Introduction 1. That said, today’s decisions are based on the conditions of today and expectations about tomorrow — not on past expectations or the conditions of the past. In order to carry daily transactions, to meet unforeseen contingencies and in order to take advantage of the market movements of bond prices, people want to hold cash; this constitutes the demand side of the Keynesian theory of the rate of interest. There are other reasons people might want to hold cash. We find that the S and I curves intersect vertically down the point E at which C + I line intersects the 45° line. 2.4 Summary 83 APPENDIX TO CHAPTER 2 86 . 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. Keynes’ General Theory tries to tackle exactly this problem. THE PRINCIPLE OF EFFECTIVE DEMAND It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. They didn’t sit down and calculate whether they could have made more money buying bonds instead. “It is in determining the volume, not the direction, of actual employment that the existing system has broken down.”. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. The same level of income gets determined whether we have the Y = C +I approach or the S=I approach. […]. And it would remain for separate decision on what scale and by what means it is right and reasonable to call on the living generation to restrict their consumption, so as to establish in course of time, a state of full investment for their successors. Finally, with the additional demand equipment and so on will have to be replaced, raising marginal costs. But it’s not easy to think of useful things to make for the future. 23: Now that Keynes has outlined his revolutionary theory, it’s time to look back at other economists the classical school dismissed. - III. Well, until you have full employment obviously. A Project Gutenberg of Australia eBook Title: The General Theory of Employment, Interest and Money Author: John Maynard Keynes eBook No. -The theory of interest restated, 215. 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… Nevertheless, the way in which modern economists view macro-economic problems owes much to the Keynesian framework. 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. There were a few direct policy implications of Keynes’ theory. Keynes himself measured these quantities in terms of money but found it rather unsatisfactory because with changes in prices, money does not depict true changes in the economic aggregate. Share Your PPT File, Is ‘General Theory’ a Depression Economics ? But in this case the value of the machine has been maintained at Rs. Keynes defined income in such a manner as enabled him to determine employment in the community. 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. Wherever these policies were adopted, recovery was remarkably rapid. If interest rates go up, it no longer becomes possible for them to make money, even though the machine remains unchanged. Saving in that case equals intended or planned investment. There’s the value of the widgets you expect [AS: there’s that word again] it to produce, less the cost of its inputs and maintenance. To arrive at this seemingly simple conclusion, however, Keynes developed a highly complex argumentation brimming with new economic terms and concepts of his own devising, such as “multipliers,” “consumption and saving functions,” “the marginal efficiency of capital,” “liquidity preference,” “I-S curve,” and many others. The result is that saving, which is income not spent on consumption, goes on increasing. In Summary: What is the difference between Hayek and Keynes? 60 crores. Keynes further assumed that the economy under analysis is a closed one; that is, he did not explicitly recognise in his analysis the influence of exports and imports. Keynes, however, called it a social vice, as more saving on the part of an individual will mean less saving on the part of another individual, leaving the total savings of the community unaffected. The only solution would be to force everyone to either to buy goods or capital assets with everything they own. But it was found that Keynes’s policies tended to create inflationary pressures to control which the government had to reduce aggregate spending. Eventually they begin to run out of iPods and start investing in additional factories to make more. Keynes disputed the classical assumption of automaticity of full employment and the classical prescription that in the event of an economic depression wage cuts would bring about full employment in the economy. If the minimum wage is doubled to $10 an hour, I’m not suddenly going to get paid $600 an hour, even though my relative productivity hasn’t changed. But the worst part of the international gold system is the way it sets countries against one another. Or perhaps between the stationary economy and the shifting one, for money’s power “flows from its being a link between the present and the future.”. It’s difficult to get people to realize that investing money doesn’t actually lead to an increase in investments. Before publishing your Articles on this site, please read the following pages: 1. Or if there is some monopoly clement somewhere, then its degree remains unchanged. vi The Economics of Keynes: A New Guide to The General Theory 3. So that’s the bust. Another way to look at it is the more stuff we make for tomorrow, the less stuff we need to make tomorrow. Effective demand manifests itself in the spending of income. Effective demand is the demand for goods and services in the economy as a whole which is fully satisfied by the supply of the output as a whole. And this is especially true in the short-term — people’s habits take time to catch up with their incomes. This incredible work of economic thought described the division of labor and the invisible hand in 1705, a full seventy years before Adam Smith. He writes: ”This simple yet powerful point doesn’t get the attention it ought to. It’s conceivable that it might lead not just to full employment, but full investment — a world with so much plenty that you couldn’t expect to make a profit on any kind of durable good. How does money influence demand? To guard against the risks of uncertain and vague future, people want to hold some of their assets in cash. It would need a volume of a different character from this one to indicate even in outline the practical measures in which they might be gradually clothed. Why does redistributing income work? 22: Why are there trade cycles, aka business cycles, aka booms and busts? 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: I’ve been saying businesses because I find it clearer, but Keynes actually says entrepreneurs. In short, increasing interest rates to kill booms “belongs to the species of remedy which cures the disease by killing the patient.”, What would the world of the permanent boom look like? It’s hard to convey the excitement I felt when reading this.] … Nor was there over-investment in the sense that the standard and equipment of housing was so high that everyone, assuming full employment, had all he wanted at a rate which would no more than cover the replacement cost, without any allowance for interest, over the life of the house; and that transport, public services and agricultural improvement had been carried to a point where further additions could not reasonably be expected to yield even their replacement cost. These are supplementary costs. And there must be a similar employment multiplier (k’) where for each person hired for a job, k’ people get hired in total. An intrinsic reason for such scarcity, in the sense of a genuine sacrifice which could only be called forth by the offer of a reward in the shape of interest, would not exist, in the long run, except in the event of the individual propensity to consume proving to be of such a character that net saving in conditions of full employment comes to an end before capital has become sufficiently abundant. For if effective demand is deficient, not only is the public scandal of wasted resources intolerable, but the individual enterpriser who seeks to bring these resources into action is operating with the odds loaded against him. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil. The equation Y= C+I, expresses the relationship between C and Y. The first half of this book will be dedicated to prying it open. Keynes, therefore, adopted a new unit for measuring the changes in the national output, that is, the unit of the employment of labour. We have seen that it’s quite the opposite — that redistribution, by increasing effective demand, promotes growth. In his ‘General Theory’ Keynes used two approaches to the determination of income: Both these approaches lead to the determination of the same level of income. Keynes has found a crack in the classical theory. Perhaps the government should start buying and selling long-term bonds to address this. At some point we just need to consume more stuff. “If we speak frankly, we have to admit that our basis of knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing; or even five years hence.”. Only the services, rendered to use during this year by these things are income.”. Eventually, we’re forced to make things for today. ], 7: Keynes spends the chapter defending his decision to define savings as equal to investment. I think I also use this kind of interchangeably with capitalists. Some conservative economists have forgotten or ignored his work, but society as a whole remembers his basic discovery: you get out of downturns by spending money. The General Theory of Employment, Interest and Money (1936). And yet, the book is a necessary now as it was then: economics has not learned a single one of his lessons. This considerably simplified his analysis, for he could thereby take employment and output as moving together in the same direction. Keynes’s first proposition was that total income depends upon the volume of total employment, which depends upon effective demand (D), which in turn, depends upon consumption expenditure (D1) and investment expenditure (D2): therefore, Effective Demand D = D1 + D2. They don’t care how good the machine is at making widgets, what matters is whether they can make money selling the widgets. (Land can’t be grown either, but if we really needed to we could free some up by moving closer together. The more virtuous we are, the more determinedly thrifty, the more obstinately orthodox in our national and personal finance, the more our incomes will have to fall when interest rises relatively to the marginal efficiency of capital. Indeed, the basic model assumed that wages and prices are fixed as long as the government is reducing unemployment. Thus we are so sensible, have schooled ourselves to so close a semblance of prudent financiers, taking careful thought before we add to the “financial” burdens of posterity by building them houses to live in, that we have no such easy escape from the sufferings of unemployment. Welcome to EconomicsDiscussion.net! 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. Column 3 in the table shows that at the level of income of 50 crores, saving is negative, that is, minus 10 crores. So how does printing money affect prices? The conservative economists liked to wait for the free- economic system to correct its ailment itself but they could not specify for how long. “Moreover, this situation might be reached comparatively soon—say within twenty-five years or less. Some industries hit “bottlenecks” first, causing their prices to rise and demand to be funneled into industries that are faster to respond. Machines, workers and raw materials were available for production but were not being used simply because the employers feared losses in the production of goods. Keynesian economics was founded by economist John Maynard Keynes. Absence of Governmental Part in Economic Activity: The government is assumed to play no (significant) part either as a taxer or as a spender. 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 … It shows that an initial increase in investment increases the national income by a multiple of it. 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. It is judged from the total expenditure in the economy. As I said, that’s the naive view — there are a couple complications. 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. 51, No. Keynes: Long-term Expectations (Ch. It is not the ownership of the instruments of production which it is important for the State to assume. In ease of disequilibrium, planned or intended or ex-ante saving is more than or less than planned investment. 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. What happens isn’t so much excessive investment as misdirected investment. Thus the government must step in. But if you’ve been unemployed long enough, you might actually want to work. So it’s how much people spend that determines employment. And, in practice, people don’t calculate their expectations from scratch each morning. For in such matters it is rash to predict how the average man will react to a changed environment. 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). Let us presume (with Keynes) that the level of investment is not related to income. 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. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. In Keynesian Economics saving is defined as the excess of income over consumption, i.e., S = Y – C. The fundamental fact about saving is that its volume depends upon income. Quarterly Journal of Economics, vol. Thus, according to Keynes, during a period of depression or recession encourage spending more to increase effective demand. Simple Income Determination 7. 1,000 in the beginning of the year remains worth Rs. and replacement cost of capital assets. However, this period was relatively short because Keynes's heart attack in 1937 meant that he was out of action … For the state of expectation is liable to constant change, a new expectation being superimposed long before the previous change has fully worked itself out; so that the economic machine is occupied at any given time with a number of overlapping activities, the existence of which is due to various past states of expectation. Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity. But this just weakens the multiplier, it doesn’t eliminate it. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. In this way by adding the user costs of all the firms in the whole economy, we get the aggregate user cost of the whole economy. Secondly, he could very nicely provide reasons for departures from the policy of balanced budgets. 140. Then the money can’t go to hire more people so it just goes to bid up the prices of things, creating inflation. In olden days, what happened was that rough-riding men of business thought taking risks was manly and invested their money as a way of life. Secondly, the Keynesian model failed to adequately take into account the problem of stagnation with inflation. You use the extra people to get you up to speed, then you lay them off. THE GENERAL THEORY 2. Keynes’s work has left a deep mark on modern macro-economics. these are contingent costs like plant becoming obsolete, catching fire. Apparatus of Keynes’s General Theory 6. Thus all ‘go’ periods tended to be followed by ‘stop’ periods and it became difficult to achieve long-term economic growth. Introduction to Keynes’s General Theory 2. We have to select the more easily manageable factors influencing aggregate income and employment. The State of Long-Term Expectation I WE have seen in the previous chapter that the scale of investment … Since the former is a direct approach while the latter is an indirect approach, the two approaches are called the Front- Door Approach and the Back-Door Approach respectively. Another thing the classical economists long mocked were laws against usury. “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. The main problem with the Keynesian model was that it was meant for the short run. OK, so you promote investment, but how much investment? As is often the case with imperfectly analysed intuitions, their significance only became apparent after I had reached my own conclusions in my own way. Instead, it might turn out “a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative.” Still, this is a comparatively conservative claim: But beyond this no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community. Bonds are for wusses. The extraordinary achievement of the classical theory was to overcome the beliefs of the ‘natural man’ and, at the same time, to be wrong. Unemployment develops, that is to say, because people want the moon; — men cannot be employed when the object of desire (i.e. The essence of Keynes’ theory, however, involves a shift from classical economics’ concern with the production of wealth to a concern with the consumption of wealt… … But there are many difficulties which Gesell did not face. But if the ideas are correct — an hypothesis on which the author himself must necessarily base what he writes — it would be a mistake, I predict, to dispute their potency over a period of time. 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. It’s often said that the interest rate is the price people demand for saving money instead of spending it. As there is disequilibrium, income will have to rise. For that may enable the so-called boom to last. Interest today rewards no genuine sacrifice, any more than does the rent of land. Since consumption depends upon net income, it is necessary that net income be calculated as accurately as possible. “One of the chief social justifications of great inequality of wealth is, therefore, removed.”. Assumptions of Keynes’s General Theory 5. They are “undoubtedly in the right [at present],” when investment is “unplanned and uncontrolled.” There’s no other way to raise employment. Since it seemed unlikely that society had run out of money-making jobs, it was assumed that unemployment was caused either by people not knowing where the jobs were (frictional unemployment) or insisting on being paid more than they could make (voluntary unemployment). 10. Thirdly, the coincidence of inflation and unemployment makes the Keynesian policy recommendation very questionable. If the national income is increased by an amount of say Rs. It’s the best book on the economy I’ve ever read; indeed, it’s one of the best books I’ve ever read. There’s an asymmetry in the system that workers will resist falling wages, but not rising ones. 10: We’ve established that an increase in investment leads to an increase in income. Thus, once again, the tribute that classical economists pay to her is due to their concealed assumption that the rate of interest always is so governed. (And when everyone follows the stock market, like in the US, this applies to everyone.) Keynes uses some archaic language and is trying to communicate some complicated ideas. As the title of “The General Theory of Employment, Interest, and Money” would indicate, much of Keynes’ ideas focused on unemployment, inflation, and the supply of money. So we’ll use only two types of counts: those of actual currency (money-values) and those of people (employment). He solved this problem in his own way. 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; He assumed that there is a fairly high degree of competition in the markets. But how much? (So inflation might actually be a better solution than wage cuts.). But mercantilists saw the key points sooner than most, calling for an increase in money to reduce the interest rate. Everyone has seen bits and pieces of wit quoted from the book, but Keynes weaves them into a beautiful tapestry that explains the whole of the modern economy. The bought and the un bought do not differ in kind from one another in any fundamental respect. 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. 21: Traditional economics is divided between the theory of value (perfect competition, supply and demand, and all that good stuff) in the main spot and then over to the side has a separate theory of money (dealing interest rates and inflation), with no clear connection between the two.   Keynesians believe consumer demand is the primary driving force in an economy. Investment depends upon the marginal efficiency of capital on the one hand and the rate of interest on the other. None of these definitions suited Keynes as he wanted to know the factors that go to determine the level of income and employment in an economy at a particular time. Keynes assumed that the techniques of production and the amount of fixed capital used remain constant in the model of his theory. 180 crores equals planned investment. Underemployment equilibrium was the result of private under-investment in relation to the savings available in the capitalist economy at the given income level. 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. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Indeed, it so scandalized its readers at the time that it was “convicted as a nuisance by the grand jury of Middlesex in 1723, which stands out in the history of the moral sciences for its scandalous reputation.”. […]. But the side effect is that “the very long-run course of prices has almost always been upward.”. The demand in the economy is ordinarily for two types of goods – consumption goods and investment goods. 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, 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. It works, it’s just slow — if you want to get people employed quickly, you’re better off starting with building the factories. For the result is inevitable. Have they insufficient roots in the motives which govern the evolution of political society? However, it may be noted that the suitability of any particular definition depends upon the purpose for which it is to be used. For there would obviously be a natural tendency towards the optimum employment of resources in a society which was functioning after the manner of the classical postulates. 3. After all, a bond is just a promise to get some money in the future. Besides the concept of income, another concept which continued to bother Keynes was the choice of units for the purpose of macroeconomic analysis and measurement in the absence of which he could never go along conveniently. All industries employ labour and their outputs can be expressed in terms of employment that they offer. 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.”. Certain definite points on which the writer diverges from previous theories, 212. He advocated the policy of starting public works and financing them with fiat money with an unbalanced budget. Most of the analysis of the General Theory is conducted in terms of relatively stable wage units (though the analysis of the theory of prices and inflation is not done in terms of constant wage units because with the rise in price, wages alone cannot remain constant). Keynes’ economic thinking and economic policy at once became popular. As income increases, consumption also increases but not so much as the increase in income. If venture capitalists are spending all their money on useless cable, the solution is to take their money away. Not all protectionism promotes the balance of trade, of course — mid-1800s Britain probably would have done best with complete free trade. Keynes defined saving as that part of income which is not spent on consumption, S = Y – C. He defined investment as expenditure on goods and services not meant for consumption, i.e., I = Y = C. When equilibrium prevails in the economy, income equals expenditure and since S and I are both equal to Y- C, saving must equal investment. It tells us that there is a direct relation between income and consumption. Keynes’s General Theory of Employment, Interest and Money (1936) is surely the most influential book of recent times. Of these ideas, unemployment and its repercussions have been given the most study.Keynes writes in one of the important quotes from “The General Theory of Employment, Interest, and Money” … the existing theory of unemployment nonsense. In other words, it shows that whatever people earn is being spent either on consumption or on investment. 24: The two great economic problems are unemployment and inequality. — III. (Since savings=investment, incomes are reduced such that the amount left over for savings equals the lesser amount now invested. Keynesian economics is a macroeconomic economic theory of total spending in the economy and its effects on output, employment, and inflation. just as wars have been the only form of large-scale loan expenditure which statesmen have thought justifiable, so gold-mining is the only pretext for digging holes in the ground which has recommended itself to bankers as sound finance; and each of these activities has played its part in progress-failing something better. The actual, private object of the most skilled investment to-day is “to beat the gun”, as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow. Investment is either foreign or domestic. Instead, saving lowers demand and thus decreases employment. 14: “Certainly the ordinary man — banker, civil servant or politician — brought up on the traditional theory, and the trained economist also, has carried away with him the idea that whenever an individual performs an act of saving he has done something which automatically brings down the rate of interest … without the necessity for any special intervention or grandmotherly care on the part of the monetary authority.”, But we’ve seen they’re quite wrong. But the truth is exactly the opposite: “That the world after several millennia of steady individual saving, is so poor as it is in accumulated capital-assets, is to be explained, in my opinion, neither by the improvident propensities of mankind, nor even by the destruction of war, but by the high liquidity-premiums formerly attaching to the ownership of land and now attaching to money.”, 19: Now that we have the theory, we can return to the point we started with: reducing nominal wages is unhelpful. 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. But this clearly isn’t true — people can save money under their mattress and not get any interest. “In estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends.”. The equilibrium level of income is determined at Rs. Privacy Policy3. Keynes’s view was that money offers ready purchasing power for commodities and bonds. Keynes’ concept of national income lies somewhat between the Gross National Product and the Net National Product. Let us imagine these policies are implemented. And if the interest rate falls, the economy will grow and people will need more cash for these sorts of transactions. (p.181), were inserted by Keynes himself. Thus, if you ignore direct investment by the government (as people had), these are the two things to be concerned about. 1: This chapter cheekily consists of a single paragraph. That said, one wouldn’t want to get rid of money altogether: [D]angerous human proclivities can be canalised into comparatively harmless channels by the existence of opportunities for money-making and private wealth, which, if they cannot be satisfied in this way, may find their outlet in cruelty, the reckless pursuit of personal power and authority, and other forms of self-aggrandisement. There are a large number of short-run and long-run influences which affect the marginal efficiency of capital. at different points on this line total income is equal to total expenditure. But as our incomes increase, we spend less on things today. We can’t measure net output, but we can count the number of people employed. Therefore, he made the specific assumption of short-period so as to concentrate on the problem at hand. Thus they can’t even be approximately estimated. 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. Think about the dot-com bubble where everyone was blowing money on useless fiber-optic cable. If this happens, then it seems likely that within a generation expected return will reach zero [AS: !!] A labour unit may be taken to mean one hour of work by ordinary, unskilled or common worker. When we deduct the aggregate user cost from the Gross National Product, we shall get national income of the economy in the Keynesian sense represented by A-U (where A is the Gross National Product, being the total product or value of goods and services obtained in a year and U represents the total user cost). Why is there a liquidity preference? And getting money for it is much harder — people don’t like it when you tell them “Yes, the stocks you bought are worthless now but just wait! Experience in the 1970’s in particular has shown that high rates of inflation can co-exist with high rates of unemployment. No, the interest rate is the “price” people demand for parting with their cash. 5 crores is made in public works, the effect of this original investment would be to increase the national income several fold. We’ve said it doesn’t have much effect on people’s propensity to consume, but a higher interest rate means it’s more expensive to borrow money, which means companies invest less, which means incomes are reduced. In the Keynesian model, a change in money supply only affects national income through its effect on the rate of interest. The most important difficulty which Keynes faced in building a Theory of Employment for the economy as a whole was the definition of national income which could be related to national employment. And then what do we do? And businesses choose whether to hire people based on how much they expect to sell. 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. This is the inevitable result of investment markets organised with a view to so-called “liquidity”. It is the return of confidence, to speak in ordinary language, which is so insusceptible to control in an economy of individualistic capitalism. Moreover, the necessary measures of socialisation can be introduced gradually and without a break in the general traditions of society.