General Interest

keynes' general theory summary

It is the return of confidence, to speak in ordinary language, which is so insusceptible to control in an economy of individualistic capitalism. 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! “An act of individual saving means — so to speak — a decision not to have dinner to-day.” But it is not a promise to have dinner tomorrow — it doesn’t replace current demand with future demand; it decreases demand altogether. At periods when gold is available at suitable depths experience shows that the real wealth of the world increases rapidly; and when but little of it is so available, our wealth suffers stagnation or decline. Distinguished British economist John Maynard Keynes (1883-1946) set off a series of movements that drastically altered the ways in which economists view the world. It tells us that there is a direct relation between income and consumption. Thus, after all, the actual rates of aggregate saving and spending do not depend on Precaution, Foresight, Calculation, Improvement, Independence, Enterprise, Pride or Avarice. Liquidity preference means preference for liquidity or cash. 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. But I now read these discussions as an honest intellectual effort to keep separate what the classical theory has inextricably confused together, namely, the rate of interest and the marginal efficiency of capital. The demand in the economy is ordinarily for two types of goods – consumption goods and investment goods. (Tyler Cowen, in his critical comments on the General Theory is struck by a throw-off clause in this chapter: Keynes says that it’s unlikely interest rates will go up if people expect inflation, since if people expected inflation prices would have gone up already. And yet, the book is a necessary now as it was then: economics has not learned a single one of his lessons. What about recovery? 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. Static Analysis: The ‘General Theory’ does not trace out the effect of the future on the present economic events clearly. 2. (Of course, this is only true until we hit full employment — then prices just inflate.). What this amounts to is Say’s Law: supply creates its own demand. Share Your PDF File If people expect inflation, then expected yields go up and people invest more. 23: Now that Keynes has outlined his revolutionary theory, it’s time to look back at other economists the classical school dismissed. 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. The distinction between consumption and investment is fundamental to Keynes’ General Theory. Thus, a piano or an overcoat made for me this year is not part of this year’s income, but an addition to capital. Keynesian economics was founded by economist John Maynard Keynes. 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. Thus if someone makes twice as much per hour as an unskilled laborer, we’ll count each hour they work as two unskilled hours. I. But although the doctrine itself has remained unquestioned by orthodox economists up to a late date, its signal failure for purposes of scientific prediction has greatly impaired, in the course of time, the prestige of its practitioners. 180 crores. But these all depend on other complicating factors. 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. But this just weakens the multiplier, it doesn’t eliminate it. The first half of this book will be dedicated to prying it open. It is convenient to mention at this point the strange, unduly neglected prophet Silvio Gesell (1862-1930), whose work contains flashes of deep insight and who only just failed to reach down to the essence of the matter. Quarterly Journal of Economics, vol. — The theory of interest restated, 215. 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. 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). There are a large number of short-run and long-run influences which affect the marginal efficiency of capital. Fisher adopted consumption instead of production as the basis of measuring the national dividend. So why should the government promote investment instead of demand? (If, indeed, there’s nobody left who can build the trucks, we say the truck factory’s efficiency has gone to zero.). The Income-Expenditure Approach (Y = C + 1): Keynes defined the equilibrium of the economy as that situation in which total income (Y) equals the total expenditure (C + I). We can add it to the various levels of consumption shown by the consumption function and get the C +I (total expenditure) line. To simplify his theory considerably, Keynes employed a few assumptions which must be noted to avoid any confusion or misunderstanding. Marginal prime costs and labor costs increase as industry is forced to use more expensive equipment and laborers, resulting in higher prices. In Keynesian economics, investment does not mean financial investment i.e., investing money in buying existing stocks and shares, bonds or equities. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. The total income of the community is just the amount sold minus the user cost. It’s often said that the interest rate is the price people demand for saving money instead of spending it. [AS: I’ve been saying businesses because I find it clearer, but Keynes actually says entrepreneurs. 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. Suppose in order to cure unemployment an investment of Rs. Keynes's General Theory has been misunderstood as relying on frictions to justify the need for the visible hand of government to complement the invisible hand of the market. 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. Even if the entrepreneurs wished he could not avoid this loss. 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. 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. Thus the government must step in. Share Your Word File [AS: This sounds pretty ridiculous, I know, but give it a minute.]. Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York. First, people may refuse to work for a lower nominal wage when they’ll accept working for a lower real (i.e. The same level of income gets determined whether we have the Y = C +I approach or the S=I approach. We can write this relation as C=f(Y). [emphasis added], 11: Imagine you get a new widget-making machine. It has a constant slope and therefore shows a functional relation between income and consumption. As problematic as this is, Keynes points out that it’s a lot more realistic than the classical theory, which just seems to magically assume everyone is paid in proportion to their productivity. ], And as for some people being better at some jobs than others, we just pretend that’s an artifact of the equipment they use. And businesses choose whether to hire people based on how much they expect to sell. 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. 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. If electing FDR gets them depressed, they might pull back their investments and send the economy into a slump. 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. Keynes’s work has left a deep mark on modern macro-economics. It simply lays down that as our incomes increase; consumption will also increase though not in the same proportion as the increase in income. 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. They got it in their head that they were going to build a railroad, and by Jove they did. In Summary: What is the difference between Hayek and Keynes? Welcome to! It means disserving or accumulated-wealth consumption. In a country where most of the goods and services are not exchanged for money, i.e. Fourthly, Keynesian model has been criticised on the ground that it tends to understate the influence of money on the real variables (like consumption and investment) in the economy. But employment is kind of a more interesting number and it will have to do. I do not attempt an answer in this place. - III. “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.”. Another thing the classical economists long mocked were laws against usury. It would be absurd to assert of the United States in 1929 the existence of over-investment in the strict sense. ), Ancient Egypt was doubly fortunate, and doubtless owed to this its fabled wealth, in that it possessed two activities, namely, pyramid-building as well as the search for the precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance. And the stock market depends on “what is, in truth, a convention” — namely that the current valuation of a company is an accurate assessment of its expected yield — that stock prices will only change if there’s new evidence suggesting the yield will be different. No, this is an overstatement. The values of income, consumption and saving shown in Table 3.1 have been plotted in Figure 3.1. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Simple Income Determination 7. But politics has triumphed over logic and we’ve forgotten all the crucial things he explained. 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. 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. Thus focusing on the balance of trade serves both purposes — and, at a time we didn’t know how to control interest rates, was the only direct means of controlling them. The straight line labelled C shows the behaviour of consumption expenditure with respect to income. We’ll define net income as just income minus supplementary costs, since people can’t really be blamed for the unforeseen events. [AS: This seems to be a little controversial (and, indeed, tends to be a bit confusing), but let’s just accept it as a quirky definition, not any kind of factual claim. Keynes has found a crack in the classical theory. The conservative economists liked to wait for the free- economic system to correct its ailment itself but they could not specify for how long. It is because of this that Keynesians have put more faith in fiscal rather than monetary policy. 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. … 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. (Recall that at this time the world was still on the gold standard and thus mining for gold was equivalent to printing new money.). But Pigou’s definition made an artificial distinction between goods that are exchanged for money and goods that are not so exchanged. 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. As I said, that’s the naive view — there are a couple complications. Obstinacy can bring only a penalty and no reward. “Never in history was there a method devised of such efficacy for setting each country’s advantage at variance with its neighbours’!”. This is known as stagflation. (And when everyone follows the stock market, like in the US, this applies to everyone.) The effective demand in turn depends upon: (2) Investment, which depends upon marginal efficiency of capital and the rate of interest. 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.”. The desire to hold cash, however, is not an absolute desire; it can be easily overcome by offering sufficiently high reward in the form of interest. A shorter account will be found in the article on Keynesian economics. What changes how much they spend? THE PRINCIPLE OF EFFECTIVE DEMAND Still, the book isn’t exactly a smooth read. money) is something which cannot be produced and the demand for which cannot be readily choked off. Hayek economics was founded by famous economist Friedrich August von Hayek. [Tyler Cowen: “This is the best chapter in the book and one of the most important economics essays of all time. 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. 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. … 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. 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… Not only is income equal to expenditure, Y = C +I, but saving also equals investment, S = I. Therefore, he made the specific assumption of short-period so as to concentrate on the problem at hand. Marginal efficiency of capital refers to the expected profitability of an additional capital asset; it may be defined as the highest rate of return over cost accruing from an additional unit of a capital asset. The classical and the neoclassical economists almost neglected the problem of unemployment. The second half is filling it in. Instead, you can give it to poor people, who will use it to buy useful things like food and clothing. Keynes assumed that the techniques of production and the amount of fixed capital used remain constant in the model of his theory. [AS: I think he only ends up in making things more confusing, but maybe I’m missing something. Certain definite points on which the writer diverges from previous theories, 212. We have seen that it’s quite the opposite — that redistribution, by increasing effective demand, promotes growth. So I thought I’d try my best at an explanation/summary. Thus, if volume of employment (labour units) in the economy is increasing, it is clear that there is an increase in the national output. Some industries hit “bottlenecks” first, causing their prices to rise and demand to be funneled into industries that are faster to respond. Since consumption expenditures in the short run remain stable, Keynes’s theory stated in simple terms maintains that employment depends upon investment. Liquidity preference is a new concept used by Keynes. At income levels less than this, planned saving is much less than planned investment. Then there’s the cost of creating one more new widget-making machine. 250 (Rs. But maybe it makes some sense: Growth depends on the inducements to new investment. In 1987, Greenwald and Stiglitz accused Keynes’s summary of the "General Theory" in chapter 18 of relying upon “neoclassical and Marshallian tools.” 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. And some of the money can “leak” out to other countries. … 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).]. Thus all ‘go’ periods tended to be followed by ‘stop’ periods and it became difficult to achieve long-term economic growth. How does money influence demand? 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. 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 is judged from the total expenditure in the economy. But as interest rates get lower, it becomes profitable to invest in building things with smaller and smaller expected yields. The solution, they propose, is redistributing money to the poor to promote jobs. Now the State will still have to guide things; it seems unlikely that just controlling interest rates will be enough to ensure this utopian state of affairs. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely on the whole to do more harm than good, commended it to authority. Certain definite points on which the writer diverges from previous theories, 212. Classical economists believed that saving was a great private and social virtue. Of course there’s lots of different things you can invest in; we’re assuming that you do whatever maximizes your expected return. "THE GENERAL THEORY OF EMPLOYMENT" by John Maynard Keynes. Another way to look at it is the more stuff we make for tomorrow, the less stuff we need to make tomorrow. It is not the ownership of the instruments of production which it is important for the State to assume. The limitations of Keynes’s theory and policy became obvious when the policies advocated by the Keynesians were implemented after the Second World War. 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. We start by observing it’s impossible to measure things like “net output” or “price level” accurately — you’re always trying to compare qualitatively different things and run into no end of difficulties. Underemployment equilibrium was the result of private under-investment in relation to the savings available in the capitalist economy at the given income level. Keynes also refers to this previous Treatise on Money, explaining the re-definition of terms in The General Theory to avoid the confusions which the previous book brought when his terms were adopted for general use, without considering the “special sense” that … Further, the amount of wages received by ordinary labour for an hour’s work, Keynes called-wage unit. So even lowering interest rates isn’t enough to recover from the crash. In other words, it shows that whatever people earn is being spent either on consumption or on investment. So we’ll use only two types of counts: those of actual currency (money-values) and those of people (employment). Thus the interest rate depends on people’s desire to hoard cash — their liquidity preference (L) — and the quantity of money (M). Keynesian economics is a macroeconomic economic theory of total spending in the economy and its effects on output, employment, and inflation. Column 3 in the table shows that at the level of income of 50 crores, saving is negative, that is, minus 10 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. The mercantilists perceived the existence of the problem without being able to push their analysis to the point of solving it. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. [AS: Marginal efficiency of capital comes up a lot, so we’ll save time by calling it “your expected return.”]. Why don’t people just invest all their money? And, in practice, people don’t calculate their expectations from scratch each morning. Generally these policies were successful in preventing heavy unemployment like that experienced during the days of the Great Depression. (Maybe large changes in interest rates, but those are rare.). For in such matters it is rash to predict how the average man will react to a changed environment. Keynes rejected classical theories based on the idea that production creates its own demand, that is, that the economy always recovers to full employment after a shock. 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. Call that the supply cost. The problem is that capitalists aren’t buying capital per se, they’re buying an expected yield. Estimates are at best estimates and they can at times differ from the actual. “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! Demand and Supply for output as a whole, 219. Perhaps the government should start buying and selling long-term bonds to address this. and measured them in wage units to be able to ignore the questions arising out of changes in relative prices of resources. Most people think that as the interest rate goes up, spending goes down and saving goes up, but this shows that saving and spending both decrease. Investment also includes additions to stocks of manufactured and semi-manufactured goods (inventories) as well as in fixed capital. It was this theory of demand and supply of output as a whole which was neglected for more than 100 years and which Keynes analysed. But how do they know what future sales will be? Its analysis remains comparatively static, though at times Keynes introduced expectations in his analysis. The bought and the un bought do not differ in kind from one another in any fundamental respect. 22: Why are there trade cycles, aka business cycles, aka booms and busts? However, this period was relatively short because Keynes's heart attack in 1937 meant that he was out of action … The equilibrium level of income is determined at Rs. Keynes considered government as the sole supplier of money in the short period. In the Keynesian model, a change in money supply only affects national income through its effect on the rate of interest. 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. 9, 1972), and served once more in the Treasury as an all-purpose adviser. Firstly, it was clear that a laissez-faire capitalist economy will not be able to maintain full employment even if it is attained. Why should it be any different from a futures contract on wheat? A man’s saving is that part of his money income that is not spent on consumption goods. 15 crores then investment multiplier is 15/5 = 3. 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. 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. 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. The extraordinary achievement of the classical theory was to overcome the beliefs of the ‘natural man’ and, at the same time, to be wrong. John Maynard Keynes' The State of Long‐Term Expectation, From the General Theory Page 3 of 4 months or a year hence. All it can do is change the price of hoarding — the interest rate. The other component is investment. But calculating expected yields is much harder than guessing what everyone else will do; there’s no reason to think spending the same amount of time doing that is any more profitable. Experience in the 1970’s in particular has shown that high rates of inflation can co-exist with high rates of unemployment. There’s an asymmetry in the system that workers will resist falling wages, but not rising ones. Investment is just the amount of current output that isn’t consumed. All industries employ labour and their outputs can be expressed in terms of employment that they offer. 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. 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; “In this event the monetary authority would have lost effective control over the rate of interest.” [AS: This, I presume, is the liquidity trap.] “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 would be the end of the rentier — the rich person who grows richer by using his wealth to exploiting others. And there must be a similar employment multiplier (k’) where for each person hired for a job, k’ people get hired in total. Fleshing out the GT with tools not available to Keynes, Marglin exposes the fundamental failure of markets to self-regulate and draws lessons for fiscal and monetary policies. Instead, saving lowers demand and thus decreases employment. Thus, through his theoretical contribution Keynes not only shook the Classical Theory in its roots but also demolished its policy implications completely. But the worst part of the international gold system is the way it sets countries against one another. The big problem is that money is the one thing market processes can’t adjust. He wanted to know the considerations that weigh with entrepreneurs when they decide to employ certain number of men. … But there are many difficulties which Gesell did not face. Keynes expressed employment in terms of labour units. If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. In fact, monetary unit (money) had been employed usually as the standard of measurement. Among Gesell’s proposals are the notion of stamped money (money you have to pay to get stamped regularly to keep it valid currency) which is a way of discouraging people from hoarding. As a result, it seems likely that the State, which can calculate these things with an eye to the long-term and the social good, will take over more and more of the job of organizing long-term investment. 60 crores. Bonds are for wusses. Two years later, though not completely recovered, he returned to teaching at Cambridge, wrote three influential articles on war finance entitled How to Pay for the War (1940; later reprinted as Collected Writings , vol. It’s because investment comes first. 100 crores and this means zero saving. Keynes’ General Theory tries to tackle exactly this problem. Since this seems so basic, Keynes is puzzled at how it’s been so ignored: The completeness of the [classical] victory is something of a curiosity and a mystery. 2 likes. THE POSTULATES OF THE CLASSICAL ECONOMICS 3. 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). 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. But even so, it will still be possible for communal saving through the agency of the State to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce. Apparatus of Keynes’s General Theory 6. If you can’t increase investment, you have to increase consumption. It may turn out that the propensity to consume will be so easily strengthened by the effects of a falling rate of interest, that full employment can be reached with a rate of accumulation little greater than at present. 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. Keynes’s General Theory of Employment, Interest and Money (1936) is surely the most influential book of recent times. The equation Y= C+I, expresses the relationship between C and Y. The higher the liquidity preference i.e., the desire of the people to hold cash, the higher the rate of interest which must be offered to overcome their liquidity preference. Consumption depends upon propensity to consume and investment is determined by inducement to invest. But it’s not easy to think of useful things to make for the future. But the side effect is that “the very long-run course of prices has almost always been upward.”. There’s no math, but there’s still a lot to chew on. Saving doesn’t lower the interest rate and thus increase investment — an increase in money does that. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. It’s hard to convey the excitement I felt when reading this.] He advocated the policy of starting public works and financing them with fiat money with an unbalanced budget. Therefore, Keynes justified state intervention in economic affairs to fight instability. No, the interest rate is the “price” people demand for parting with their cash. Have they insufficient roots in the motives which govern the evolution of political society? 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. What will we do when we’ve built all the factories the people of the future can be expected to use? If you make $1M, you might spend $500K of it. 20: We’ve said that employment ultimately comes from demand. More efficient and skilled labour, he observed, can be evaluated at a higher rate and the wage unit in this case can also be higher. Our precision will be a mock precision if we try to use such partly vague and non-quantitative concepts as the basis of a quantitative analysis. He divided effective demand into two components – consumption and 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. We’ll call these hours labor-units and we’ll call the money that gets paid for them wage-units. This considerably simplified his analysis, for he could thereby take employment and output as moving together in the same direction. Everyone builds houses thinking they’ll all sell for lots and lots, then they find they aren’t actually selling for so much and the economy collapses. Therefore, point E shows equilibrium in the economy. Keynes. 10) = Rs. This is fortunate, because lower consumption also means lower income (when people buy less, businesses make less, so they pay you less). 750 at the end of the year having suffered a reduction in the value worth Rs. […]. 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. The Two Approaches to Income Determination 8. 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. [AS: This is the first use of that suspicious definition.]) 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. But how much they sell is exactly dependent on how much people spend. Indeed, the basic model assumed that wages and prices are fixed as long as the government is reducing unemployment. 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’. Thus, according to Keynes, during a period of depression or recession encourage spending more to increase effective demand. 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. To conclude, Keynes uses the term income in two senses: (1) Gross Income (A-U) on which the volume of employment depends. You use the extra people to get you up to speed, then you lay them off. 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. We have to select the more easily manageable factors influencing aggregate income and employment. Prices in Keynes’s model use only after full employment. 6: When you’re producing something, there are a couple of things involved. 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. 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.”. At levels of income greater than Rs. and replacement cost of capital assets. But the actual course of events is more complicated still. 1. As such it is called Consumption Function. Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity. Nevertheless, the way in which modern economists view macro-economic problems owes much to the Keynesian framework. During depression he would advocate a deficit budget to stimulate effective demand and in times of inflation, he wanted the government to have a surplus budget to restrict effective demand. What happens isn’t so much excessive investment as misdirected investment. And since future demand is estimated based on present demand, it tends to decrease investment as well. Keynes’ economic thinking and economic policy at once became popular. But this is good, because otherwise wages would fall to zero in any downturn and the entire economy would shut down. An uninterrupted process of transition, such as the above, to a new long-period position can be complicated in detail. (The details of how the remainder gets invested has to do with interest and will be addressed later.). Hitherto the increment of the world’s wealth has fallen short of the aggregate of positive individual savings; and the difference has been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. In practical life the exact line of demarcation between investment and consumption is easily drawn; for example, expenditures on food and clothing are clearly consumption while those on buildings, factories and transportation facilities are easily investment. But in this case the value of the machine has been maintained at Rs. The only thing that can save us is if “millionaires find their satisfaction in building mighty mansions to contain their bodies when alive and pyramids to shelter them after death, or, repenting of their sins, erect cathedrals and endow monasteries or foreign missions.” That’s no way to run a country. It conveys the impression that there are several factors on which employment depends. 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. “We have all of us become used to finding ourselves sometimes on the one side of the moon and sometimes on the other, without knowing what route or journey connects them, related, apparently, after the fashion of our waking and our dreaming lives.” The right split is between the theory of the individual industry and the theory of the economy as a whole. Is the fulfilment of these ideas a visionary hope? This is a depressing thought, especially since Keynes throughout seems optimistic that once he’s explained everything so clearly, economics will be back on the right track. 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. 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.” For example, a machine worth Rs. The analogy between this expedient and the goldmines of the real world is complete. 5 crores is made in public works, the effect of this original investment would be to increase the national income several fold. Privacy Policy3. The points on this line fulfill the equilibrium condition in the economy: i.e. Keynes was writing about the short-period problem of depression. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. THE GENERAL THEORY OF EMPLOYMENT SUMMARY 1. At various levels of income and employment, there will be different levels of aggregate demand, but all the levels of demand are not effective. And, Keynes points out, it’s largely about the paradox of thrift — centuries before Keynes! And there’s the issue that even at low rates of interest, banks still need to trust their borrowers and make enough to pay their expenses, which may require them to raise rates. “The idea behind stamped money is sound. Then as some workers receive better wages other workers will demand it and, since business is booming, receive it. 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. 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. Not much, Keynes argues. Keynesian economics is a theory that says the government should increase demand to boost growth. These policies needed modification and moderation. Meanwhile, like other academic economists, I treated his profoundly original strivings as being no better than those of a crank. The concept of underemployment equilibrium is the most revolutionary idea put forth by Keynes. Expected return would then probably fall steadily keep it there, unless there’s an increase in the propensity to consume (including by the State). 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. Column 1 in the table shows the various levels of income while column 2 shows the levels of consumption associated with it. The only solution would be to force everyone to either to buy goods or capital assets with everything they own. 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. 12 of Interest Rate Theory) Page 1 John Maynard Keynes The General Theory of Employment, Interest and Money Chapter 12. [AS: Obviously this accounting fiction isn’t particularly realistic since, in reality, the multiples people get paid change as the wage-unit goes up. The remaining chapters of Keynes's book contain amplifications of various sorts and are described later in this article. It is in this respect that his definition differed from those of his predecessors. The General Theory of Employment, Interest and Money (1936). It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. “Moreover, this situation might be reached comparatively soon—say within twenty-five years or less. these are contingent costs like plant becoming obsolete, catching fire. It will be, moreover, a great advantage of the order of events which I am advocating, that the euthanasia of the rentier, of the functionless investor, will be nothing sudden, merely a gradual but prolonged continuance of what we have seen recently in Great Britain, and will need no revolution. ‘“What will you do,” it is asked, “when you have built all the houses and roads and town halls and electric grids and water supplies and so forth which the stationary population of the future can be expected to require?”’ But the same logic applies to private investment. If people are unemployed, it must be because they’re refusing to take the job. But it was found that Keynes’s policies tended to create inflationary pressures to control which the government had to reduce aggregate spending. Thus in the absence of money and in the absence — we must, of course, also suppose — of any other commodity with the assumed characteristics of money, the rates of interest would only reach equilibrium when there is full employment. It was a man-made calamity, a situation of poverty amidst plenty. Disclaimer Copyright, Share Your Knowledge Limitations of the Keynesian Theory. 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. 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. But the money-wage level as a whole should be maintained as stable as possible, at any rate in the short period.”. There are all sorts of practical problems with lowering interest below zero, so instead what happens is that, in laissez-faire, employment falls to reach the new low levels. The general apparatus of the Keynesian theory of employment can be briefly summarised in the following form: We start explaining the concepts from the top of the format given above. The policy recommendations he made were not entirely new but the theoretical justification he gave for them was remarkable. Reading this, you might think the solution is to raise interest rates to prevent overinvestment during booms, since lowering them doesn’t get you out of slumps. I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work. | Keynes’s General Theory. “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. We could imagine paying the future wheat contracts in terms of wheat, resulting in a wheat interest rate. It all depends on how far the rate of interest is favourable to investment, after taking account of the marginal efficiency of capital. If the national income is increased by an amount of say Rs. But this means that as national income increases, a smaller proportion of it will get spent, so more of it will have to be invested. We can’t measure net output, but we can count the number of people employed. 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. 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. Finally we come to Major Douglas, who led the unorthodox Social Credit movement in the UK: Major Douglas is entitled to claim, as against some of his orthodox adversaries, that he at least has not been wholly oblivious of the outstanding problem of our economic system. 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. 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. 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". After all, a bond is just a promise to get some money in the future. In other words, as employment goes up and we run out of skilled truck-builders, we say the truck factory is getting less efficient. And if the interest rate falls, the economy will grow and people will need more cash for these sorts of transactions. Only the services, rendered to use during this year by these things are income.”. A labour unit may be taken to mean one hour of work by ordinary, unskilled or common worker. Keynes seems to suggest this can be modeled as “a rapid liability to change in the supply of labor;” I guess that’s possible. 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. 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. 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. Why is there a liquidity preference? — II. Eventually, we’re forced to make things for today. If the interest rate goes up, that will slow investment. In Table 3.1, planned saving at the levels of income of Rs. The public can’t control the amount of hoarding, since that’s necessarily equal to the amount of cash. (Land can’t be grown either, but if we really needed to we could free some up by moving closer together. 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). [AS: This is truly brilliant. Otherwise, our only relief comes from printing more money. 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. This raises the price, which makes Apple richer but doesn’t help any employees — and Apple likes to save its money much more than its employees do. The classical school — including Keynes in earlier years — grew up mocking mercantilism (protectionism) as incoherent and absurd.

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