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. The big problem is that money is the one thing market processes can’t adjust. 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… 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. In fact, monetary unit (money) had been employed usually as the standard of measurement. To simplify his theory considerably, Keynes employed a few assumptions which must be noted to avoid any confusion or misunderstanding. 16 quotes from The General Theory of Employment, Interest, and Money: ... ― John Maynard Keynes, The General Theory of Employment, Interest, and Money. In addition, there are the unavoidable and unforeseen, which we’ll call windfall loss. Policy Recommendations of Keynes’s Theory 9. For the book is, indeed, truly brilliant, a definite work of genius. Investment also includes additions to stocks of manufactured and semi-manufactured goods (inventories) as well as in fixed capital. The first half of this book will be dedicated to prying it open. I think I also use this kind of interchangeably with capitalists. Fisher adopted consumption instead of production as the basis of measuring the national dividend. 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. The analogy between this expedient and the goldmines of the real world is complete. “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. 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. 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. Obviously a lot more in absolute terms, but far less proportionately.) And “it is not so easy to revive the marginal efficiency of capital, determined, as it is, by the uncontrollable and disobedient psychology of the business world. Not much, Keynes argues. It was a man-made calamity, a situation of poverty amidst plenty. Thus, a piano or an overcoat made for me this year is not part of this year’s income, but an addition to capital. Why should it be any different from a futures contract on wheat? An uninterrupted process of transition, such as the above, to a new long-period position can be complicated in detail. Interest, in turn, affects investment and employment. 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. 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. He solved this problem in his own way. Or, to change the metaphor slightly, professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. We could imagine paying the future wheat contracts in terms of wheat, resulting in a wheat interest rate. Share Your Word File 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. 2 likes. […]. 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. “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.”. We have addressed the first, but what are its implications of the second? 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. There must be an investment multiplier — call it k — such that an extra $1 invested leads to $k increase in income. Further as income rises, saving also rises. If people lose “confidence” because of all the spending, they may decide to hold onto their money. -The theory of interest restated, 215. “— which implies that if the rate of interest were lower, i.e. According to Keynes, number of people to be employed (N) depends upon income (7) in this sense. In a country where most of the goods and services are not exchanged for money, i.e. It is very necessary to measure the aggregative quantities like saving, investment, consumption, income output etc. Let us presume (with Keynes) that the level of investment is not related to income. This is fortunate, because lower consumption also means lower income (when people buy less, businesses make less, so they pay you less). 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. 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. It may well be that the classical theory represents the way in which we should like our economy to behave. (If, indeed, there’s nobody left who can build the trucks, we say the truck factory’s efficiency has gone to zero.). 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. The marginal efficiency of capital is the yield less the supply cost. Quite the contrary. It is striking how few economists have thought this problem through.”), 12: As we noted before, capitalists invest if they expect future sales to be high. 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). 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 1936, in the midst of the Great Depression, John Maynard Keynes forever transformed the field of macroeconomics with this classic and still controversial work. “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.”. Meanwhile, like other academic economists, I treated his profoundly original strivings as being no better than those of a crank. In the post-war years his devotees bombarded me with copies of his works; yet, owing to certain palpable defects in the argument, I entirely failed to discover their merit. Classical economists believed that saving was a great private and social virtue. There are other reasons people might want to hold cash. To conclude, Keynes uses the term income in two senses: (1) Gross Income (A-U) on which the volume of employment depends. Secondly, he could very nicely provide reasons for departures from the policy of balanced budgets. 15: The central bank can lower the short-term interest rate through open-market operations: printing money and using it to buy short-term government debt. Another thing the classical economists long mocked were laws against usury. Obstinacy can bring only a penalty and no reward. These two combined are the prime cost. Since consumption depends upon net income, it is necessary that net income be calculated as accurately as possible. He assumed that there is a fairly high degree of competition in the markets. If you make $1M, you might spend $500K of it. 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. Production in excess of what is currently-consumed is called investment. Storage costs for goods and services may eliminate this paradox but perhaps not completely. 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’. In this event a scheme for the higher taxation of large incomes and inheritances might be open to the objection that it would lead to full employment with a rate of accumulation which was reduced considerably below the current level. 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’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. For example, a machine worth Rs. 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. After all, a bond is just a promise to get some money in the future. But the money-wage level as a whole should be maintained as stable as possible, at any rate in the short period.”. 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. It’s often said that the interest rate is the price people demand for saving money instead of spending it. No doubt Dr. Marshall’s definition was theoretically sound, simple and comprehensive; even then it had serious practical limitations; for example, it is not easy to make statistically correct estimates of the total production of goods and services in a country, besides the difficulties of double counting and the portion of the produce that is retained for personal consumption. What about recovery? 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. Which is why the suggestion of making it spoil (by printing money with expiration dates, etc.) “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. 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. We’ll define net income as just income minus supplementary costs, since people can’t really be blamed for the unforeseen events. 70 crores while their income is only Rs. All it can do is change the price of hoarding — the interest rate. “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. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. 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. Either way, new expectations don’t always take effect immediately (if you just opened a new store and then decide it wasn’t worth it, you don’t immediately close it). Virtue and vice play no part. Consumption function is written as a schedule of various amounts of consumption expenditure that consumers will incur at different levels of income. But this just weakens the multiplier, it doesn’t eliminate it. Keynes: Long-term Expectations (Ch. It is judged from the total expenditure in the economy. 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. John Maynard Keynes' The State of Long‐Term Expectation, From the General Theory Page 3 of 4 months or a year hence. Only the services, rendered to use during this year by these things are income.”. 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. One is the amount of capital and equipment and so on you use up, which we’ll call the user cost. They don’t care how good the machine is at making widgets, what matters is whether they can make money selling the widgets. 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. 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. 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. The main problem with the Keynesian model was that it was meant for the short run. However, this period was relatively short because Keynes's heart attack in 1937 meant that he was out of action … If venture capitalists are spending all their money on useless cable, the solution is to take their money away. I. What changes how much they spend? Professor A.P. This may be great simplification of facts but it brings forth the crucial importance of investment in Keynesian theory of employment. 100 + Rs. For example, unemployment relief financed by loans is more readily accepted than the financing of improvements at a charge below the current rate of interest; whilst the form of digging holes in the ground known as gold-mining, which not only adds nothing whatever to the real wealth of the world but involves the disutility of labour, is the most acceptable of all solutions. Long-term expectations can’t be easily checked, so when they do change, they often change suddenly. We have seen that it’s quite the opposite — that redistribution, by increasing effective demand, promotes growth. Thus they can’t even be approximately estimated. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil. The State of Long-Term Expectation I WE have seen in the previous chapter that the scale of investment … Let us imagine these policies are implemented. 24: The two great economic problems are unemployment and inequality. It is curious how common sense, wriggling for an escape from absurd conclusions, has been apt to reach a preference for wholly “wasteful” forms of loan expenditure rather than for partly wasteful forms, which, because they are not wholly wasteful, tend to be judged on strict “business” principles. 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. They’d much rather invest their money so that its valuation keeps going up and up and up. For the result is inevitable. Sorry.] Prices in Keynes’s model use only after full employment. The fact of the matter is that employment fluctuates on account of the fluctuations in investment. 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. 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. The book has proved revolutionary in the sense that it has left its imprint on all branches of economic theory. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. Therefore, the various points on this line are equidistant from the horizontal and the vertical axis. Interest rates never go below zero, after all. But the actual course of events is more complicated still. 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. Second, if wages go down, then the cost of making things goes down, which means that prices go down, which means that in real terms wages end up staying about the same. Indeed the world is ruled by little else. 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. Operation of the Law of Diminishing Returns: Further, directly flowing from his assumption of unchanging techniques was his assumption of the operation of diminishing returns to productive resources or increasing cost. So I thought I’d try my best at an explanation/summary. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority. 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. Hayek economics was founded by famous economist Friedrich August von Hayek. In Summary: What is the difference between Hayek and Keynes? The only solution would be to force everyone to either to buy goods or capital assets with everything they own. But employment is kind of a more interesting number and it will have to do. 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. Assumptions of Keynes’s General Theory 5. 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. 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. 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 … … 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. Classical economists always believed that the economy was in equilibrium at full employment level only, but in his general theory Keynes could show successfully that the free enterprise market economy could be in equilibrium at less than full employment-to this, he gave the name of underemployment equilibrium.
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