Keynes spearheaded a revolution in economic thinking, overturning the older ideas of neoclassical economics that held that free markets would, in the short to medium term, automatically provide full employment, as long as workers were flexible in their wage demands. Keynes instead argued that aggregate demand determined the overall level of economic activity and that inadequate aggregate demand could lead to prolonged periods of high unemployment. According to Keynesian economics, state intervention was necessary to moderate "boom and bust" cycles of economic activity. He advocated the use of fiscal and monetary measures to mitigate the adverse effects of economic recessions and depressions. Following the outbreak of World War II, Keynes's ideas concerning economic policy were adopted by leading Western economies.The book was a hard read for me, particularly the first 1/3, in which he laid a lot of the groundwork for the rest of the book and defined a lot of his terms. I'm guessing that he was "classically educated" - he uses several latin terms that are useful but not part of the current vernacular. It was harder to read than Adam Smith's "Wealth of Nations" written 160 years earlier.
I don't think I can really do this book justice without more study of economics and another read. So I'll just jump around some and include my favorite quotes. I'll also focus on Keynes's championing of social justice, while keeping an appreciation of individualism and personal liberty.
Keynes main task here is to address the problem that was gripping the world in the 1930's: how do we put all the unemployed workers back to work and achieve "full employment". The dominant school of economics at the time was neo-classical, which held that free markets would do the job, but that obviously wasn't working out. Classical economics included Say's Law, which says that you don't have to worry about demand; demand will always rise to meet supply.
Here's a nice slap-down of Recardian economics, which were the basis of classical economics. His description reminds me very much of the values espoused by conservative economists and politicians today.
That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. 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. 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.Ricardo was also the father of monetarism, "the theory that excess currency leads to inflation" (Wikipedia). This theory is still popular with conservative economists, like those that predicted hyperinflation after the Fed tripled the money supply in response to The Great Recession of 2008, and who still refuse to admit that they were completely wrong in their predictions.
Classical economics placed great emphasis on thriftiness and saving. Keynes saw this in the context of a bigger picture.
The prevalence of the idea that saving and investment, taken in their straightforward sense, can differ from one another, is to be explained, I think, by an optical illusion due to regarding an individual depositor's relation to his bank as being a one-sided transaction, instead of seeing it as the two-sided transaction which it actually is.This is obvious to anyone who has worked with (double-entry) accounting. All transactions are two-sided, always.
Keynes looks at the factors that create demand, in particular "the propensity to consume". Chapter 8 is on "objective factors" and Chapter 9 is on "subjective factors" which affect the propensity to consume. The subjective factors for saving vs consuming read like an oddly mixed list of virtues and vices.
These eight motives might be called the motives of Precaution, Foresight, Calculation, Improvement, Independence, Enterprise, Pride and Avarice; and we could also draw up a corresponding list of motives to consumption such as Enjoyment, Shortsightedness, Generosity, Miscalculation, Ostentation and Extravagance.Chapter 10 is titled "The Marginal Propensity To Consume And The Multiplier". It introduces one of Keynes's most important concepts: the multiplier, related to the velocity of money.
the greater the marginal propensity to consume, the greater the multiplier, and hence the greater the disturbance to employment corresponding to a given change in investment.Keynes sounds as frustrated with conservative economists and politicians who oppose government stimulus Just Because as Paul Krugman does now.
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.Classical economists explain The Great Depression as having been caused by an excessive money supply leading to speculative investments which created the bubble that triggered The Great Depression when it popped. Keynes's formulation of the business cycle was different.
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. 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.
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.
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. The Middle Ages built cathedrals and sang dirges. Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York. 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.
the succession of boom and slump can be described and analysed in terms of the fluctuations of the marginal efficiency of capital relatively to the rate of interest.The "Marginal Efficiency of Capital" seems to be Keynes's secret sauce in explaining the business cycle. Wikipedia defines it as "that rate of discount which would equate the price of a fixed capital asset with its present discounted value of expected income". I find this statement in Wikipedia much more comprehensible: "The MEC needs to be higher than the rate of interest for investment to take place." So it determines, will I do better with my money invested in a business (or the stock market) than with it collecting interest in a bank.
Exploring this concept, Keynes talks about "long-term expectation" and "state of confidence". He sees the same problems we have now with financial speculation versus investment that creates value rather than just harvesting it, and proposes as a solution - the Robin Hood tax!
The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism - which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object.Keynes talks about interest rates in terms of liquidity preference.
The introduction of a substantial government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise in the United States.
the rate of interest is the reward for parting with liquidity for a specified period.He also notes how this is contrary to monetarism.
For whilst an increase in the quantity of money may be expected, cet. par., to reduce the rate of interest, this will not happen if the liquidity-preferences of the public are increasing more than the quantity of money; and whilst a decline in the rate of interest may be expected, cet. par., to increase the volume of investment, this will not happen if the schedule of the marginal efficiency of capital is falling more rapidly than the rate of interest; and whilst an increase in the volume of investment may be expected, cet. par., to increase employment, this may not happen if the propensity to consume is falling off.Note, "cet. par." is short for "ceteris paribus", which is latin for "other things being equal". Being able to look this up instantly is one of those eBook features that has me pretty much deserting print.
Ha ha, talking about the convoluted formulations of "The Classical Theory Of The Rate of Interest" (Chapter 14), he uses this quotation from Ibsen's "The Wild Duck":
'The wild duck has dived down to the bottom - as deep as she can get - and bitten fast hold of the weed and tangle and all the rubbish that is down there, and it would need an extraordinarily clever dog to dive after and fish her up again.'Chapter 15 is "The Psychological And Business Incentives To Liquidity". I was in general encouraged with how much Keynes talks about psychology, of which I had not seen that much in my economic readings.
But at a level above the rate which corresponds to full employment, the long-term market-rate of interest will depend, not only on the current policy of the monetary authority, but also on market expectations concerning its future policy.He also describes very succinctly our current situation at the zero lower bound, and says what Krugman says now re the opportunities this offers the government. This is amazing given that up to that time interest rates had never approached the zero lower bound.
There is the possibility, for the reasons discussed above, that, after the rate of interest has fallen to a certain level, liquidity-preference may become virtually absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. In this event the monetary authority would have lost effective control over the rate of interest. But whilst this limiting case might become practically important in future, I know of no example of it hitherto. Indeed, owing to the unwillingness of most monetary authorities to deal boldly in debts of long term, there has not been much opportunity for a test. 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.Chapter 16 is titled "Sundry Ovservations On The Nature Of Capital". Keynes talks about capitalism as something that we can maybe eventually get rid of, as he does in his wonderful "Economic Possibilities for our Grandchildren". According to the 2014 Credit Suisse World Wealth Report, the total wealth of the world is currently $263T, with $91T in North America. So why aren't we living in a post-scarcity utopia?
On such assumptions I should guess that a properly run community equipped with modern technical resources, of which the population is not increasing rapidly, ought to be able to bring down the marginal efficiency of capital in equilibrium approximately to zero within a single generation; so that we should attain the conditions of a quasi-stationary community where change and progress would result only from changes in technique, taste, population and institutions, with the products of capital selling at a price proportioned to the labour, etc., embodied in them on just the same principles as govern the prices of consumption-goods into which capital-charges enter in an insignificant degree.The book was written when most countries were still on the gold standard. Such an odd concept, surely highlighted by the fact that it requires a physical activity - gold mining - to create more money. Chapter 17, "The Essential Properties of Interest and Money" talks about why we have money:
If I am right in supposing it to be comparatively easy to make capital-goods so abundant that the marginal efficiency of capital is zero, this may be the most sensible way of gradually getting rid of many of the objectionable features of capitalism.
But it is an essential difference between money and all (or most) other assets that in the case of money its liquidity-premium much exceeds its carrying cost, whereas in the case of other assets their carrying cost much exceeds their liquidity-premium.In Chapter 19, "Changes In Money Wages", Keynes argues against the classical truism that the best way to lower unemployment is to lower wages.
The second differentia of money is that it has an elasticity of substitution equal, or nearly equal, to zero which means that as the exchange value of money rises there is no tendency to substitute some other factor for it;
Thus, not only is it impossible to turn more labour on to producing money when its labour-price rises, but money is a bottomless sink for purchasing power, when the demand for it increases, since there is no value for it at which demand is diverted - as in the case of other rent-factors - so as to slop over into a demand for other things.
Perhaps it will help to rebut the crude conclusion that a reduction in money-wages will increase employment 'because it reduces the cost of production', if we follow up the course of events on the hypothesis most favourable to this view, namely that at the outset entrepreneurs expect the reduction in money-wages to have this effect. It is indeed not unlikely that the individual entrepreneur, seeing his own costs reduced, will overlook at the outset the repercussions on the demand for his product and will act on the assumption that he will be able to sell at a profit a larger output than before. If, then, entrepreneurs generally act on this expectation, will they in fact succeed in increasing their profits? Only if the community's marginal propensity to consume is equal to unity, so that there is no gap between the increment of income and the increment of consumption; or if there is an increase in investment, corresponding to the gap between the increment of income and the increment of consumption, which will only occur if the schedule of marginal efficiencies of capital has increased relatively to the rate of interest. Thus the proceeds realised from the increased output will disappoint the entrepreneurs and employment will fall back again to its previous figure, unless the marginal propensity to consume is equal to unity or the reduction in money-wages has had the effect of increasing the schedule of marginal efficiencies of capital relatively to the rate of interest and hence the amount of investment. For if entrepreneurs offer employment on a scale which, if they could sell their output at the expected price, would provide the public with incomes out of which they would save more than the amount of current investment, entrepreneurs are bound to make a loss equal to the difference; and this will be the case absolutely irrespective of the level of money-wages. At the best, the date of their disappointment can only be delayed for the interval during which their own investment in increased working capital is filling the gap.In other words, as we have seen in The Great Recession, you can't sell stuff if nobody has enough money to buy it. You can have demand side recessions.
There is, therefore, no ground for the belief that a flexible wage policy is capable of maintaining a state of continuous full employment;- any more than for the belief that an open-market monetary policy is capable, unaided, of achieving this result. The economic system cannot be made self-adjusting along these lines.Keynes also references "social justice" twice as a goal worth targeting.
In Chapter 21, "The Theory of Prices", Keynes again demomlishes the monetarist contention that inflation follows the money supply.
But when they pass ... to the theory of money and prices, we hear no more of these homely but intelligible concepts [supply and demand] and move into a world where prices are governed by the quantity of money, by its income-velocity, by the velocity of circulation relatively to the volume of transactions, by hoarding, by forced saving, by inflation and deflation et hoc genus omne; and little or no attempt is made to relate these vaguer phrases to our former notions of the elasticities of supply and demand. If we reflect on what we are being taught and try to rationalise it, in the simpler discussions it seems that the elasticity of supply must have become zero and demand proportional to the quantity of money; whilst in the more sophisticated we are lost in a haze where nothing is clear and everything is possible. 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.Chapter 22 is titled "Notes On The Trade Cycle". Again, we see the importance that Keynes puts on psychology, particularly what is now known as "consumer confidence", and get back to his secret sauce, MEC.
The trade cycle is best regarded, I think, as being occasioned by a cyclical change in the marginal efficiency of capital, though complicated and often aggravated by associated changes in the other significant short-period variables of the economic system.This seems to be Keynes strongest statement on the requirement for outside regulation of markets:
It is the return of confidence, to speak in ordinary language, which is so insusceptible to control in an economy of individualistic capitalism.
Once doubt begins it spreads rapidly.
When once the recovery has been started, the manner in which it feeds on itself and cumulates is obvious. But during the downward phase, when both fixed capital and stocks of materials are for the time being redundant and working-capital is being reduced, the schedule of the marginal efficiency of capital may fall so low that it can scarcely be corrected, so as to secure a satisfactory rate of new investment, by any practicable reduction in the rate of interest. Thus with markets organised and influenced as they are at present, the market estimation of the marginal efficiency of capital may suffer such enormously wide fluctuations that it cannot be sufficiently offset by corresponding fluctuations in the rate of interest. Moreover, the corresponding movements in the stock-market may, as we have seen above, depress the propensity to consume just wlaen it is most needed. In conditions of laissez-faire the avoidance of wide fluctuations in employment may, therefore, prove impossible without a far-reaching change in the psychology of investment markets such as there is no reason to expect. I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands.He again places emphasis on making sure that there is adequate demand.
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.Keynes again dangles the carrot of a post-scarcity "economy" (I put "economy" in quotes because the word itself implies scarcity). Where are the modern economists formulating how to juggle the numbers - because that is all we have to do - to get us to a post-scarcity world?
I am myself impressed by the great social advantages of increasing the stock of capital until it ceases to be scarce.Chapter 23 is titled "Notes On Mercantilism, The Usury Laws, Stamped Money And Theories of Under-Consumption". Keynes seems to be pretty much of a free trade guy, opposed to mercantilism.
Usury laws, which limit the allowable rate of interest, were around as late as the 1970s. When we bought our 1st house in 1975, the rate was topped by the Kentucky law of that time. Keynes feels that this is not unreasonable.
I mean the doctrine that the rate of interest is not self-adjusting at a level best suited to the social advantage but constantly tends to rise too high, so that a wise government is concerned to curb it by statute and custom and even by invoking the sanctions of the moral law.Keynes also introduces us to some economic figures of the past, including "the strange, unduly neglected prophet Silvio Gesell (1862-1930)".
He cites the comparative stability of the rate of interest throughout the ages as evidence that it cannot depend on purely physical characters, inasmuch as the variation of the latter from one epoch to another must have been incalculably greater than the observed changes in the rate of interest;Others mentioned in this chapter:
- Irving Fisher;
- Bernard Mandeville;
- Major Douglas;
- and from earlier chapters, I think his favorite whipping boy, Professor Pigou.
The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes.Ha, ha, here's a different read on why capitalism is not all bad. Unfortunately, we are now seeing his last point being made. The rich are not satisfied with just being uber-wealthy, they also want to run things.
I believe that there is social and psychological justification for significant inequalities of incomes and wealth, but not for such large disparities as exist to-day.
dangerous 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. It is better that a man should tyrannise over his bank balance than over his fellow-citizens; and whilst the former is sometimes denounced as being but a means to the latter, sometimes at least it is an alternative.Again he dangles a post-capitalist, post-scarcity world before us:
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.But Keynes was not a socialist. Despite being the father of government fiscal policy as a tool to solve economic problems, he saw the government intervention necessary as limited, and touted individualism.
I see, therefore, the rentier aspect of capitalism as a transitional phase which will disappear when it has done its work.
apart from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest, there is no more reason to socialise economic life than there was before.Keynes was such an optimist, I really identify with that. He believed in the power of the idea. He was a hope and change kind of guy. Here is the close of the book (and this review):
But, above all, individualism, if it can be purged of its defects and its abuses, is the best safeguard of personal liberty in the sense that, compared with any other system, it greatly widens the field for the exercise of personal choice. It is also the best safeguard of the variety of life, which emerges precisely from this extended field of personal choice, and the loss of which is the greatest of all the losses of the homogeneous or totalitarian state. For this variety preserves the traditions which embody the most secure and successful choices of former generations; it colours the present with the diversification of its fancy; and, being the handmaid of experiment as well as of tradition and of fancy, it is the most powerful instrument to better the future.
Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.