John Maynard Keynes and the Keynesian Revolution

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John Maynard Keynes and the Keynesian Revolution
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1. Background and Characteristic of John Maynnard
   Keynes
2. Keynes Tract
3. General Theory of Employment, Interest and Money
4. Post Keynesians and Neu Keynesians

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John Maynard Keynes (1883-1946)

• Born in 1883 in Cambridge, England
• Son of John Neville Keynes
• Neville was a professor of Economics and Logic at
  Cambridge Univ., and wrote on Economic
  Methodology
• Won a scholarship to Eton
• Boy Genius
• Won prizes for his work in the classics,
  mathematics, history, English essays
• Wrote papers on contemporary social problems,
  participated in crew and debate, acted, read
  everything
• Became an expert in medieval latin poetry
• Part of Etons social elite
• Won a scholarship to Kings College, Cambridge

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Keynes at College

• President of the Student Union
• President of the University Liberal Club
• Rowed, studied philosophy, played bridge, visited
  art galleries, collected rare books, went to the
  theatre
• Became a member of the Apostles, a secret and
  highly exclusive Cambridge intellectual society
• Became a member of the literary set called the
  Bloomsbury Group.

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Keynes After College

• Studied economics for perhaps 1 year, but did
  poorly on his exams.
• Took a civil service exam and took a job at the
  India Office for 2 years.
• 1908, his father managed to get him a job as a
  lecturer at Kings College. Later he became a
  Fellow.
• 1911, he became editor of the Economic Journal.
• Worked at the Treasury during WWI.
• 1921, he published A Treatise on Probability.
  This was his dissertation. It won him a
  fellowship at Kings College, Cambridge.
• Marries Lydia Lopokova.

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Keynes, Inter-war Years

• Keynes wrote the Economic Consequences of the
  Peace (1919), regarding reparation payments
• Best Seller
• Made him a public celebrity
• 1923, Tract on Monetary Reform (against returning
  to the pre-war gold standard)
• Economic Consequences of Mr Churchill (1925,
  warned of depression)
• 1930, Treatise On Money
• Makes millions in the stock market, commodity,
  and forex markets.
• 1936, General Theory of Employment, Interest and
  Money
• 1937, he has a serious heart attack

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John Maynard Keynes (1883-1946)

• Keynes lived as if he had more than 24 hours per
  day.
• Keynes kept himself busy with a variety of jobs
  and tasks.
• Keynes had a golden touch as an investor and
  raised money for himself and various causes.
• He wrote and edited economic articles and books.
• He was a great teacher.
• Overall, he was extraordinary person.

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• World War I was followed by sense of economic
  stagnation and istability.
• Keynes perceived that the economy, the world, and
  especially the capitalist institutions were
  breaking down.

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He believed that in the very long run, economic
progress would endure.

• Keynes believed the economy would grow at two
  percent annually.
• He concluded that, barring wars, the economic
  problem would be solved within one hundred years.
• Although he believed that the short-run outlook
  was terrible, he was confident that things would
  improve in the long run.

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Keynes Tract

• Relates money supply variability and uncertainty
  to inflation and deflation.
• Variability of prices is a major cause of
  business cycles.
• Wages and other costs of production adjust more
  slowly than prices.
• Therefore price variability affects profits and
  therefore investment.
• Investment cycles cause business cycles.

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General Theory of Employment, Interest and Money

• The main his book is the General Theory of
  Employment, Interest, and Money.

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The General Theory
I believe myself to be writing a book on
economic theory which will largely
revolutionizenot, I suppose, at once but in
the course of the next ten years the way the
world thinks about economic problems. --
John Maynard Keynes
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Comment by Paul Samuelson
It is a badly written book, poorly organized
any layman who, beguiled by the authors previous
reputation, bought the book was cheated of his 5
shillings. It is not well suited for classroom
use. It is arrogant, bad-tempered, polemical, and
not overly-generous in its acknowledgements... In
it the Keynesian system stands out indistinctly,
as if the author were hardly aware of its
existence or cognizant of its properties and
certainly he is at his worst when expounding on
its relations to its predecessors. Flashes of
insight and intuition intersperse tedious
algebra. An awkward definition gives way to an
unforgettable cadenza. When it is finally
mastered, we find its analysis to be obvious and
at the same time new. In short, it is the work of
genius.
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The General Theory

• If the consumer is an economic optimizer, he/she
  must be unable to buy the goods they planned to
  buy because of some kind of constraintrisk,
  convention, social institutions, cash, or ...?
• According to the classical model, the consumer
  has insatiable wants.
• The consumer sells his/her labor in exchange for
  enough income to buy the goods.
• The money value of the incomes received must be
  equal to the value of the output produced.
• So how can unsold goods pile up in warehouses,
  causing firms to lay off workers?

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The General Theory (2)

• Says Law cannot hold. (Supply creates its own
  demand.)
• If spending constraints are in effect, then there
  will be a difference between (unlimited) demand
  and effective demand.
• Actual (effective) demand will usually be
  deficient to purchase total output.

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The General Theory (3)

• Microeconomics and macroeconomics do not operate
  on the same basis. One cannot assume that what is
  true for the economic agent at the level of the
  individual consumer or firm is true in aggregate.
  This amounts to the fallacy of composition.
• In microeconomics, relative price effects
  dominate. This is not true in macroeconomics. In
  macroeconomics, income effects dominate, making
  income more important in determining aggregate
  economic behavior.

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The General Theory (4)

• Therefore, consumption depends primarily upon
  income, not interest rates.
• C ? C(r), but rather C C(Y)
• People dont change their standard of living
  simply because the interest rate changes a few
  points.

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The General Theory (5)

• Saving occurs as the result of a habit,
  convention, or social norm. People on average set
  aside a certain percentage of their income.
  Saving is not a function of interest rates.
• S ? S(r), but rather S S(Y)
• Investment is related to interest rates, but also
  to businesspeoples expectations for the future.
• That is, I I(r,E).

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The General Theory (6)

• If S S(Y) and I I(r,E), then there is no
  coordinating variable to bring supply and demand
  together in the loanable funds (capital) market.
• There is no reason to assume that supply equals
  demand in this market.
• There is no reason to believe that there will be
  adequate funds available to provide adequate
  investment demand.
• Since AD C I G NX, if investment demand
  is deficient, then AD lt AS, and inventories may
  pile up, with unemployment a natural outcome.
• Without the coordinating variable, this will be
  the normal outcome, with AD AS only happening
  accidentally.

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The General Theory (7)

1. Investment is a large and long-term commitment,
   and is based on weakly supported expectations
   about the future. This makes investment very
   different from consumption. Investment decisions
   will be erratic and emotional, and the risks
   associated with investment are very high. As a
   result, business decision makers will tend to
   under-invest, further worsening the problem of
   deficient investment.

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The General Theory (8)

1. It may be a natural outcome of the organization
   and institutions of modern economies that prices
   and wages may not be fully flexible. This would
   result in markets (like the labor and goods
   markets) being unable to clear, leading to
   unemployment and aggregate supply exceeding
   demand.

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The General Theory (9)

• Money plays a key role in the economy. The use of
  money leads to uncertainty, and makes piercing
  the veil impossible. A money economy is
  fundamentally different from a barter economy.
  The classical dichotomy cannot hold.
• Interest rates are established in the money
  market.
• People may rationally hoard money, holding money
  for purposes other then making transactions.
• Equilibrium is not AD AS. It is a state that
  persists.

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• Economists balanced these contrary issues.
• In the long run, innovation grew the economy, but
  in the short run there was a grinding of gears.
• Keynes believed that we need to be concerned
  about the processes and the immediate
  difficulties.

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• Keynes ideas are open to some criticism.
• All economic problems are not solved today, as
  Keynes had predicted.
• Growth does not actually look after itself, as
  Keynes had thought.

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General Theory of Employment, Interest and Money

• Keynes attempted to explain the reasons for the
  Great Depression.
• Keynes distinguished between the decision to save
  and the decision to invest.
• In practice Keynes thought people generally saved
  the same amount regardless of interest rates.
• Yet he also thought that business investment
  fluctuated greatly depending on the interest
  rates.
• Therefore savings and investment would be out of
  sync.

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Keynes criticized stock market investors and the
disease of speculation.

• He thought that stock market investing was merely
  a game, based on anticipation rather than on
  logic or sense.
• He proposed a tax on speculation to slow it
  down.

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Keynes found that a lack of effective demand
caused economic problems.

• He believed that when savings increased and
  investment was discouraged, buying power, and in
  turn production, would decrease, causing a
  vicious circle to develop.
• He found that as an economy became richer, people
  saved their money, which also slowed down the
  economy.

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Keynes felt that businesses had two choices when
demand fell.

• He believed that business could respond to the
  lack of demand by cutting wages or laying off
  workers.
• He argued it was easier for workers to accept a
  rise in inflation than a personal cut in pay.

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Keynes defendad the governments ability to pump
up demand.

• He wonted the government to inject money into the
  economy.
• He encouraged the government to do something
  other than watch the economy sink into a
  depression.

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• Keynes altered economic thinking.
• He referred to his predecessors and used their
  work.
• He acknowledged Mandeville, the mercantilists,
  and Malthus.
• Keynes was not wholly orginal in his ideas.
• Keynes moved from one equilibrium to another
  equilibrium.

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Keynes highlighted the negative aspects of saving.

• He showed the effects of too much saving.
• He showed the effects of too much savings on the
  government deficit.
• He thought that the government needed to
  encourage demand in the economy.

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Keynes brought macroeconomic analysis to the fore.

• Macroeconomics did not exist pior to the 1930s.
• Keynes focused on the overall system and the
  aggregate demand in the economy.

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Keynes conceived the idea that goverment had the
responsibility and power to manege the economy.

• Due to Keynes, we hold the president accountable
  for the economy.
• His analysis focused on solving current economic
  problems.
• He understood both the policies and the theories
  of economics.

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Keynes developed a philosophy of correctable
capitalism.

• Keynes thought that capitalism could coexist with
  some forms of government intervention.
• He defended capitalism, but he believed that at
  times the government must monitor the overall
  economic weather.

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Keynes inspired numerous groups of modern
economic followers.

• The Old Keynesians believed that goverment should
  ensure a certain level of aggregate demand, low
  interest rates, and abundant credit.
• The Post Keynesians argued that the economy was
  full of monopolistic tendencies. They fevored
  wage and price control.
• The New Keynesians focused on wages, process,
  and problems of information.

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Post Keynesians

• Sraffa, Robinson, Pasinetti, Weintraub, Davidson
• Neo-Ricardian view of production, value, and
  distribution
• Oligopolistic corporations. markup pricing
• Endogenous money
• Cyclical instability
• Incomes policy
• Class struggle for income shares, markup pricing
  necessitate a permanent incomes policy

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New Keynesians

• Fischer, Taylor, Howitt, and many others
• Rational expectations, general equilibrium,
  microfoundations
• Offer theoretical support at the firm profit
  maximization level for Keynesian features in the
  economy
• Contracting models
• Menu/transactions costs
• Efficiency wages
• Insider-Outsider theory