Keynesian economics

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v d e
n economics Keynesianism (prono!nced " ke n#i$n" , also Keynesian
economics and Keynesian Theory), is %ased on the ideas of twentieth&cent!ry
'ritish economist (ohn )aynard Keynes* +ccordin, to Keynesian economics
the state sho!ld stim!late economic ,rowth and improve sta%ility in theprivate
sector & thro!,h, for e-ample, interest rates, ta-ation and p!%lic pro.ects*
/he theories formin, the %asis of Keynesian economics were first presented
in The General Theory of Employment, Interest and Money, p!%lished in 0123*
n Keynes4s theory, some micro&level actions of individ!als and firms can lead
to a,,re,ate macroeconomic o!tcomes in which the economy operates %elow
its potential o!tp!t and ,rowth* )any classical economists had %elieved in 5ay4s
6aw, that s!pply creates its own demand, so that a 7,eneral ,l!t7 wo!ld
therefore %e impossi%le* Keynes contended that a,,re,ate
demand for ,oods mi,ht %e ins!fficient d!rin, economic downt!rns, leadin, to
!nnecessarily hi,h !nemployment and losses of potential o!tp!t* Keynes ar,!ed
that ,overnment policies co!ld %e !sed to increase a,,re,ate demand, th!s
increasin, economic activity and red!cin, hi,h !nemployment and deflation*
Keynes ar,!ed that the sol!tion to depression was to stim!late the economy
(7ind!cement to invest7) thro!,h some com%ination of two approaches 8
a red!ction in interest rates*
9overnment investment in infrastr!ct!re & the in.ection of income res!lts
in more spendin, in the ,eneral economy, which in t!rn stim!lates more
prod!ction and investment involvin, still more income and spendin, and so
forth* /he initial stim!lation starts a cascade of events, whose total increase
in economic activity is a m!ltiple of the ori,inal investment*
[0]
+ central concl!sion of Keynesian economics is that in some sit!ations, no
stron, a!tomatic mechanism moves o!tp!t and employment towards f!ll
employment levels* /his concl!sion conflicts with economic approaches that
ass!me a ,eneral tendency towards an e:!ili%ri!m* n the 4neoclassical
synthesis4, which com%ines Keynesian macro concepts with a micro fo!ndation,
the conditions of 9eneral e:!ili%ri!m allow for price ad.!stment to achieve this
,oal*
/he ;ew classical macroeconomics movement, which %e,an in the late 013<s
and early 01=<s, critici#ed Keynesian theories, while ;ew Keynesian
economics have so!,ht to %ase Keynes4s idea on more ri,oro!s theoretical
fo!ndations*
)ore %roadly, Keynes saw his as a general theory, in which !tili#ation of
reso!rces co!ld %e hi,h or low, whereas previo!s economics foc!sed on
the particular case of f!ll !tili#ation*
5ome interpretations of Keynes have emphasi#ed his stress on the international
coordination of Keynesian policies, the need for international economic
instit!tions, and the ways in which economic forces co!ld lead to war or co!ld
promote peace*
[>]
Contents
[hide]
0 Keynes and the ?lassics
o 0*0 Wa,es and spendin,
o 0*> @-cessive savin,
o 0*2 +ctive fiscal policy
o 0*A 7)!ltiplier effect7 and interest rates
o 0*B Keynes and redistri%!tion
> Postwar Keynesianism
2 ?riticism
o 2*0 )onetarist criticism
o 2*> /he 6!cas criti:!e
o 2*2 /he +!strian 5chool
o 2*A )ethodolo,ical Cisa,reement and Cifferent Res!lts that @mer,e
A Keynesian responses to the critics
B 5ee also
3 References
= F!rther readin,
D @-ternal links
[edit]Keynes and the ?lassics
Keynes so!,ht to distin,!ish his theories from 7classical economics,7 %y which
he meant the economic theories of Cavid Ricardo and his followers, incl!din,
(ohn 5t!art )ill, +lfred )arshall, F*E* @d,eworth, and +* ?ecil Pi,o!* +
central tenet of the classical view, known as 5ay4s law, states that Fs!pply
creates its own demand*G 5ay4s 6aw can %e interpreted in two ways* First, the
claim that the total val!e of o!tp!t is e:!al to the s!m of income earned in
prod!ction is a res!lt of a national income acco!ntin, identity, and is therefore
indisp!ta%le* + second and stron,er claim, however, that the 7costs of o!tp!t are
always covered in the a,,re,ate %y the sale&proceeds res!ltin, from demand7
depends on how cons!mption and savin, are linked to prod!ction and
investment* n partic!lar, Keynes ar,!ed that the second, stron, form of 5ay4s
6aw only holds if increases in individ!al savin,s e-actly match an increase in
a,,re,ate investment* (cf* General Theory, ?h*0,>)
Keynes so!,ht to develop a theory that wo!ld e-plain determinants of savin,,
cons!mption, investment and prod!ction* n that theory, the interaction of
a,,re,ate demand and a,,re,ate s!pply determines the level of o!tp!t and
employment in the economy*
'eca!se of what he considered the fail!re of the F?lassical /heoryG in the
012<s, Keynes firmly o%.ects to its main theory&&ad.!stments in prices wo!ld
a!tomatically make demand tend to the f!ll employment level*
;eo&classical theory s!pports that the two main costs that shift demand and
s!pply are la%or and money* /hro!,h the distri%!tion of the monetary policy,
demand and s!pply can %e ad.!sted* f there were more la%or than demand for it,
wa,es wo!ld fall !ntil hirin, %e,an a,ain* f there was too m!ch savin,, and not
eno!,h cons!mption, then interest rates wo!ld fall !ntil people either c!t their
savin,s rate or started %orrowin,*
[edit]Wages and spending
C!rin, the 9reat Cepression, the classical theory defined economic collapse as
simply a lost incentive to prod!ce* )ass !nemployment was ca!sed only %y
hi,h and ri,id real wa,es*
/o Keynes, the determination of wa,es is more complicated* First, he ar,!ed
that it is not real %!t nominal wa,es that are set in ne,otiations %etween
employers and workers, as opposed to a %arter relationship* First, nominal wa,e
c!ts wo!ld %e diffic!lt to p!t into effect %eca!se of laws and wa,e contracts*
@ven classical economists admitted that these e-istH !nlike Keynes, they
advocated a%olishin, minim!m wa,es, !nions, and lon,&term contracts,
increasin, la%or&market fle-i%ility* Iowever, to Keynes, people will resist
nominal wa,e red!ctions, even witho!t !nions, !ntil they see other wa,es
fallin, and a ,eneral fall of prices*
Ie also ar,!ed that to %oost employment, real wa,es had to ,o down8 nominal
wa,es wo!ld have to fall more than prices* Iowever, doin, so wo!ld
red!ce cons!mer demand, so that thea,,re,ate demand for ,oods wo!ld drop*
/his wo!ld in t!rn red!ce %!siness sales reven!es and e-pected profits*
nvestment in new plants and e:!ipmentJperhaps already disco!ra,ed %y
previo!s e-cessesJwo!ld then %ecome more risky, less likely* nstead of
raisin, %!siness e-pectations, wa,e c!ts co!ld make matters m!ch worse*
F!rther, if wa,es and prices were fallin,, people wo!ld start to e-pect them to
fall* /his co!ld make the economy spiral downward as those who had money
wo!ld simply wait as fallin, prices made it more val!a%leJrather than
spendin,* +s rvin, Fisher ar,!ed in 0122, in his Debt-Deflation Theory of
Great Depressions, deflation (fallin, prices) can make a depression deeper as
fallin, prices and wa,es made pre&e-istin, nominal de%ts more val!a%le in real
terms*
[edit]Excessive saving
/o Keynes, e-cessive savin,, i*e* savin, %eyond planned investment, was a
serio!s pro%lem, enco!ra,in, recession or even depression* @-cessive savin,
res!lts if investment falls, perhaps d!e to fallin, cons!mer demand, over&
investment in earlier years, or pessimistic %!siness e-pectations, and if savin,
does not immediately fall in step, the economy wo!ld decline*
/he classical economists ar,!ed that interest rates wo!ld fall d!e to the e-cess
s!pply of 7loana%le f!nds7* /he first dia,ram, adapted from the only ,raph
in The General Theory, shows this process* (For simplicity, other so!rces of the
demand for or s!pply of f!nds are i,nored here*) +ss!me that fi-ed investment
in capital ,oods falls from 7old I7 to 7new I7 (step a)* 5econd (step ), the
res!ltin, e-cess of savin, ca!ses interest&rate c!ts, a%olishin, the e-cess s!pply8
so a,ain we have savin, (!) e:!al to investment* /he interest&rate fall prevents
that of prod!ction and employment*
Keynes had a comple- ar,!ment a,ainst this laissez-faire response* /he ,raph
%elow s!mmari#es his ar,!ment, ass!min, a,ain that fi-ed investment falls
(step ")* First, savin, does not fall m!ch as interest rates fall, since
the income ands!%stit!tion effects of fallin, rates ,o in conflictin,
directions* Second, since planned fi-ed investment in plant and e:!ipment is
mostly %ased on lon,&term e-pectations of f!t!re profita%ility, that spendin,
does not rise m!ch as interest rates fall* 5o ! and I are drawn as steep (inelastic)
in the ,raph* 9iven the inelasticity of %oth demand and s!pply, a largeinterest&
rate fall is needed to close the savin,"investment ,ap* +s drawn, this re:!ires
a negatie interest rate at e:!ili%ri!m (where the new I line wo!ld intersect
the old ! line)* Iowever, this ne,ative interest rate is not necessary to Keynes4s
ar,!ment*
Third, Keynes ar,!ed that savin, and investment are not the main determinants
of interest rates, especially in the short r!n* nstead, the s!pply of and the
demand for the stock of money determine interest rates in the short r!n* (/his is
not drawn in the ,raph*) ;either chan,es :!ickly in response to e-cessive
savin, to allow fast interest&rate ad.!stment*
Finally, %eca!se of fear of capital losses on assets %esides money, Keynes
s!,,ested that there may %e a 7li:!idity trap7 settin, a floor !nder which interest
rates cannot fall* (n this trap, %ond&holders, fearin, rises in interest rates
(%eca!se rates are so low), fear capital losses on their %onds and th!s try to sell
them to attain money (li:!idity)*) @ven economists who re.ect this li:!idity trap
now reali#e that nominal interest rates cannot fall %elow #ero (or sli,htly
hi,her)* n the dia,ram, the e:!ili%ri!m s!,,ested %y the new I line and the old
! line cannot %e reached, so that e-cess savin, persists* 5ome (s!ch as Pa!l
Kr!,man) see this latter kind of li:!idity trap as prevailin, in (apan in the
011<s*
@ven if this 7trap7 does not e-ist, there is a fourth element to Keynes4s criti:!e
(perhaps the most important part)* 5avin, involves not spendin, all of one4s
income* t th!s means ins!fficient demand for %!siness o!tp!t, !nless it is
%alanced %y other so!rces of demand, s!ch as fi-ed investment*
/h!s, e!cessie savin, corresponds to an !nwanted acc!m!lation of inventories,
or what classical economists called a ,eneral ,l!t [>] * /his pile&!p of !nsold
,oods and materials enco!ra,es %!sinesses to decrease %oth prod!ction and
employment* /his in t!rn lowers people4s incomesJand savin,, ca!sin, a
leftward shift in the !line in the dia,ram (step #)* For Keynes, the fall in
income did most of the .o% %y endin, e-cessive savin, and allowin, the
loana%le f!nds market to attain e:!ili%ri!m* nstead of interest&rate ad.!stment
solvin, the pro%lem, a recession does so* /h!s in the dia,ram, the interest&rate
chan,e is small*
Whereas the classical economists ass!med that the level of o!tp!t and income
was constant and ,iven at any one time (e-cept for short&lived deviations),
Keynes saw this as the key varia%le that ad.!sted to e:!ate savin, and
investment*
Finally, a recession !ndermines the %!siness incentive to en,a,e in fi-ed
investment* With fallin, incomes and demand for prod!cts, the desired demand
for factories and e:!ipment (not to mention ho!sin,) will fall* /his accelerator
effect wo!ld shift the I line to the left a,ain, a chan,e not shown in the dia,ram
a%ove* /his recreates the pro%lem of e-cessive savin, and enco!ra,es the
recession to contin!e*
n s!m, to Keynes there is interaction %etween e-cess s!pplies in different
markets, as !nemployment in la%or markets enco!ra,es e-cessive savin,J
and ice-ersa* Rather than prices ad.!stin, to attain e:!ili%ri!m, the main story
is one of :!antity ad.!stment allowin, recessions and possi%le attainment
of !nderemployment e:!ili%ri!m*
[edit]"ctive $iscal policy
+s noted,
[clarification needed]
the classicals wanted to %alance the ,overnment %!d,et*
/o Keynes, this wo!ld e-acer%ate the !nderlyin, pro%lem8 followin, either
policy
[clarification needed]
wo!ld raise saing (%roadly defined) and th!s lower the
demand for %oth prod!cts and la%or* For e-ample, Keynesians see Ier%ert
Ioover4s (!ne 012> ta- increase as makin, the Cepression "orse*
[citation needed]
[clarification needed]
Keynes4s ideas infl!enced Franklin C* Roosevelt4s view that ins!fficient %!yin,&
power ca!sed the Cepression* C!rin, his presidency, Roosevelt adopted some
aspects of Keynesian economics, especially after 012=, when, in the depths of
the Cepression, the Knited 5tates s!ffered from recession yet a,ain followin,
fiscal contraction* '!t to many the tr!e s!ccess of Keynesian policy can %e seen
at the onset of World War , which provided a kick to the world economy,
removed !ncertainty, and forced the re%!ildin, of destroyed capital* Keynesian
ideas %ecame almost official in social&democratic @!rope after the war and in
the K*5* in the 013<s*
Keynes4s theory s!,,ested that active ,overnment policy co!ld %e effective in
mana,in, the economy* Rather than seein, !n%alanced ,overnment %!d,ets as
wron,, Keynes advocated what has %een called co!ntercyclical fiscal policies,
that is policies which acted a,ainst the tide of the %!siness cycle8 deficit
spendin, when a nation4s economy s!ffers from recession or when recovery is
lon,&delayed and !nemployment is persistently hi,hJand the s!ppression of
inflation in %oom times %y either increasin, ta-es or c!ttin, %ack on
,overnment o!tlays* Ie ar,!ed that ,overnments sho!ld solve pro%lems in the
short r!n rather than waitin, for market forces to do it in the lon, r!n, %eca!se
7in the lon, r!n, we are all dead*7
[2]
/his contrasted with the classical and neoclassical economic analysis of fiscal
policy* Fiscal stim!l!s (deficit spendin,) co!ld act!ate prod!ction* '!t to these
schools, there was no reason to %elieve that this stim!lation wo!ld o!tr!n the
side&effects that 7crowd o!t7 private investment8 first, it wo!ld increase the
demand for la%or and raise wa,es, h!rtin, profita%ilityH 5econd, a ,overnment
deficit increases the stock of ,overnment %onds, red!cin, their market price and
enco!ra,in, hi,h interest rates, makin, it more e-pensive for %!siness to
financefi-ed investment* /h!s, efforts to stim!late the economy wo!ld %e self&
defeatin,*
/he Keynesian response is that s!ch fiscal policy is only appropriate when
!nemployment is persistently hi,h, a%ove what is now termed the ;on&
+cceleratin, nflation Rate of Knemployment, or 7;+RK7* n that case,
crowdin, o!t is minimal* F!rther, private investment can %e 7crowded in78 fiscal
stim!l!s raises the market for %!siness o!tp!t, raisin, cash flow and
profita%ility, sp!rrin, %!siness optimism* /o Keynes, this accelerator
effect meant that ,overnment and %!siness co!ld %e complements rather
than s!%stit!tes in this sit!ation* 5econd, as the stim!l!s occ!rs, ,ross domestic
prod!ct rises, raisin, the amo!nt of savin,, helpin, to finance the increase in
fi-ed investment* Finally, ,overnment o!tlays need not always %e wastef!l8
,overnment investment in p!%lic ,oods that will not %e provided %y profit&
seekers will enco!ra,e the private sector4s ,rowth* /hat is, ,overnment spendin,
on s!ch thin,s as %asic research, p!%lic health, ed!cation,
and infrastr!ct!re co!ld help the lon,&term ,rowth of potential o!tp!t*
nvokin, p!%lic choice theory, classical and neoclassical economists do!%t that
the ,overnment will ever %e this %eneficial and s!,,est that its policies will
typically %e dominated %yspecial interest ,ro!ps, incl!din, the
,overnment %!rea!cracy* /h!s, they !se their political theory to re.ect Keynes4
economic theory*
+ Keynesian economist mi,ht point o!t that classical and neoclassical theory
does not e-plain why firms actin, as 7special interests7 to infl!ence ,overnment
policy are ass!med to prod!ce a ne,ative o!tcome, while those same firms
actin, with the same motivations o!tside of the ,overnment are s!pposed to
prod!ce positive o!tcomes* 6i%ertarians co!nter that %eca!se %oth parties
consent, free trade increases net happiness, %!t ,overnment imposes its will %y
force, decreasin, happiness* /herefore firms that manip!late the ,overnment do
net harm, while firms that respond to the free market do net ,ood*
n Keynes4 theory, there m!st %e si,nificant slack in the la%or
market %efore fiscal e-pansion is .!stified* 'oth conservative and
some neoli%eral economists :!estion this ass!mption, !nless la%or !nions or the
,overnment 7meddle7 in the free market, creatin, persistent s!pply&side
or classical !nemployment*
[clarification needed]
/heir sol!tion is to increase la%or&
market fle-i%ility, e*,*, %y c!ttin, wa,es, %!stin, !nions, and dere,!latin,
%!siness*
Ceficit spendin, is not Keynesianism* 9overnments had lon, !sed deficits to
finance wars* Keynesianism recommends co!nter&cyclical policies to smooth
o!t fl!ct!ations in the %!siness cycle* +n e-ample of a co!nter&cyclical policy is
raisin, ta-es to cool the economy and to prevent inflation when there is
a%!ndant demand&side ,rowth, and en,a,in, in deficit spendin, on la%or&
intensive infrastr!ct!re pro.ects to stim!late employment and sta%ili#e wa,es
d!rin, economic downt!rns* ?lassical economics, on the other hand, ar,!es that
one sho!ld cutta-es when there are %!d,et s!rpl!ses, and c!t spendin,Jor, less
likely, increase ta-esJd!rin, economic downt!rns* Keynesian economists
%elieve that addin, to profits and incomes d!rin, %oom cycles thro!,h ta- c!ts,
and removin, income and profits from the economy thro!,h c!ts in spendin,
and"or increased ta-es d!rin, downt!rns, tends to e-acer%ate the ne,ative
effects of the %!siness cycle* /his effect is especially prono!nced when the
,overnment controls a lar,e fraction of the economy, and is therefore one
reason fiscal conservatives advocate a m!ch smaller ,overnment*
[edit]%M&ltiplier e$$ect% and interest rates
Main article# Multiplier $economics%
/wo aspects of Keynes4 model had implications for policy8
First, there is the 7Keynesian m!ltiplier7, first developed %y Richard F*
Kahn in 0120* @-o,eno!s increases in spendin,, s!ch as an increase in
,overnment o!tlays, increases total spendin, %y a m!ltiple of that increase*
+ ,overnment co!ld stim!late a ,reat deal of new prod!ction with a modest
o!tlay if8
0* /he people who receive this money then spend most on cons!mption
,oods and save the rest*
>* /his e-tra spendin, allows %!sinesses to hire more people and pay
them, which in t!rn allows a f!rther increase cons!mer spendin,*
/his process contin!es* +t each step, the increase in spendin, is smaller
than in the previo!s step, so that the m!ltiplier process tapers off and allows
the attainment of an e:!ili%ri!m* /his story is modified and moderated if
we move %eyond a 7closed economy7 and %rin, in the role of ta-ation8 the
rise in imports and ta- payments at each step red!ces the amo!nt of ind!ced
cons!mer spendin, and the si#e of the m!ltiplier effect*
5econd, Keynes re&analy#ed the effect of the interest rate on investment* n
the classical model, the s!pply of f!nds (savin,) determined the amo!nt of
fi-ed %!siness investment* /hat is, since all savin,s was placed in %anks,
and all %!siness investors in need of %orrowed f!nds went to %anks, the
amo!nt of savin,s determined the amo!nt that was availa%le to invest* /o
Keynes, the amo!nt of investment was determined independently %y lon,&
term profit e-pectations and, to a lesser e-tent, the interest rate* /he latter
opens the possi%ility of re,!latin, the economy thro!,h money
s!pply chan,es, via monetary policy* Knder conditions s!ch as the 9reat
Cepression, Keynes ar,!ed that this approach wo!ld %e relatively
ineffective compared to fiscal policy* '!t d!rin, more 7normal7 times,
monetary e-pansion can stim!late the economy, mostly %y enco!ra,in,
constr!ction of new ho!sin,*
[edit]Keynes and redistri&tion
Keynesians and redistri%!tionists tend to associate with each other* Keynes,
in the twenties, wrote a%o!t a hydro&electric pro.ect* n his opinion it wo!ld
have %een %etter if the rewards of the pro.ect had ,one to the worker&
%!ilders rather than to the investors who had financed the pro.ect*
[citation needed]
Keynesians %elieve that fiscal policy sho!ld %e directed towards the lower&
income se,ment of the pop!lation, %eca!se that se,ment is more likely to
spend the money, contri%!tin, to demand, than to save it*
[edit]Postwar Keynesianism
+fter Keynes, Keynesian analysis was com%ined with neoclassical
economics to prod!ce what is ,enerally termed the 7neoclassical synthesis7
which dominates mainstream macroeconomic tho!,ht* /ho!,h it was
widely held that there was no stron, a!tomatic tendency to f!ll
employment, many %elieved that if ,overnment policy were !sed to ens!re
it, the economy wo!ld %ehave as classical or neoclassical theory predicted*
n the post&WW years, Keynes4s policy ideas were widely accepted* For
the first time, ,overnments prepared ,ood :!ality economic statistics on an
on,oin, %asis and had a theory that told them what to do* n this era of new
li%eralism and social democracy, most western capitalist co!ntries en.oyed
low, sta%le !nemployment and modest inflation*
t was with (ohn Iicks that Keynesian economics prod!ced a
clear model which policy&makers co!ld !se to attempt to !nderstand and
control economic activity* /his model, the I!'(Mmodel is nearly as
infl!ential as Keynes4 ori,inal analysis in determinin, act!al policy and
economics ed!cation* t relates a,,re,ate demand and employment to
three e-o,eno!s:!antities, i*e*, the amo!nt of money in circ!lation, the
,overnment %!d,et, and the state of %!siness e-pectations* /his model was
very pop!lar with economists after World War %eca!se it co!ld %e
!nderstood in terms of ,eneral e:!ili%ri!m theory* /his enco!ra,ed a m!ch
more static vision of macroeconomics than that descri%ed a%ove*
[citation needed]
/he second main part of a Keynesian policy&maker4s theoretical apparat!s
was the Phillips c!rve* /his c!rve, which was more of an empirical
o%servation than a theory, indicated that increased employment, and
decreased !nemployment, implied increased inflation* Keynes had only
predicted that fallin, !nemployment wo!ld ca!se a hi,her price, not a
hi,her inflation rate* /h!s, the economist co!ld !se the I!&(M model to
predict, for e-ample, that an increase in the money s!pply wo!ld raise
o!tp!t and employmentJand then !se the Phillips c!rve to predict an
increase in inflation*
[citation needed]
/hro!,h the 01B<s, moderate de,rees of ,overnment demand leadin,
ind!strial development, and !se of fiscal and monetary co!nter&cyclical
policies contin!ed, and reached a peak in the 7,o ,o7 013<s, where it
seemed to many Keynesians that prosperity was now permanent* Iowever,
with the oil shock of 01=2, and the economic pro%lems of the 01=<s,
modern li%eral economics %e,an to fall o!t of favor* C!rin, this time, many
economies e-perienced hi,h and risin, !nemployment, co!pled with hi,h
and risin, inflation, contradictin, the Phillips c!rve4s prediction*
/his sta,flation meant that the sim!ltaneo!s application of e-pansionary
(anti&recession) and contractionary (anti&inflation) policies appeared to %e
necessary, a clear impossi%ility* /his dilemma led to the end of the
Keynesian near&consens!s of the 013<s, and the rise thro!,ho!t the 01=<s
of ideas %ased !pon more classical analysis, incl!din,monetarism, s!pply&
side economics
[citation needed]
and new classical economics* +t the same time
Keynesians %e,an d!rin, the period to reor,ani#e their thinkin, (some
%ecomin, associated with ;ew Keynesian economics)H one strate,y,
!tili#ed also as a criti:!e of the nota%ly hi,h !nemployment and potentially
disappointin, 9;P ,rowth rates associated with the latter two theories %y
the mid&01D<s, was to emphasi#e low !nemployment and ma-imal
economic ,rowth at the cost of somewhat hi,her inflation (its conse:!ences
kept in check %y inde-in, and other methods, and its overall rate kept lower
and steadier %y s!ch potential policies as )artin Weit#man4s share
economy)
[A]
*
[edit]?riticism
/he impact of Keynesianism can %e seen %y the wave of economists who
have %ased their analysis on a criticism of Keynesianism*
[edit]Monetarist criticism
Lne school %e,an in the late 01A<s with )ilton Friedman* nstead of
re.ectin, macro&meas!rements and macro&models of the economy,
the monetarist school em%raced the techni:!es of treatin, the entire
economy as havin, a s!pply and demand e:!ili%ri!m* Iowever, they
re,arded inflation as solely %ein, d!e to the variations in the money s!pply,
rather than as %ein, a conse:!ence of a,,re,ate demand* /hey ar,!ed that
the 7crowdin, o!t7 effects disc!ssed a%ove wo!ld ho%%le or deprive fiscal
policy of its positive effect* nstead, the foc!s sho!ld %e on monetary
policy, which was lar,ely i,nored %y early Keynesians*
)onetarism had an ideolo,ical as well as a practical appeal8 monetary
policy does not, at least on the s!rface, imply as m!ch ,overnment
intervention in the economy as other meas!res* /he monetarist criti:!e
p!shed Keynesians toward a more %alanced view of monetary policy, and
inspired a wave of revisions to Keynesian theory*
[edit]The (&cas criti)&e
+nother infl!ential school of tho!,ht was %ased on the 6!cas criti:!e of
Keynesian economics* /his called for ,reater consistency
with microeconomic theory and rationality, and partic!larly emphasi#ed the
idea of rational e-pectations* 6!cas and others ar,!ed that Keynesian
economics re:!ired remarka%ly foolish and short&si,hted %ehavior from
people, which totally contradicted the economic !nderstandin, of their
%ehavior at a micro level* ;ew classical economics introd!ced a set of
macroeconomic theories which were %ased on
optimisin,microeconomic %ehavior, for instance real %!siness cycles*
[edit]The "&strian !chool
Keynesian ideas were critici#ed %y +!strian economist and
philosopher Friedrich Iayek* Iayek4s most famo!s work The &oad to
Serfdom, was written in 01AA* Iayek ta!,ht at the6ondon 5chool of
@conomics from 0120 to 01B<* Iayek critici#ed Keynesian economic
policies for what he called their f!ndamentally collectivist approach,
ar,!in, that s!ch theories, no matter their pres!mptively !tilitarian
intentions, re:!ire centrali#ed plannin,, which Iayek ar,!ed leads to
totalitarian a%!ses* Keynes seems to have noted this concern, since, in the
foreword to the 9erman version of the 4/he 9eneral /heory of @mployment
nterest and )oney4, he declared that 7the theory of a,,re,ated prod!ction,
which is the point of [4/he 9eneral /heory of @mployment nterest and
)oney4], nevertheless can %e m!ch easier adapted to the conditions of a
totalitarian state [eines totalen 5taates] than the theory of prod!ction and
distri%!tion of a ,iven prod!ction p!t forth !nder conditions of free
competition and a lar,e de,ree of laisse#&faire*7
[B]
+nother criticism leveled %y Iayek a,ainst Keynes was that the st!dy of the
economy %y the relations %etween a,,re,ates is fallacio!s, and that
recessions are ca!sed %y micro&economic factors* Iayek claimed that what
starts as temporary ,overnmental fi-es !s!ally %ecome permanent and
e-pandin, ,overnment pro,rams, which stifle the private sector and civil
society* Keynes himself descri%ed the criti:!e as 7deeply movin,7, which
was :!oted on the cover of the Road to 5erfdom*
Ienry Ia#litt critici#ed Keyne4s /he 9eneral /heory of @mployment,
nterest and )oney in The Failure of the '(e" Economics'# )n )nalysis of
the *eynesian Fallacies*
+narcho&capitalist )!rray Roth%ard was also fond of pointin, o!t
perceived flaws in Keynesian economics* Roth%ard acc!ses that
Keynesianism has 7its roots deep in medieval and mercantilist tho!,ht*7
[3]
[edit]Methodological *isagreement and *i$$erent
Res&lts that Emerge
'e,innin, in the late 01B<s ;ew ?lassical )acroeconomists %e,an to
disa,ree with the methodolo,y employed %y Keynes and his s!ccessors*
Keynesians emphasi#ed the dependence of cons!mption on disposa%le
income and, also, of investment on c!rrent profits and c!rrent cash flow* n
addition Keynes posited a Phillips c!rve that tied nominal wa,e inflation to
!nemployment rate* /o %!ttress these theories Keynesians typically traced
the lo,ical fo!ndations of their model (!sin, introspection) and %!ttressed
their ass!mptions with statistical evidence*
[=]
;ew ?lassical theorists
demanded that )acroeconomic %e ,ro!nded on the same fo!ndations as
)icroeconomic theory, profit&ma-imi#in, firms and !tility ma-imi#in,
cons!mers*
[=]
/he res!lt of this shift in methodolo,y prod!ced several important
diver,ences from Keynesian )acro economics8
[=]
1. ndependence of ?ons!mption and c!rrent ncome (life&
cycle permanent income hypothesis)
2. rrelevance of ?!rrent Profits to nvestment ()odi,liani&)iller
theorem)
3. 6on, r!n independence of inflation and !nemployment (nat!ral rate
of !nemployment)
4. /he ina%ility of monetary policy to sta%ili#e o!tp!t (rational
e-pectations)
B* rrelevance of /a-es and '!d,et Ceficits to ?ons!mption (Ricardian
@:!ivalence)
[edit]Keynesian responses to the critics
/he heart of the 4new Keynesian4 view rests on microeconomic models that
indicate that nominal wa,es and prices are 7sticky,7 i*e*, do not chan,e
easily or :!ickly with chan,es in s!pply and demand, so that :!antity
ad.!stment prevails* +ccordin, to economist Pa!l Kr!,man, 7while re,ard
the evidence for s!ch stickiness as overwhelmin,, the ass!mption of at least
temporarily ri,id nominal prices is one of those thin,s that works
%ea!tif!lly in practice %!t very %adly in theory*7
[D]
/his inte,ration is f!rther
sp!rred %y the work of other economists which :!estions rational decision&
makin, in a perfect information environment as a necessity for micro&
economic theory* mperfect decision makin, s!ch as that investi,ated
%y (oseph 5ti,lit#!nderlines the importance of mana,ement of risk in the
economy*
Lver time, many macroeconomists have ret!rned to the I!'(M model and
the Phillips ?!rve as a first appro-imation of how an economy works* ;ew
versions of the Phillips ?!rve, s!ch as the 7/rian,le )odel7, allow for
sta,flation, since the c!rve can shift d!e to s!pply shocks or chan,es
in %!ilt&in inflation* n the 011<s, the ori,inal ideas of 7f!ll employment7
had %een modified %y the ;+RK doctrine, sometimes called the 7nat!ral
rate of !nemployment*7 ;+RK advocates s!,,est restraint in com%atin,
!nemployment, in case acceleratin, inflationsho!ld res!lt* Iowever, it is
!nclear e-actly what the val!e of the ;+RK sho!ld %eJor whether it even
e-ists*
For the Keynesian revival of ><<D, see (ohn )aynard Keynes*
+edit,
T-E .E/ER"( T-EOR0 O1 EMP(O0ME/T2
I/TERE!T2 3 MO/E0
y
4ohn Maynard Keynes
Part II5 Interest Rates2 "ggregate *emand2 and the #&siness Cycle
Pa,e ?ontents
Keynesian theory )onetary policy /he %!siness cycle Fiscal policy
FK/KR@?+5/5 online ma,a#ine
www*f!t!recasts*com
Mol* 3, ;o* B, B"0"<A*
Iomepa,e
Introd&ction to Parts I 3 II
Keynesian theory5

In the so&rce o$ Keynesian theory2 7/he 9eneral /heory of

@mployment, nterest, and )oney,7 (ohn )aynard Keynes
p!rports to provide a 7,eneral theory7 for self&re,!latin,
capitalist market systems* Ie asserts that it is applica%le
,enerally in all economic circ!mstances* ?lassical concepts, on
the other hand, operate only in those rare 7special7
circ!mstances where f!ll employment is possi%le*

+ith disconcerting
fre,uency, Mar!ian
stupidities "ere
ino-ed "ith
approal, although
in only one instance
e!plicitly crediting
Mar!.
-owever2 it is Keynes6 theory that ' i$ applicale at all & is
applica%le only in very narrow circ!mstances & like the 7special7
circ!mstances of the depths of the 9reat Cepression where
political leaders proved incapa%le of reformin, the f!ndamental
policy st!pidities that prevented recovery*

Keynes nevertheless s!ccessf!lly convinced m!ltit!des of
s!pposedly knowled,ea%le economists to accept a series of
%lack&is&white ar,!ments* 5avin,s %ecame %ad and deficits
%ecame ,ood, and the pr!dent acc!m!lation of reserves for
foreseea%le and !nforeseea%le contin,encies was impr!dently
responsi%le for disastro!s conse:!ences* /he acc!m!lation of
capital assets %ecomes an economic o%stacle rather than an
economic advanta,e* nvestment and employment is stim!lated
%y inflation and hindered %y price declines* )arket li:!idity
%ecomes more of a pro%lem than an advanta,e*

Free trade has disadvanta,es and closed economic systems
have advanta,es %eca!se of the ,reater ease of manip!latin, the
latter* With disconcertin, fre:!ency, )ar-ian st!pidities were
invoked with approval, altho!,h in only one instance e-plicitly
creditin, )ar-*

+ltho!,h controversy over war de%ts and other international
de%ts and trade war protectionism was ra,in, aro!nd him,
Keynes has not a word to offer a%o!t the o%vio!s roles of s!ch
,overnment policies in the %!siness cycle in ,eneral and the
9reat Cepression in partic!lar* 5ee 9reat Cepression
?hronolo,y 5eries, %e,innin, with 7/he 9reat Cepression8 /he
?rash of 4>1*7

*eynes proides a
rationale for
pursuing short term
relief from economic
problems by means
of budgetary deficits
and monetary
inflation - palliaties
that must ultimately
/ust ma-e matters
considerably "orse.
Over a cent&ry o$ capitalist economic history was th!s
i,nored, as were all ar,!ments to the contrary, !ntil Keynesian
theories were p!t to the test in the 01=<s & and predicta%ly failed
misera%ly wherever p!rs!ed*

;evertheless, Keynesian concepts are once a,ain pop!lar and
in !se today & especially in the Knited 5tates !nder the '!sh ()
administration* /hey remain very pop!lar with political leaders,
since they provide intellect!al cover for doin, what political
leaders have always done when seekin, to p!t off confrontin,
the real pro%lems that afflict an economy* Keynes provides a
rationale for p!rs!in, short term relief from those pro%lems %y
means of %!d,etary deficits and monetary inflation & palliatives
that m!st !ltimately .!st make matters considera%ly worse*

The in$l&ence o$
Marx5

It is evident that Keynes re7ected m!ch of the worst of

)ar-ian doctrine* Keynes relies on competitive markets to
allocate reso!rces where )ar- naNvely relies on socialist
directives* Keynes !ses market e-chan,e val!es instead of
)ar-4s impractical concept of ind!strial la%or !se&val!es*
Keynes had infinite faith in paper money mana,ed %y
,overnments & )ar- had none* ('oth are wron, on this last
one*)

Keynes can th&s omit all o$ the twisted indeterminate and
nonf!nctional definitions and redefinitions of economic terms
that )ar- relied !pon for the defense of his narrow ind!strial
la%or !se&val!e concept and for s!pport of his propa,anda myth*
Profits & fre:!ently referred to as 7income7 or 7yields7 & takes its
o%vio!s place for Keynes as a determinin, factor for capitalist
economic activity* +ltho!,h he views capitalism as !na%le to
operate at optimal levels for any len,th of time, Keynes
reco,ni#es & !nlike )ar- & that capitalism is inherently sta%le
within the parameters of the %!siness cycle*

)oreover, Keynes avoids many of the weaknesses of lo,ic that
permeate )ar-4s work* 5ee the series of articles %e,innin,
withKarl )ar-, 7?apital (Cas Kapital)7 vol* 0 (), 7Mal!e
Cetermined %y an +%stract 6a%or 5tandard*7

*eynes, li-e Mar!,
ignores the
particular reasons
"hy particular
periods of economic
trouble hae ta-en
place.

*eynes appears
totally ignorant of
the inherent
inefficiency of
goernment
management.
/evertheless2 Marx6s %mat&re capitalism% $allacy & for
which Keynes cites )ar- with approval & is the central feat!re
of the 9eneral /heory, and Keynes relies !pon some
indeterminate concepts of his own to s!pport his 7mat!re
capitalism7 theme* n the process, Keynes, like )ar-, i,nores
the partic!lar reasons why partic!lar periods of economic
tro!%le have taken place* 5ee, Keynes, 7/he 9eneral /heory of
@mployment, nterest, O )oney,7 Part , 7@lements of /he
9eneral /heory*7

6ike )ar-, Keynes %elieves the ownership interest is not an
essential element in capitalist prod!ctivity* 5tock market
investors are 7f!nctionless*7 ,norin, +dam 5mith4s warnin,s
a%o!t the weaknesses inherent in the separation of mana,ement
from ownership, Keynes a,rees with )ar- that ,ood
mana,ement and s!pervision is always readily availa%le and can
%e proc!red simply %y offer of a s!ita%le salary*

6ike )ar- and all socialists, Keynes appears totally i,norant
of the inherent inefficiency of ,overnment mana,ement* 5ee,
79overnment F!t!recast,7 Part , 79overnment )ana,ement*7
Ie has total faith in the capa%ilities of ,overnment and
7comm!nity7 administered economic systems* While )ar-
offers %road socialist sol!tions, Keynes offers narrower
administered sol!tions directed at controllin, interest rates,
directin, investment flows, redistri%!tin, wealth, and !ltimately
directin, the activities of ma.or %!siness entities*

To entice the cred&lo&s2 Keynes like )ar- offers a vision of
an impossi%le !topia* f a capitalist system is resol!tely
stim!lated p!rs!ant to Keynesian policies, it will ,enerate
a%!ndant capital assets & 7f!ll capitali#ation7 & so that capital
assets are no lon,er scarce* /hen, there wo!ld no lon,er %e any
need for financiers and rentiers* While resid!al entreprene!rs
wo!ld contin!e to %e tolerated, Keynes a,rees with )ar- that
the entreprene!r will %ecome !nnecessary*

Keynes & also like )ar- & ass!mes that the st!dy of economics
is a 7scientific7 endeavor* Ie th!s avails himself & or at least
s!cc!m%s to & the 7science7 propa,anda ploy that was a central
feat!re in the propa,anda myth created %y Karl )ar-* Iis
followers wo!ld ardently contin!e this propa,anda deception
!ntil forced to retreat somewhat %y their ,ross fail!res in the
01=<s*

The savings gap5

Keynes provides &s with psychological propensities to

cons!me and save* Ie %lames the %!siness cycle and
invol!ntary !nemployment on the notion that wealthy nations &
7mat!re7 capitalist systems & will inevita%ly save more than can
%e profita%ly invested, leadin, to periods of economic decline &
if not chronic economic decline* 6ike )ar-4s concepts, none of
this can %e meas!red, and in fact all the evidence is e-actly the
opposite*

)s assets
accumulate, people
and businesses can -
and obserably do -
rely more on their
asset "ealth than on
monetary saings.

The decline in
saings rates in the
0.S. in recent
prosperous times has
been notorious for
decades.
Mat&re ' wealthy ' capitalist systems re)&ire and have
lower rates o$ savings & not hi,her* +s assets acc!m!late,
people and %!sinesses can & and o%serva%ly do & rely more on
their asset wealth than on monetary savin,s* /heir asset wealth
s!pports vast increases in the p!rchasin, power of credit,
nat!rally stim!latin, %oth cons!mption and investment, with
profit rates and interest rates sensitively ad.!stin, these flows
e-cept when other factors !ndermine the pertinent markets*

Except d&ring the depths o$ already developed severe
depressions2 $inancial intermediaries and the money
mar8ets have no tro&le instantly p&tting all savings to
wor8 in commerce9 +s is repeatedly pointed o!t thro!,ho!t the
articles on )ar-, 7Cas Kapital,7 and Keynes, 7/he 9eneral
/heory,7 there is a%sol!tely no evidence that e-cess savin,s
play any role in initiatin, periods of economic distress*

n fact, savin,s declined s!%stantially in the last f!ll year
%efore the 9reat Cepression & the first decline since WW& &
accompanied %y a s!%stantial decline in the n!m%er of savin,s
acco!nts* /he decline in savin,s rates in the K*5* in recent
prospero!s times has %een notorio!s for decades*

1onsidering the
e!tent and nature of
man's "ea-nesses -
and the stubbornness
"ith "hich policy
stupidities are
fre,uently
maintained, it is
astounding that
capitalism can
function as "ell as it
does.
The roots o$ the &siness cycle are to %e fo!nd in the
m!ltit!de of pertinent weaknesses of man & ;L/ in weaknesses
alle,ed in capitalism* ndeed, considerin, the e-tent and nat!re
of man4s weaknesses & %oth in the private sector and ,overnment
sector & and the st!%%ornness with which policy st!pidities are
fre:!ently maintained, it is asto!ndin, that capitalism can
f!nction as well as it does*

t is always the nitty&,ritty of analy#in, partic!lar factors
involved in partic!lar periods of economic distress that is
re:!ired for an !nderstandin, of the %!siness cycle* @conomists
who are too la#y or inept for this task & or !nwillin, to offend
political patrons or private employers & have nothin, to tell !s*
;o simplistic 79eneral /heory7 will s!ffice*
Interest Rates
The impacts o$
interest rates5

Interest rates play a ma.or role in the investment demand&

sched!le* Keynes advocates ,overnment 7monetary policy
directed at infl!encin, the rate of interest*7 Iowever, he
%elieves that the other factors that infl!ence the investment
demand&sched!le are too powerf!l for s!ch 7monetary policy7
alone to achieve levels of investment s!fficient to maintain f!ll
employment*

*eynes argues that it
is impossible to
determine the rate of
interest /ust from
inestment demand
and saings supply.
There is a well recogni:ed relationship %etween investment
demand and interest rates* +ccordin, to classical economic
theory, interest rates sensitively ad.!st to allocate all availa%le
f!nds for investment p!rposes*
With the ,rowth of cons!mer credit & already a reco,ni#ed
factor in the 01><s & investment demand is not the only ma.or
!se of f!nds availa%le for loans* /he fact that interest rates
allocate availa%le f!nds not .!st for vario!s investment p!rposes
%!t for cons!mption p!rposes as well is omitted %y Keynes* /he
availa%ility at low interest rates of a%!ndant f!nds has to
infl!ence the propensity to cons!me*
Keynes attacks the classical view* Ie ar,!es that it is
impossi%le to determine the rate of interest .!st from investment
demand and savin,s s!pply*

*eynes assumes that Keynes &ses the term %li)&idity pre$erence% for those who
people part from
their saings only if
offered an interest
return. Thus, the
interest offered
counters a 2li,uidity
preference2 to hold
"ealth in the form of
immediately usable
but sterile cash.
prefer to keep si,nificant s!ms in the sterile form of cash*
Keynes ass!mes that people part from their savin,s only if
offered an interest ret!rn* /h!s, the interest offered co!nters a
7li:!idity preference7 to hold wealth in the form of immediately
!sa%le %!t sterile cash*
7/h!s, the rate of interest at any time, %ein, the reward for
partin, with li:!idity, is a meas!re of the !nwillin,ness of those
who possess money to part with their li:!id control over it* /he
rate of interest is not the 4price4 which %rin,s into e:!ili%ri!m
the demand for reso!rces to invest with the readiness to a%stain
from present cons!mption*7
/his is, in fact, a correct view of matters where financial
intermediaries are !navaila%le or !nrelia%le & as in !ndeveloped
nations or & d!rin, the 9reat Cepression & even in the K*5* t is
also tr!e when & for any reason & profits are so scarce that there
is no ind!cement to %orrow at any interest rate & as d!rin, the
9reat Cepression*

Iowever, in developed nations with relia%le %ankin, systems,
Keynes4 7li:!idity preference7 disappears* t is then safer and
more convenient to deposit cash in %anks than in mattresses,
even with little or no interest on offer* @-cept d!rin, the depths
of already e-istin, depressions, %anks and other financial
intermediaries have no tro!%le immediately circ!latin, +66
savin,s thro!,h the money markets if not thro!,h direct
lendin,*

In developed nations2 idle hoards don6t ca&se depressions9
*epressions ca&se idle hoards9

Iowever, interest rates W66 determine & alon, with vario!s
risk factors & whether f!nds availa%le for loan will %e drawn into
domestic markets from a%road & or will flow a%road to take
advanta,e of %etter opport!nities in forei,n markets*"rti$icially
low interest rates will ca&se capital $light9

Keynes provides some simplistic mathematical e:!ations
e-plainin, 7li:!idity preference7 & all of it inapplica%le to
capitalist economics e-cept when & for other reasons & there has
%een a %reakdown in the financial system* @ven then, interest
rates won4t eliminate or red!ce 7li:!idity preference*7 Lnly the
elimination of the factors that !ndermined the relia%ility of the
financial system and the f!nctionin, of the economy will red!ce
or eliminate 7li:!idity preference*7 /his involves analysis and
reform of f!ndamentals* 9overnment deficits and manip!lation
of money and interest don4t solve f!ndamental pro%lems*

t is to the ,reat credit of Keynes and his followers that &
when ,iven the a!thority and opport!nity after WW& & they
took steps needed to end the trade war* With commenda%le
K*5* leadership, steps were taken to facilitate international trade,
and war de%ts from %oth world wars were s!%stantially written
off* Wo!ldst that it had all %een done two decades earlier*
There are three general reasons $or holding cash identified
%y Keynes* ?ash is held for transactions, safety, and spec!lation
p!rposes* )onetary e-pansion may not always red!ce interest
rates, and interest rate red!ctions may not always stim!late
economic recovery* Keynes reco,ni#es many of the factors that
may ,et in the way*

-owever2 Keynes asserts that the level o$ income is the key
factor that determines if savin,s will e:!al investment, and that
this %elief is what separates him from the classical view*
?lassical theory asserts that interest rates will a!tomatically
e:!ate net savin,s with investment (which e-cept d!rin, the
depths of depression does indeed happen)*

Keynes here disc!sses the s!pply and demand for savin,s as if
investment ret!rns were the only reason for savin,s* Iowever,
as elsewhere reco,ni#ed %y Keynes, savin,s depend on many
factors other than interest and investment yields* nterest rates &
or more precisely, the comple- of interest rates & allocate
acc!m!lated savin,s %etween vario!s investment !ses and
periods
Lnly if %anks are less sec!re than mattresses & and th!s
themselves constit!te an investment risk & are yields essential to
draw savin,s into the financial system*
Eet, Keynes4 whole disc!ssion of 7classical theory7 ass!mes
that it depends on how interest rates ind!ce savin,s* (/his may
have %een tr!e when early capitalist economic systems had
archaic financial systems, %!t for economic systems with
modern financial systems, it is an o%vio!s straw man & a
nonsense theory*) Ie correctly notes that savin,s do not in fact
necessarily increase when interest rates increase & %!t the
investment demand&sched!le does in fact fall* /h!s, the two
lines need not intersect at all* 5ome other factors indeed m!st %e
involved*

Keynes th!s easily slays this straw man* Ie correctly notes that
many interrelated factors s!ch as money, incomes, savin,s rates,
and cons!mption rates, impact interest and investment*
Keynes is here still theori#in, a%o!t a closed system &
!nconcerned with international money flows*
n the Keynesian world of dysf!nctional financial systems (as
indeed e-isted in 012B in the midst of the 9reat Cepression),
red!ced spendin, that increased savin,s indeed did not red!ce
interest rates & which were already as low as they co!ld ,o* n
s!ch a world, it did indeed red!ce employment instead, since
there e-isted almost no profit&ind!cement to %orrow even at
minimal interest rates*

It is proaly the nat&re o$ his times that led Keynes
astray2since he clearly !nderstood money & as can %e seen from
the followin, para,raph*
7/he stren,th of all [transactions and reserve motives for
holdin, cash] will depend on the cheapness and the relia%ility of
methods of o%tainin, cash, when it is re:!ired, %y some form of
temporary %orrowin,, in partic!lar %y overdraft or its
e:!ivalent* For there is no necessity to hold idle cash to %rid,e
over intervals if it can %e o%tained witho!t diffic!lty at the
moment when it is act!ally re:!ired* /heir stren,th will also
depend on what we may term the relative cost of holdin, cash*
f the cash can only %e retained %y for,oin, the p!rchase of a
profita%le asset, this increases the cost and th!s weakens the
motive towards holdin, a ,iven amo!nt of cash* f deposit
interest is earned or if %ank char,es are avoided %y holdin,
cash, this decreases the cost and stren,thens the motive* t may
%e, however, that this is a minor factor e-cept where lar,e
chan,es in the cost of holdin, cash are in :!estion*7
?learly, in the midst of the 9reat Cepression, money on
deposit in %anks is viewed %y Keynes as sittin, idle & as the
e:!ivalent of 7holdin, cash7 & since there is little profit
ind!cement for re,!lar or overni,ht %orrowin, of s!ch f!nds*
/oday, credit cards and lines of credit s!%stit!te for cash
reserves, lar,e and small*
) relatiely small
monetary effort may
be all that is
!pec&lation will a$$ect any %monetary policy% that is
desi,ned to chan,e or control interest rates* /he cash needs for
transactions and reserve p!rposes are fairly constant, %!t
re,uired to moe
interest rates up or
do"n as desired,
because speculators
"ill ,uic-ly enter to
moe the mar-et in
the e!pected
direction, and they
"ill arbitrage
subse,uent interest
rate fluctuations on
the basis of the
e!pected rate.
spec!lation rises and falls like passin, waves, in sensitive
response to e-pectations %ased on a wide variety of factors*

/h!s, a relatively small monetary effort may %e all that is
re:!ired to move interest rates !p or down as desired, %eca!se
spec!lators will :!ickly enter to move the market in the
e-pected direction, and they will ar%itra,e s!%se:!ent interest
rate fl!ct!ations on the %asis of the e-pected rate*
Iowever & in the nat!re of markets & to maintain a desired
level of interest rates %elow the market rate will inevita%ly
re:!ire an increasin, rate of monetary e-pansion over time*

)oreover, interest rates are the time cost o$ money9 /hey
dictate investment patterns* /hey also infl!ence savin, and
cons!mption patterns* 'y fiddlin, with interest rates, Keynesian
7monetary policy7 inevita%ly sends erroneo!s si,nals and
screws !p the economy* + s!%stantial period of artificially low
interest rates M;!T leave an economic system increasin,ly
!n%alanced* /h!s, the Keynesian effort to provide short term
sta%ility )K5/ create increasin, insta%ility over time*
Kltimately, this insta%ility will increase to levels that will prove
!nmana,ea%le*

'!t these are lon, r!n factors, while Keynes is still here
analy#in, short r!n phenomena*
n his !s!al style, Keynes offers a mathematical model to trace
the relationships of monetary policy and e-pectations* /hese
relationships depend on cash holdin,s, ), and li:!idity
preferences, 6, for p!rposes of transactions and reserves, )
0,
and
spec!lation, )
>,
and their related li:!idity f!nctions,
6
0
and6
>,
which are determined %y income, E, and interest rates,
r* +side from ), none of these factors are precisely
determina%le, as Keynes candidly notes, (and even ) has more
than a few am%i,!ities)* ;evertheless, he proceeds to e-plain
the ,eneral impacts of monetary policy in these %road, ill
defined terms*
7+ chan,e in ) [the money s!pply] can %e ass!med to operate
%y chan,in, r [interest rates], and a chan,e in r [interest rates]
will lead to a new e:!ili%ri!m partly %y chan,in, )
>
[reserves
held for spec!lation], and partly %y chan,in, E [income] and
therefore )
0
[transactions and ordinary contin,ency reserves]*7
+ whole variety of factors apply to this calc!lation, Keynes
notes, s!ch as the financial and ind!strial characteristics of the
economy, social ha%its, income ine:!ality, and 7 the effective
cost of holdin, cash*7 Iowever, for short period calc!lations,
they can all %e treated as constants*
/his is the key to the Keynesian remedies of monetary
e-pansion and %!d,etary deficits* 'y concentratin, only on
immediate res!lts & and in a system s!%stantially closed to
international trade & the fact that these 7policies7 can %e no more
than temporary palliatives with inevita%le !npleasant lon, term
impacts can %e i,nored*
If bonds are traded
on public mar-ets,
mar-et li,uidity
should reduce long
term opportunity
ris-s to a series of
short term
opportunity ris-s,
and thus facilitate
the raising of debt
capital.
The impacts o$ interest rate changes are perceptively
analy#ed %y Keynes* Ie especially notes the impacts of interest
rates that are artificially p!shed %elow market rates* Ie calls
market rates 7safe7 rates*

6on, term interest rates & properly viewed as the most
si,nificant for the economy & m!st offer an ade:!ate ret!rn to
%alance a variety of risks that incl!de opport!nity risks as well
as risks of defa!lt* 5omethin, like >P, then, is viewed as a%o!t
as low as lon, term rates can ,o* Iowever, if the sec!rities are
traded on p!%lic markets, market li:!idity sho!ld red!ce lon,
term opport!nity risks to a series of short term opport!nity risks,
and th!s facilitate the raisin, of de%t capital*

/he concl!sion of this analysis is that short term rates are
7easily controlled %y the monetary a!thority7 %eca!se it is easier
to prod!ce a conviction of %oth policy consistency and s!ccess
in the short r!n* 'rin,in, lon, term rates down %elow nat!ral
market rates will %e more diffic!lt & even if market rates are too
hi,h to prod!ce f!ll employment*
'y concentratin, only on short term impacts, Keynes provides
an intellect!al e-c!se for the ancient political vice of
moneti#in, de%t* /hat4s why the politicians hire only Keynesian
economists & and they %ecome the 7a!thoritative voices7 that
provide people with a!thoritative misinformation on economic
matters*
Moneti:ing the
det5

Interest rates are very psychological9 )anip!lation of

interest rates & %y e-pandin, the money s!pply to %!y interest
o%li,ations & can only s!cceed if viewed %roadly as 7reasona%le
and practica%le and in the p!%lic interest, rooted in stron,
conviction, and promoted %y an a!thority !nlikely to %e
s!perseded*7 (5o!nds like the rationale for a pyramid scheme*)

Keynes sees no reason why long term dets as well as short
term o%li,ations sho!ldn4t %e moneti#ed to %rin, interest rates
down to levels consistent with f!ll employment* Ie views the
hyperinflation of ?entral @!rope d!rin, the 01><s & when
monetary e-pansion res!lted in capital fli,ht and %reakdown of
c!rrencies and credit & 7when no one co!ld %e ind!ced to retain
holdin,s either of money or of de%ts on any terms whatever7 &
as 7very a%normal circ!mstances*7
n the 01=<s, lesser %!t still !n%eara%le levels of %reakdown &
of sta,nant capitali#ation and in some nations even
decapitali#ation & occ!rred as a res!lt of Keynesian policies*
5!ch responses to Keynesian policies take some time to
develop, %!t are not 7very a%normal7 at all*
!avings and
capital5
The dire conse)&ences o$ savings are emphasi#ed %y Keynes*

The world had responded to the .reat *epression %y
red!cin, cons!mption rates and increasin, savin, rates, in an
environment where there were no investment opport!nities for
s!ch savin,s*
L!tside his 9reat Cepression world, Keynes4 lament a%o!t
savin,s is p!re ,i%%erish* 6ike )ar- in the previo!s cent!ry,
Keynes d!rin, the 9reat Cepression views 7mat!re7 capitalist
systems as static, ri,id systems incapa%le of ,eneratin,
contin!o!s increases in prosperity and wealth* Lnce this
capacity for contin!o!s ,rowth is acknowled,ed, the followin,
sentence %ecomes !ntena%le*
7@very act of savin, involves a 4forced4 inevita%le transfer of
wealth to him who saves, tho!,h he in his t!rn may s!ffer from
the savin, of others*7
Ln the contrary, a constantly & if cyclically & e-pandin,
capitalist system will demand a correspondin, diet of savin,s &
from a%road if not s!fficiently availa%le from domestic so!rces*
The impact o$ interest rates ' the %time cost o$ money% ' on
capital is disc!ssed %y Keynes* +,ain la%orin, !nder a 7mat!re
capitalism7 concept similar to that of )ar-, Keynes spec!lates
on the possi%ility that capital co!ld %ecome so a%!ndant as to
meet all prod!ctive needs* 5o serio!sly does he take this
incredi%ly st!pid concept that he views post WW& e-perience
as an e-ample of this phenomenon*

/he 01><s %oom prod!ced so m!ch wealth in the K*5* and
9reat 'ritain 7that its mar,inal efficiency has fallen more
rapidly than the rate of interest can fall in the face of the
prevailin, instit!tional and psycholo,ical factors7 that dictate a
minim!m lon, term interest rate of at least appro-imately >P* t
is this, accordin, to Keynes, that prevents interest rates fallin,
low eno!,h to co!nter depression levels of !nemployment in
the face of a s!pera%!ndance of wealth* t is this that condemns
the laisse#&faire capitalist states to live in 7poverty in the midst
of plenty*7 ndeed, only if cons!mption and investment are
7deli%erately controlled in the social interest7 can this %e
avoided*

Properly mana,ed, only one ,eneration & a%o!t >B years &
wo!ld %e needed to create a socially mana,ed !topia of
a%!ndance, accordin, to Keynes*
7 sho!ld ,!ess that a properly r!n comm!nity e:!ipped with
modern technical reso!rces, of which the pop!lation is not
increasin, rapidly, o!,ht to %e a%le to %rin, down the mar,inal
efficiency of capital in e:!ili%ri!m appro-imately to #ero within
a sin,le ,enerationH so that we sho!ld attain the conditions of a
:!asi&stationary comm!nity where chan,e and pro,ress wo!ld
res!lt only from chan,es in techni:!e, taste, pop!lation and
instit!tions, with the prod!cts of capital sellin, at a price
proportioned to the la%o!r, etc*, em%odied in them on .!st the
same principles as ,overn the prices of cons!mption&,oods into
which capital&char,es enter in an insi,nificant de,ree*7
From a%s!rd premises come a%s!rd concl!sions & even for the
7science7 of economics* /his opinion perhaps most starkly
reveals the e-tent of the a%s!rdity of Keynes4 views*
Interest and money5
The signi$icance o$ money and the rate o$ interest in terms
o$ money are perceptively e-plained %y Keynes*

It is the nature of
money that it "ill not
by itself ad/ust to the
factors that cause
unemployment. It is
those factors that
must ad/ust.

The factor that
ma-es money money
- its inelasticity of
Money is relialy scarce for private p!rposes %eca!se of8
6imited elasticity of prod!ction*
;o a%ility to s!%stit!te other cheaper alternatives* t is a
7%ottomless sink for p!rchasin, power*7
6ow or ne,li,i%le carryin, costs*
t is the nat!re of money that it will not %y itself ad.!st to the
factors that ca!se !nemployment* t is those factors that m!st
ad.!st*

ndeed, the factor that makes money money & its inelasticity of
supply - is ie"ed by
*eynes as the
fundamental
problem causing
inoluntary
unemployment.
s!pply & is viewed %y Keynes as the f!ndamental pro%lem
ca!sin, invol!ntary !nemployment* Ie ,oes into some detail
a%o!t these familiar characteristics of money* Ie notes here that
e-pectations of sharp chan,es in the money s!pply will ro%
money of its essential 7li:!idity7 characteristics & an important
limitation on Keynesian monetary manip!lation*

-igh interest rates ' high %li)&idity premi&ms% ' are
%lamed %y Keynes for keepin, the world relatively poor in the
capital assets needed to prod!ce widespread a%!ndance* +,ain &
followin, )ar- & he %lasts 7!s!ry*7
/his is not consistent with his haran,!es a,ainst savin,s*
5avin,s tend to red!ce interest rates* n well r!n capitalist
systems, it is the on,oin, processes of depreciation,
o%solescence and creative destr!ction in competitive markets
that are the primary factors dictatin, the relative scarcity and
contin!in, profita%ility of capital assets*
The #&siness Cycle
Variales5

In critici:ing the %Ricardian world2% Keynes emphasi#es

that there are factors that fre:!ently prevent interest rates from
settlin, at a level that ass!res f!ll employment* (n this, he is
s!rely correct, %!t not for the reasons he p!ts forth*)

Interest rate $l&ct&ations alone o%serva%ly cannot ass!re f!ll
employment & and may even %e prevented from tendin, towards
s!ch levels for e-tended periods of time*

The primary ca&ses o$ cyclical shi$ts in per$ormance in the
Keynesian world are his 7propensity to cons!mer, the sched!le
of the mar,inal efficiency of capital and the rate of interest*7
/hese impact the key dependent varia%les & 7the vol!me of
employment and the national income & or national dividend*7

Three psychological
factors - affecting
consumption rates,
ris- assessments,
and yield or profit
e!pectations - plus
the general "age
rate - and the
,uantity of money -
The s&pply and demand sched&les $or laor2 prod&cts and
services all f!nction within parameters dictated %y these
varia%les* /he comple- of factors that create the economic
environment are all taken as ,iven & altho!,h Keynes reco,ni#es
that the mar,inal efficiency of capital 7depends & & & partly on
the ,iven factors and partly on the prospective yield of capital&
assets of different kindsH whilst the rate of interest depends
partly on the state of li:!idity&preference & i.e., on the li:!idity
f!nction & and partly on the :!antity of money meas!red in
are ie"ed by
*eynes as the
2ultimate
independent
ariables2 that
determine national
income and
employment at any
particular time.
wa,e&!nits*7

/h!s, three psycholo,ical factors & affectin, cons!mption
rates, risk assessments, and yield or profit e-pectations & pl!s
the ,eneral wa,e rate & and the :!antity of money & are viewed
%y Keynes as the 7!ltimate independent varia%les7 that
determine national income and employment at any partic!lar
time*

/hat these factors themselves are .!st way&stations alon, the
infinite chains of ca!se and effect in the economic world is
readily admitted %y Keynes* /hese factors are at %est ine-act
simplifications of a comple- reality* Iowever, he chooses to
emphasi#e these factors %eca!se of their dominant impacts and
their key characteristics as factors that 7can %e deli%erately
controlled or mana,ed %y central a!thority7 in capitalist
systems*

Keynes also reco,ni#es the comple-ity of impacts of chan,es
in the vario!s interrelated factors* /he task for him is to identify
7the factors which it is !sef!l and convenient to isolate*7

1apitalism is
obserably stable
"ithin cyclical
parameters.
While $&ll employment is a %rare and short'lived
occ&rrence2% the system is o%serva%ly sta%le within cyclical
parameters* @mployment and pricin, shifts tend to r!n their
co!rse and then move in reverse & rather than proceedin, to
e-tremes*

It is to eliminate or minimi:e the $l&ct&ations and move
them closer to f!ll employment that is the p!rpose of the
theoretical analysis and the policies proposed %y Keynes*
/OTE that this approach totally i,nores the roles played %y
e-istin, ,overnment policies in determinin, economic
performance and sta%ility* Ieavens for%id that Keynes sho!ld
have had to confront the political leaders of the 012<s with the
essential need to end trade war levels of protectionism and
reco,ni#e the impossi%ility of collectin, the WW& war de%ts*
Ie wo!ld have %een i,nored, and wo!ld not have risen to the
infl!ence he s!%se:!ently en.oyed %y offerin, an intellect!al
e-c!se for the monetary e-pansion and %!d,etary deficits that
the political leadership was anyway employin,*
Wages5 The aility to increase employment y aggregate
red&ctions in wage levels is critically analy#ed %y Keynes in
some detail* While wa,e rate red!ctions in partic!lar entities or

ind!stries will ,enerally %e favora%le to employment levels in

those entities or ind!stries, red!ctions spread over the entire
economic system have impacts on cons!mption and psycholo,y
that present a far more comple- pict!re*

It is much easier to
e!pand the money
supply, "hich
enables political
leaders to aoid
many of the
immediate
unpleasant
conse,uences loosed
by do"n"ard
pressures on "ages.
In an open trading system2 there are clear advanta,es for
employment from system&wide red!ctions in wa,e rates* (5mall
nations that m!st trade %eca!se they cannot %e nearly self&
s!fficient ro!tinely e-port their way o!t of tro!%le when faced
with periods of domestic economic decline*) n a closed system,
however, Keynes ar,!es that the advanta,es and disadvanta,es
are more evenly %alanced*

n a closed system, the primary stim!l!s from red!ced wa,es &
as from any a,,re,ate decline in costs & is the red!ction in
interest rates* Iowever, Keynes ar,!es that this same impact
can %e achieved %y keepin, wa,es fi-ed and increasin, the
s!pply of money* ( Ie disc!sses only the impact on interest
rates from an a,,re,ate decline in costs* Ie i,nores the
increased p!rchasin, power of e-istin, money & dispara,in,
s!ch %enefits %eca!se of the no-io!s impact on de%t*)
7t follows that wa,e red!ctions, as a method of sec!rin, f!ll
employment, are also s!%.ect to the same limitations as the
method of increasin, the :!antity of money* /he same reasons
as those mentioned a%ove, which limit the efficacy of increases
in the :!antity of money as a means of increasin, investment to
the optim!m fi,!re, applymutatis mutandis to wa,e red!ctions*
(!st as a moderate increase in the :!antity of money may e-ert
an inade:!ate infl!ence over the lon,&term rate of interest,
whilst an immoderate increase may offset its other advanta,es
%y its dist!r%in, effect on confidenceH so a moderate red!ction
in money&wa,es may prove inade:!ate, whilst an immoderate
red!ction mi,ht shatter confidence even if it were practica%le*

7/here is, therefore, no ,ro!nd for the %elief that a fle-i%le
wa,e policy is capa%le of maintainin, a state of contin!o!s f!ll
employmentH && any more than for the %elief that an open&market
monetary policy is capa%le !naided, of achievin, this res!lt* /he
economic system cannot %e made self&ad.!stin, alon, these
lines*7
/his applies only in a closed system & a system that doesn4t
en.oy all the prod!ctivity advanta,es of international trade*
+lso, it applies only in a system that has relied to a ,reat de,ree
on de%t*

n an open system, an increase in money s!pply increases
imports and !ltimately !ndermines c!rrency val!es and
p!rchasin, power* ?ost red!ctions & any costs, not .!st wa,es &
increase e-ports, red!ce imports, %oost c!rrency val!es and
p!rchasin, power*

Keynes th!s draws a %road concl!sion %ased on his very
narrow special case* Iis concl!sion applies only for a closed
system & th!s necessarily ho%%led with ,rossly limited economic
prod!ctivity and livin, standards & that determinedly i,nores
lon, term implications* @ven for closed systems, ri,id wa,e
systems m!st p!t ,reater press!res for ad.!stment on other cost
factors & each with their own comple- of impacts & that Keynes
doesn4t consider*
Keynes correctly notes that the %enefits of declinin, prices can
%e offset %y the increased diffic!lty of servicin, de%t* (Ie does
not, however, dei,n to note that this is a powerf!l ar,!ment
a,ainst over reliance on de%t capital and ,overnment %!d,et
deficits*) Ie also correctly notes that it is m!ch easier to e-pand
the money s!pply, which ena%les political leaders to avoid
many of the immediate !npleasant conse:!ences loosed %y
downward press!res on wa,es* +n e-pandin, money s!pply is
also favora%le for e-istin, de%tors & as there are in a%!ndance in
a Keynesian system*

/he ,overnment & as the %i,,est de%tor & %enefits immediately
from the moneti#ation of vast :!antities of its de%t* /he
economy as a whole %enefits in the short r!n %y the palliative
impacts on cons!mption and investment of an increase in the
money s!pply*
+ll of this is nothin, new* nflation is always adopted for its
palliative short term impacts & the reasons for the inflation of the
money s!pply for millennia* +nd the 7lon, r!n7 is not so lon, in
arrivin, as Keynes ass!med & especially for soft c!rrency
nations*
Keynes th!s advises ri,id wa,e systems for closed economic
systems*
'oth ri,id la%or markets and closed systems have since proven
individ!ally to %e serio!s %!rdens on %oth prod!ctivity and
employment* 5omethin, m!st o%vio!sly %e wron, with Keynes4
analysis* What co!ld it %eQ
"ggregate
employment5
To eval&ate the changes in employment that will res!lt from
chan,es in other economic factors & and chan,es in other
economic factors from chan,es in employment & Keynes
introd!ces an 7employment f!nction7 that he presents in
mathematical terms for individ!al entities or ind!stries or for
the economy as a whole*

1lassical concepts
unrealistically tie
employment to
changes in real
"ages in a "ay that
fails to e!plain
inoluntary
unemployment.
Employment / e)&als the employment $&nction 1 times
effective demand C at the pertinent economic level*
@mployment is meas!red in %asic 7wa,e&!nits7 %ased on market
wa,es and calc!lated in terms of money&wa,es*

Knlike standard s!pply and demand c!rves that are ,enerally
applica%le only to individ!al entities or ind!stries, Keynes4
approach is desi,ned to facilitate analysis of dynamic elements
in a,,re,ate economics*
7/h!s we have the advanta,e that, in these conditions, the
individ!al employment f!nctions are additive in the sense that
the employment f!nction for ind!stry as a whole, correspondin,
to a ,iven level of effective demand, is e:!al to the s!m of the
employment f!nctions for each separate ind!stry*7
/his facilitates meas!rement of the elasticity of %oth
employment and o!tp!t in each ind!stry and for the economy as
a whole* Keynes provides the econometric e:!ations for these
calc!lations* Ie notes that s!ch calc!lations have no place in
classical concepts, which !nrealistically tie employment to
chan,es in real wa,es in a way that fails to e-plain invol!ntary
!nemployment* /he classical ass!mption is 7that in practice it is
impossi%le to increase e-pendit!re in terms of wa,e !nits*7
/he difference is that & in the classical concepts descri%ed %y
Keynes & price and wa,e movements in response to chan,es in
money s!pply are practically instantaneo!s* Keynes more
realistically %ases his concepts on the fact that prices and wa,es
respond to chan,es in money s!pply with delays that can %e
:!ite lon, & especially for lar,e, wealthy capitalist systems*
ndeed, Keynes specifically confines this analysis to that short
r!n period*

Lf co!rse, once inflation achieves real moment!m in risin,
prices and th!s %ecomes a widely reco,ni#ed factor, prices and
wa,es chan,e very rapidly indeed, and with other factors like
capital fli,ht, the collapse of credit, and decapitali#ation of fi-ed
assets, p!rchasin, power declines m!ch faster than #eroes can
%e added to the c!rrency*
Income can be spent
in many "ays - so
his suggested
calculations must be
ie"ed as /ust 2a
first appro!imation2
of pertinent impacts.

&eal "ages "ill not
rise in response to
increasing demand
as long as there is
substantial leels of
inoluntary
unemployment, so
price increases from
monetary stimulation
should be relatiely
inconse,uential.
Keynes recogni:es n&mero&s complications9 Knlike )ar-,
he is no simpleton*

ncome can %e spent in many ways & so his s!,,ested
calc!lations m!st %e viewed as .!st 7a first appro-imation7 of
pertinent impacts*

ncreases or decreases in income will chan,e 7effective
demand7 in varyin, ways for vario!s ,oods and services, and
the employment 7elasticity7 of vario!s ind!stries will vary &
providin, differin, impacts on employment res!lts* + shift in
demand amon, ind!stries may also impact employment witho!t
any chan,e in the level of demand* )oreover, there will %e
varyin, rates of response to these chan,es dependin, on
prod!ction characteristics & the time it takes for prod!ction to
respond & the 7period of prod!ction*7 /he stat!s of e-istin,
inventories will also have o%vio!s impacts* mpacts on profits,
interest, and rents will f!rther modify res!lts*

Iowever, real wa,es will not rise in response to increasin,
demand as lon, as there is s!%stantial levels of invol!ntary
!nemployment, so price increases from monetary stim!lation
sho!ld %e relatively inconse:!ential* Lnly with f!ll employment
wo!ld artificial stim!lation of demand %e a%sor%ed and
rendered f!tile %y price inflation*
/his is all very lo,ical & e-cept for the n!mero!s instances in
economic history when monetary e-pansion not only led to
price inflation witho!t f!ll employment, %!t o%serva%ly
!ltimately worsened !nemployment* 6atin +merica provides
n!mero!s e-amples* Keynes does not dei,n to analy#e s!ch
periods & immersed as he is in the deflationary world of the
9reat Cepression*
"ggregate *emand
Prices5

The disconnect etween microeconomic and

macroeconomic theory in classical economics is emphasi#ed
%y Keynes* /he s!pply and demand sched!les for individ!al
entities and ind!stries do not a,,re,ate*

Instead2 a cr&de theory o$ prices and money s&pply and
money volatility is invoked* Keynes4 theories %rin, the two
worlds to,ether and facilitate analyses of dynamic factors where
there are many varia%les & as in fact there always are in the real
world*

"ggregate demand is the variale Keynes is most interested
in* t is %y manip!lation of demand that he proposes to
favora%ly impact employment* 7t is on the side of demand that
we have to introd!ce :!ite new ideas when we are dealin, with
demand as a whole, & & &*7 /he key is to eval!ate 7the effect of
chan,es in the :!antity of money on the price level7 to
determine the increase in demand from an increase in money
s!pply*

+ simplified analysis wo!ld s!pport a concl!sion that, as lon,
as la%or is 7content with the same money&wa,e so lon, as there
is a s!rpl!s of them !nemployed & & & an increase in the :!antity
of money will have no effect whatever on prices & & & and that
employment will increase in e-act proportion to any [res!ltin,]
increase in effective demand*7

*eynes emphasizes
that analysis of
particular factors
should not blind us
to their complicated
interactions, and
"arns about the
tendency of
econometric formula
to gloss oer such
complications.
-owever2 $ive speci$ic complications are :!ickly noted %y
Keynes*
0* 7@ffective demand will not chan,e in e-act proportion to
the :!antity of money*7
>* 75ince reso!rces are not homo,eneo!s, there will %e
diminishin,, and not constant, ret!rns as employment
,rad!ally increases*7
2* 75ince reso!rces are not interchan,ea%le, some
commodities will reach a condition of inelastic s!pply
whilst there are still !nemployed reso!rces availa%le for
the prod!ction of other commodities*7
A* 7/he wa,e !nit will tend to rise, %efore f!ll employment
has %een reached*7
B* 7/he rem!nerations of the factors enterin, into mar,inal
cost will not all chan,e in the same proportion*7
/OTE5 Keynes is here a,ain clearly analy#in, a closed system*
/he impacts on forei,n trade and payments are i,nored*
/h!s, prices will indeed %e,in risin, ,rad!ally prior to f!ll
employment, a%sor%in, :!ickly some of the stim!latory impact
of an increase in money s!pply*

Keynes perceptively analy#es some of the many complicated
interactions of these complicatin, factors* Ie emphasi#es that
analysis of partic!lar factors sho!ld not %lind !s to their
complicated interactions, and warns a%o!t the tendency of
econometric form!la to ,loss over s!ch complications* Ie th!s
provides warnin,s all too often s!%se:!ently i,nored %y
Keynesians*
7t is a ,reat fa!lt of sym%olic pse!do&mathematical methods
of formalisin, a system of economic analysis, s!ch as we shall
set down in section vi of this chapter, that they e-pressly
ass!me strict independence %etween the factors involved and
lose all their co,ency and a!thority if this hypothesis is
disallowedH whereas, in ordinary disco!rse, where we are not
%lindly manip!latin, %!t know all the time what we are doin,
and what the words mean, we can keep 4at the %ack of o!r heads4
the necessary reserves and :!alifications and the ad.!stments
which we shall have to make later on, in a way in which we
cannot keep complicated partial differentials 4at the %ack4 of
several pa,es of al,e%ra which ass!me that they all vanish* /oo
lar,e a proportion of recent 4mathematical4 economics are mere
concoctions, as imprecise as the initial ass!mptions they rest on,
which allow the a!thor to lose si,ht of the comple-ities and
interdependencies of the real world in a ma#e of pretentio!s and
!nhelpf!l sym%ols*7
"ll macroeconomic econometric analyses sho&ld carry this
warning paragraph<
Keynes ,oes at some len,th into impacts on interest rates of
chan,es in the money s!pply, the res!ltin, impacts on savin,s
and investment, and the impacts of the identified complicatin,
factors* Ie provides s!ita%le e:!ations & wisely a,ain warnin,
a%o!t their inherent limitations*

2The ery long-run
course of prices has
almost al"ays been
up"ards.2

+ages had in fact
increased during the
(ong r&n implications are $inally ac8nowledged9 Keynes
accepts that, in the lon, r!n, there may indeed %e a connection
%etween monetary inflation and price inflation prior to f!ll
employment* Iowever, the manner in which he e-plains this
has some defects*

+t some point, an enlar,ed money s!pply may drive interest
rates near their minim!m, increasin, effective demand %eyond
one of those critical %ottleneck points where wa,es and prices
preious 345 years,
but no faster than
productiity, so that
prices remained
stable "hile the
liing standards of
labor and the
general population
-ept rising.
spike !pwards* 5ince there is 7less friction in the !pward than in
the downward direction,7 the political response to periods of
deflation is to enlar,e the money s!pply so as to avoid the
pro%lems of deflation* 7/h!s the very lon,&r!n co!rse of prices
has almost always %een !pwards*7
/his is fact!ally erroneo!s* /he records on the @n,lish
commodity e-chan,es r!n %ack to the end of the 03th cent!ry*
/here were indeed many !pward s!r,es in prices & !s!ally
associated with s!ch thin,s as wars or crop fail!res & %!t the
vacillations remained within a remarka%ly level ran,e for the
almost 2 0"2 cent!ries prior to the 9reat Cepression* Keynes
himself notes this remarka%le price sta%ility %etween the
;apoleonic Wars and WW&*

)oreover, the 01th cent!ry was a period of persistent
price de$lation in the K*5* & a period when the K*5* economy
prospered and the K*5* %ecame an economic s!perpower* With
the e-ception of the 0DB<s and 0D3<s & the decades of the ,old
r!sh and the ?ivil War & prices declined on avera,e a%o!t 0
0">P per year & reflectin, prod!ctivity ,ains and providin, the
K*5* economy with vast ,ains in p!rchasin, power*
Keynes also notes that %asic interest rates had not declined, %!t
had remained remarka%ly steady d!rin, the previo!s 0B< years*
6on, term rates remained at a%o!t BP, with ,ilts %etween 2P
and 2 0">P* Wa,es had in fact increased, %!t no faster than
prod!ctivity, so that prices remained sta%le while the livin,
standards of la%or and the ,eneral pop!lation kept risin,* ()ar-
was totally o%livio!s to the fact that la%or was indeed reapin,
the %enefits of prod!ctivity increases*)

Iowever, Keynes & like )ar- & is fi-ated on the 7mat!re
capitalism7 fallacy* Iis perspective dominated %y the 9reat
Cepression, he insists that declinin, yields on capital assets are
red!cin, investment rates to a point that makes reasona%ly hi,h
employment rates impossi%le in the a%sence of some kind of
intervention*

/his also, however, !ndermines the power of interest rates &
and therefore of monetary e-pansion & 7monetary policy7 & to
ass!re reasona%le employment rates, since lon, term rates are
already at or near their a%sol!te minim!m levels* nterest yields
are already close to the minim!m that people will accept for the
risks and inconveniences of permittin, others to %orrow their
savin,s* /heir 7li:!idity preferences7 prevent f!rther interest
rate declines s!fficient to promote f!ll employment*
7f a tolera%le level of employment re:!ires a rate of interest
m!ch %elow the avera,e rates which r!led in the nineteenth
cent!ry, it is most do!%tf!l whether it can %e achieved merely
%y manip!latin, the :!antity of money* From the percenta,e
,ain, which the sched!le of mar,inal efficiency of capital
allows the %orrower to e-pect to earn, there has to %e ded!cted
(0) the cost of %rin,in, %orrowers and lenders to,ether, (>)
income and s!r&ta-es and (2) the allowance which the lender
re:!ires to cover his risk and !ncertainty, %efore we arrive at the
net yield availa%le to tempt the wealth&owner to sacrifice his
li:!idity* f, in conditions of tolera%le avera,e employment, this
net yield t!rns o!t to %e infinitesimal, time&honored methods
may prove !navailin,*7
Remedies $or the
&siness cycle5
The sched&le o$ the marginal e$$iciency o$ capital is the key
factor in the comple- mechanism of the %!siness cycle,
accordin, to Keynes*



2The e!planation of
the time-element in
the trade cycle, of
the fact that an
interal of time of a
particular order of
magnitude must
usually elapse before
recoery begins, is
to be sought in the
influences "hich
goern the recoery
of the marginal
efficiency of
capital.2

Interest rates are
obiously incapable
by themseles of
preenting the "ide
With optimistic expectations driving investment d!rin,
prospero!s times, capital assets flood into the economy*
5!ddenly, reali#ation spreads that the hi,h yields optimistically
e-pected cannot %e reali#ed* /he mar,inal efficiency of capital
is revealed to %e m!ch lower than e-pected*

Lther factors also contri%!te in a cascade of ca!se and effect*
Fear p!shes li:!idity preferences & and th!s interest rates &
hi,her, contri%!tin, to the decline*
/his is fact!ally in error, as previo!sly noted* Keynes sho!ld
have known this from the financial history of the first year of
the 9reat Cepression* /he final s!r,e in interest rates typical of
the last phase of a %!ll market always corresponds with a period
of irrational e-!%erance & not 7fear*7 + lack of ca!tion is in fact
the predominant characteristic* Fear attacks e:!ities well %efore
it !ndermines credit*
?ollapsin, e:!ity val!es and levels of confidence ca!se
cons!mption rates to decline* @vent!ally, as economic activity
declines and red!ces demand for f!nds, interest rates fall*
C!rin, s!ch t!rnin, points, interest rates in fact fall
immediately with red!ctions in demand for f!nds & as occ!rred
steadily and s!%stantially from the %e,innin, of 5eptem%er,
s"ings of the
business cycle both
as a matter of theory
and of obseration.

*eynes concludes
that 2the duty of
ordering the current
olume of inestment
cannot safely be left
in priate hands.2


01>1*
Iowever, Keynes correctly notes that interest rate declines are
helpless to :!ickly reverse the cycle !ntil the s!rpl!s capital
assets and inventories are a%sor%ed 7thro!,h !se, decay and
o%solescence,7 permittin, the mar,inal efficiency of capital to
rise to a point that provides s!fficient incentives for investment
and %orrowin, at the low interest rates* nventories are then
re%!ilt, and cons!mption levels recover*
7/he e-planation of the time-element in the trade cycle, of the
fact that an interval of time of a partic!lar order of ma,nit!de
m!st !s!ally elapse %efore recovery %e,ins, is to %e so!,ht in
the infl!ences which ,overn the recovery of the mar,inal
efficiency of capital* /here are reasons, ,iven firstly %y the
len,th of life of d!ra%le assets in relation to the normal rate of
,rowth in a ,iven epoch, and secondly %y the carryin,&costs of
s!rpl!s stocks, why the d!ration of the downward movement
sho!ld have an order of ma,nit!de which is not fort!ito!s,
which does not fl!ct!ate %etween, say, one year this time and
ten years ne-t time, %!t which shows some re,!larity of ha%it
%etween, let !s say, three and five years*7
/his e-planation is simplistic %!t tolera%le for re,!lar
recessions* Iowever, the 9reat Cepression did last a f!ll decade
& and the inflationary pro%lems of the 01=<s, too, lasted thro!,h
the decade* What were the specific factors that prevented
recoveryQ Lnly ,overnment is capa%le of maintainin, its policy
st!pidities st!%%ornly thro!,ho!t s!ch lon, periods of economic
dislocation*
Reliance on interest rates to miti,ate & m!ch less avoid & the
%!siness cycle is th!s misplaced, Keynes correctly emphasi#es*
nterest rates are o%vio!sly incapa%le %y themselves of
preventin, the wide swin,s of the %!siness cycle %oth as a
matter of theory and of o%servation*
7/h!s & & & the market estimation of the mar,inal efficiency of
capital may s!ffer s!ch enormo!sly wide fl!ct!ations that it
cannot %e s!fficiently offset %y correspondin, fl!ct!ations in
the rate of interest* & & & n conditions of laissez-faire the
avoidance of wide fl!ct!ations in employment may, therefore,
prove impossi%le witho!t a far&reachin, chan,e in the
psycholo,y of investment markets s!ch as there is no reason to
e-pect* concl!de that the d!ty of orderin, the c!rrent vol!me
of investment cannot safely %e left in private hands*7
&aising the rate of
interest fre,uently
2cures the disease by
-illing the patient.2

The proper remedy
may lie in
stimulating the
propensity to
consume 2by
redistributing
income or
other"ise.2

2The right remedy
for the trade cycle is
not to be found in
abolishing booms
and thus -eeping us
permanently in a
semi-slump6 but in
abolishing slumps
and thus -eeping us
permanently in a
,uasi-boom.2

)s little as 74 years
might be all that is
re,uired to reach a
true state of 2full
inestment2 if only
full employment
could be maintained
for that length of
time.

It is possible as a
!o2 what is to e done= Keynes reco,ni#es that hi,h rates of
interest can %e effective in limitin, the investment e-cesses of
%oom periods, so that there will %e less of an overhan, of capital
assets and inventories to work off d!rin, recessions* Iowever,
this is a cr!de and destr!ctive weapon, since it inhi%its e:!ally
all investment & not .!st that which is e-cessive* t can also
inhi%it the propensity to cons!me* t fre:!ently 7c!res the
disease %y killin, the patient*7

/h!s, 7drastic steps7 may %ecome advisa%le* /he proper
remedy may lie in stim!latin, the propensity to cons!me 7%y
redistri%!tin, income or otherwise*7

Fort!nately, most cyclical downt!rns occ!r %efore capital
assets reach widespread overa%!ndance* /hey %e,in while
investments can still yield profits & %!t at m!ch lower rates than
previo!sly e-pected* /his ca!ses a s!%stantial decline in %oth
earnin,s e-pectations and price&earnin,s m!ltiples for capital
assets*

+t s!ch times, the %oom may %e e-tended if interest rates can
%e p!shed sharply lower, restorin, positive e-pectations*
7/he ri,ht remedy for the trade cycle is not to %e fo!nd in
a%olishin, %ooms and th!s keepin, !s permanently in a semi&
sl!mpH %!t in a%olishin, sl!mps and th!s keepin, !s
permanently in a :!asi&%oom*7
@-cept d!rin, war, Keynes finds no instances of 7f!ll
employment,7 altho!,h shorta,es of some skills and the
development of some prod!ction %ottlenecks have o%serva%ly
occ!rred d!rin, prospero!s times & especially d!rin, the 01>D&
01>1 %oom*
7;or was there over&investment in the sense that the standard
and e:!ipment of ho!sin, was so hi,h that everyone, ass!min,
f!ll employment, had all he wanted at a rate which wo!ld no
more than cover the replacement cost, witho!t any allowance
for interest, over the life of the ho!seH and that transport, p!%lic
services and a,ric!lt!ral improvement had %een carried to a
point where f!rther additions co!ld not reasona%ly %e e-pected
to yield even their replacement cost*7
n short & like )ar- & Keynes views the need for profits as the
o%stacle rather than as the drivin, force for ,eneratin,
matter of public
policy to increase
2the stoc- of capital
until it ceases to be
scarce.2

The correct ans"er
is to increase
consumption so
inestment retains its
profitability.

widespread prosperity* 'y this standard, economic and social
7needs7 are witho!t practical limit, and are impossi%le to satisfy*
+t least )ar- honestly limited his !topian promises to mere
s!%sistence*
+,ain, Keynes offers the prepostero!s opinion that as little as
>B years mi,ht %e all that is re:!ired to reach a tr!e state of s!ch
7f!ll investment7 if only f!ll employment co!ld %e maintained
for that len,th of time* )oreover, even if it is not possi%le to
s!stain investment at f!ll employment levels, the answer is not
to red!ce investments thro!,h hi,her interest rates, %!t to
increase cons!mption so investment retains its profita%ility*

Keynes %elieves it is possi%le as a matter of p!%lic policy to
increase 7the stock of capital !ntil it ceases to %e scarce*7 /his
can %e achieved if p!%lic policy is desi,ned to stim!late %oth
investment and cons!mption*
7Whilst aimin, at a socially controlled rate of investment with
a view to a pro,ressive decline in the mar,inal efficiency of
capital, sho!ld s!pport at the same time all sorts of policies for
increasin, the propensity to cons!me* For it is !nlikely that f!ll
employment can %e maintained, whatever we may do a%o!t
investment, with the e-istin, propensity to cons!me*7
What co!ld %e more o%vio!sQ What co!ld possi%ly ,o wron,
with s!ch a well meanin, policyQ

;ot !ntil the world had e-perienced the ,ross ineptness of
,overnment mana,ement in socialist and in other administered
systems & and in administered se,ments of capitalist systems &
wo!ld the answer %ecome clear eno!,h to co!nter s!ch facile
policy s!,,estions*
Partic&lar private sector ca&ses of cyclical downt!rns are
noted .!st once %y Keynes* Ie offers some %rief tho!,hts on the
impacts of inventory and a,ric!lt!ral crop fl!ct!ations*
ncredi%ly & considerin, the e-perience of the previo!s half
do#en years & he downplays their si,nificance for recent events*
Knfort!nately, he totally i,nores the impacts of the h!,e
a,ric!lt!ral crop carryovers from the record and near record
crops of 01>D, 012< and 0120, and the disr!ption of world
a,ric!lt!ral markets early in 012< and thereafter %y the
c!m!lative impacts of a decade of trade war protectionism*
+,ric!lt!ral trade & a h!,e percenta,e of the market for K*5*
crops & had totally disappeared, and wo!ld not even %e,in to
revive for fo!r more years* 5ee, 79reat Cepression ?hronolo,y,
/he ?ollapse of +,ric!lt!re*7
Trade Policy
Mercantilism5

International trade is le$t $or last %y Keynes* Ie never

directly faces the fact that his policy prescriptions )K5/ have
adverse impacts on international trade and payments flows, %!t
he provides stron, indications that he knew this to %e the case*

0nder laissez-faire
capitalism, 2all
measures helpful to
a state of chronic or
intermittent under
employment "ere
ruled out, e!cept
measures to improe
the balance of trade
on income account.2
Keynes clearly has a Marxist perspective on $oreign
trade9/he !ltimate limitations on mat!re domestic capitalist
markets re:!ire that capitalist systems seek investment
opport!nities and markets a%road* Knder laisse#&faire
capitalism, 7all meas!res helpf!l to a state of chronic or
intermittent !nder employment were r!led o!t, e-cept meas!res
to improve the %alance of trade on income acco!nt*7
/his assertion is patently false* + wide variety of ,overnment
policies desi,ned to facilitate commerce are availa%le & and
indeed are essential & to improve economic res!lts* n fact, s!ch
,overnment policies have always %een a vital part of every
s!ccessf!l capitalist system* While ,overnments vary in the
partic!lar policies they implement or re.ect, none has ever
depended on a ,eneral laisse#&faire economic policy* 5ee,
79overnment F!t!recast,7 Part , 7@conomic virt!es of the K*5*
political system*7
) modestly faorable
balance of trade is
thus ital for
capitalist nations
under traditional
laissez-faire interest
rate policies.

There are numerous
"ays in "hich
mercantilist trade
restrictions result in
unfaorable trade
balances instead of
faorable balances.
" $avorale alance o$ trade is essential to directly f!nd
forei,n investments and indirectly increase monetary metals*
/he increase in monetary metals is essential to keep interest
rates low eno!,h to keep domestic investment levels hi,h* +
modestly favora%le %alance of trade is th!s vital for capitalist
nations !nder traditional laissez-faire interest rate policies* 7+n
!nfavora%le %alance of trade may soon prod!ce a state of
persistent depression*7 (Keynesian policies +6W+E5 adversely
impact the %alance of trade*)

)ercantilist o%.ectives are th!s correct, even if their policies
,enerally have adverse !nintended conse:!ence* Iowever,
protection of infant ind!stries and efforts to improve the terms
of trade are realistic o%.ectives for national policy, accordin, to
Keynes, even when they are disadvanta,eo!s for the world as a
whole* ('!t see, rwin, 7Free /rade Knder Fire*7)

While many of their practices were self&defeatin,, the overall

2) policy of trade
restrictions is a
treacherous
instrument een for
the attainment of its
ostensible ob/ect,
since priate
interest,
administratie
incompetence and
the intrinsic
difficulty of the tas-
may diert it into
producing results
directly opposite to
those intended.2
o%.ectives of the mercantilists were correct, accordin, to
Keynes*
7/here was wisdom in their intense preocc!pation with
keepin, down the rate of interest %y means of !s!ry laws & & &,
%y maintainin, the domestic stock of money and %y
disco!ra,in, rises in the wa,e&!nitH and in their readiness in the
last resort to restore the stock of money %y deval!ation, if it had
%ecome plainly deficient thro!,h an !navoida%le forei,n drain,
a rise in the wa,e&!nit, or any other ca!se*7
/he 7any other ca!se7 almost always involves ,overnment
overspendin, and de%t & often %!t not always as an essential
response to military conflicts* )onetary deval!ation & clippin,
the coins or r!nnin, the printin, presses & is a form of ,eneral
ta-ation & appropriatin, the prod!ce of the p!%lic for
,overnment p!rposes* /hat4s the real reason all modern
,overnments want as m!ch inflation as they can ,et away with
witho!t ca!sin, o%serva%le economic harm* /his ,enerally
incl!des a%o!t >P price inflation in addition to the inflation
which eats !p prod!ctivity ,ains* /oday, in the K*5*, these two
to,ether ,enerate additional reven!e e:!ivalents in e-cess of
BP of 9CP*

nternational markets tend to %e %roadly self&correctin, & in
ways similar to those of domestic markets* Fle-i%le e-chan,e
rates permit smoother ad.!stments, while fi-ed e-chan,e rates
,enerally re:!ire financial earth:!akes to achieve any ma.or
ad.!stments that may %e needed*

When not .!stified %y prod!ctivity ,ains, lower domestic
interest rates and hi,her domestic rates of investment and
cons!mption will draw in additional imports and have similar
e:!ili%ratin, impacts on the %alance of payments* Keynes
reco,ni#es s!ch impacts & %!t disc!sses them only after they
have proceeded s!fficiently to increase domestic costs or to shift
investment flows towards hi,her interest opport!nities a%road*
Keynes is co,ni#ant of the n!mero!s ways in which
mercantilist trade restrictions res!lt in !nfavora%le trade
%alances instead of favora%le %alances* Ie notes that @n,land
en.oyed a favora%le %alance in the 01th cent!ry while operatin,
essentially an open & free trade & economic system*
7/here are stron, pres!mptions of a ,eneral character a,ainst
trade restrictions !nless they can %e .!stified on special ,ro!nds*
/he advanta,es of the international division of la%o!r are real
and s!%stantial, even tho!,h the classical school ,reatly
overstressed them* /he fact that the advanta,e which o!r own
co!ntry ,ains from a favora%le %alance is lia%le to involve an
e:!al disadvanta,e to some other co!ntry & a point to which the
mercantilists were f!lly alive & means not only that ,reat
moderation is necessary, so that a co!ntry sec!res for itself no
lar,er a share of the stock of the precio!s metals than is fair and
reasona%le, %!t also that an immoderate policy may lead to a
senseless international competition for a favo!ra%le %alance
which in.!res all alike* +nd finally, a policy of trade restrictions
is a treachero!s instr!ment even for the attainment of its
ostensi%le o%.ect, since private interest, administrative
incompetence and the intrinsic diffic!lty of the task may divert
it into prod!cin, res!lts directly opposite to those intended*7
The only means of
correcting trade and
payments
imbalances "hile
still maintaining the
currency peg "as to
raise domestic
interest rates
sufficiently to slo"
do"n the entire
economy.
The gold'ased $ixed exchange rate system prior to the 9reat
Cepression created dan,ero!s conditions* /he only means of
correctin, trade and payments im%alances while still
maintainin, the c!rrency pe, was to raise domestic interest rates
s!fficiently to slow down the entire economy* /his red!ced
imports, drove costs down, and improved international
competitiveness & %!t at the cost of domestic depression*
7[/h!s], the o%.ective of maintainin, a domestic rate of
interest consistent with f!ll employment was wholly r!led o!t*
5ince, in practice, it is impossi%le to ne,lect the %alance of
payments, a means of controllin, it was evolved which, instead
of protectin, the domestic rate of interest, sacrificed it to the
operation of %lind forces*7
Ieavens for%id that anyone s!,,est the prod!ctivity
improvements always possi%le %y the removal of ,overnment
o%stacles to and %!rdens on commerce*
With the advent of the 9reat Cepression, s!ch practices were
a%andoned %y 9reat 'ritain and in many other nations in favor
of more fle-i%le practices, Keynes notes with approval*
5!ch fle-i%le practices failed to protect the po!nd d!rin, the
last half of the ><th cent!ry* ;or did they ass!re f!ll
employment or prevent the fl!ct!ations of the %!siness cycle*
If all nations
abandoned fi!ed
e!change rates and
pursued *eynesian
policies for
The gold standard ' a fi-ed e-chan,e rate standard & was at
the heart of the pro%lem prior to the 9reat Cepression, Keynes
asserts* /his sets every nation in competition over flows of
precio!s metal that alone can dictate prosperity or decline*
achieing full
employment, then all
"ould benefit and
international
competition for
precious metals
"ould end.
?ompetition is ,ood for national economic policies as well as
for so m!ch else* t imposes discipline on political leaders that
they hate* t forces them to strive to provide the most favora%le
commercial environment possi%le for the prosperity of their
people, and %l!ntly p!nishes political e-cess and irresponsi%ility
& at cost to the citi#enry as well as the politicians*

Where ,overnments have so!rces of wealth that do not depend
on the prosperity of the people & as where there are a%!ndant oil
or diamond reso!rces in small nations & s!ch wealth can prove a
c!rse for the people* /hen, political leaders need not ,ive a
damn for the commercial environment and the economic well
%ein, of the people*

+ccess to the monetary printin, presses is cond!cive to similar
disre,ard for the p!%lic well&%ein,* /he ina%ility to print money
is a ma.or reason why individ!al states in the K*5* concentrate
so hard on facilitatin, commerce within their %orders* 5mall
nations with soft c!rrencies and little mineral wealth operate
!nder similar imperatives*
Keynes provides some interestin, %ack,ro!nd on early
mercantilist tho!,ht, %!t %asically provides a simplistic & partial
e-planation of the pro%lems of the ,old standard and fi-ed
e-chan,e rates in the 01><s and %efore* Ie concl!des that, if all
nations a%andoned fi-ed e-chan,e rates and p!rs!ed Keynesian
policies for achievin, f!ll employment, then all wo!ld %enefit
and international competition for precio!s metals wo!ld end*
7t is the policy of the a!tonomo!s rate of interest, !nimpeded
%y international preocc!pations, and of a national investment
pro,ramme directed to an optim!m level of domestic
employment which is twice %lessed in the sense that it helps
o!rselves and o!r nei,h%ors at the same time* +nd it is the
sim!ltaneo!s p!rs!it of these policies %y all co!ntries to,ether
which is capa%le of restorin, economic health and stren,th
internationally, whether we meas!re it %y the level of domestic
employment or %y the vol!me of international trade*7
/his is a typical assertion of many !topians & and all pyramid
schemes* f only every%ody wo!ld %elieve in the scheme and act
on that %elief, it wo!ld %e s!re of s!ccess and never %reak
down* /hat Keynes wo!ld write s!ch a para,raph is a stron,
indication that he knew and feared the impacts on international
trade and payments %alances that his policies wo!ld have for
any partic!lar nations that adopted them*

t is not fi-ed e-chan,e rates and free trade that are the
pro%lems* +ltho!,h financial e-cesses in the private economy
can also play a role, always & and for any system & especially
Keynesian systems & it is irresponsi%le ,overnment policies and
,overnment profli,acy & and monetary e-pansion & that ca!se
pro%lems*

n fact, fi-ed e-chan,e rates offer many %enefits* 5ee, 7/he
determinants of p!rchasin, power7 in 7?apital as P!rchasin,
Power*7

/he politicians & and the Keynesian economists who provide
them with intellect!al s!pport for irresponsi%le policies & ra,e
a,ainst nat!ral limitations & nat!ral disciplines & that %lock their
desire for !nlimited e-pendit!res and the easy sol!tions of the
printin, presses* /hey seek o!t scape,oats to divert %lame from
themselves, and %lame capitalism and the disciplines of
capitalist processes for the conse:!ences of their own
mismana,ement*
Th&s2 Keynes had to ass&me that $loating exchange
ratesimposed no similar disciplines* Ie even looked with some
sympathy on closed systems*
/he 01=<s wo!ld prove Keynes4 view to %e disastro!sly in
error* t was then demonstrated that ,old reserves and monetary
pe,s in fact offered some temporary shelter from the merciless
.!d,ments of international money markets* For the K*5* after
WW& & with its then vast ,old holdin,s & this temporary shelter
e-tended for two decades*

Witho!t ,old or hard c!rrencies to e-pend in s!pport of a
national c!rrency, adverse c!rrency movements :!ickly and
r!thlessly p!nish ,overnment profli,acy & especially in soft
c!rrency nations*
The relationship etween interest rates and prosperity has
%een o%vio!s for millennia, Keynes notes* @fforts of all kinds
have %een directed at the pro%lem* 7Provisions a,ainst !s!ry are
amon,st the most ancient economic practices of which we have
record*7 /hat interest rates tend to rise 7too hi,h7 & a%ove 7a
level %est s!ited to the social advanta,e7 & is a view that Keynes
stron,ly s!pports* (@ven +dam 5mith viewed !s!ry laws with
some sympathy*)
/here is a vast difference %etween & on the one hand &
administratively attemptin, to set low interest rates & and & on
the other hand & enco!ra,in, lower interest rates %y
improvements in the ,eneral commercial environment that
red!ce the risks of %oth the lender and the %orrowin,
entreprene!r* +dministered rates & like any other administered
prices & )K5/ prove co!nterprod!ctive*;ltimately2 the
mar8et always wins9
5chemes for artificially dealin, with li:!idity preference or
hoardin, pro%lems have historically %een :!ite common*
Keynes notes one & advocated %y 5ilvio 9esell & for imposin, a
carryin, cost on money %y re:!irin, that money %e stamped
each month, with a char,e somewhat less than 3P on an ann!al
%asis* Keynes correctly notes that this wo!ld .!st chase people
into other stores of val!e & art, ,old %ars, .ewelry, etc*
n fact, this is e-actly what inflation does & with the same
impacts and defects* + 3P char,e on money is like a 3P rate of
price inflation & a rate that already inflicts so m!ch distress as to
prove intolera%le wherever it has %een e-perienced*
;topia
The virt&es and
vices o$ savings5
Excess savings and inade)&ate rates o$ cons&mption are
concepts at the heart of Keynes4 79eneral /heory*7 +t the end of
the %ook, Keynes notes with approval views that attack
e-cessive savin,s as an economic sin* Ie does not incl!de
)ar-, here, since )ar- viewed all savin,s as 7hoardin,*7
!avings in excess o$ investment needs & 7e-cess7 or 7!nd!e7
savin, & is a straw man* t is an analysis of pro%lems of
economic distress that starts too late in the infinite chains of
economic ca!se and effect*

Lf co!rse, with perfect price fle-i%ility, there tr!ly cannot %e
ins!fficient money in circ!lation, since prices wo!ld simply
ad.!st to the money availa%le & .!st as +dam 5mith e-plains* Lf
co!rse, there can never %e anythin, near perfect price fle-i%ility
& so monetary fl!ct!ations matter* ;evertheless, policies that
facilitate price fle-i%ility will improve economic performance,
while those that inhi%it price fle-i%ility m!st make pro%lems
worse*

n the private sector & where the prospect of commercial death
serves to concentrate minds & the process of policy reform
occ!rs nat!rally* Iowever, st!pidities in ,overnment policies
periodically pose far more intracta%le pro%lems*

t is not 7!nd!e savin,s7 & %!t the reasons why savin,s %ecome
7!nd!e7 & that m!st %e addressed*
" promise o$
&topia5

" $inal note that is p&re Marxist ideology concl!des this

work* Keynes finds 7no intrinsic reason for the scarcity of
capital*7 Ie, like )ar-, has total confidence in the a%ility of
,overnment & of 7the comm!nity7 & to administer economic
markets and mana,e economic activities*

Keynesian policies vigoro&sly applied for a%o!t >B years
wo!ld prod!ce f!ll capitali#ation s!fficient to make the roles of
financiers, rentiers and 7the f!nctionless investor7 s!perfl!o!s*
ndeed, their interest rates and rents are o%stacles to pro,ress*

/he achievement of this no%le ,oal wo!ld involve some
7comprehensive sociali#ation of investment*7 5ystems of
ta-ation and administration wo!ld have to more nearly e:!ali#e
res!lts and ass!re ade:!ate levels of cons!mption and
investment* /he costs of capital assets wo!ld then need to cover
only o%solescence, risks and the costs of skill and s!pervision &
costs s!fficiently low to dispense with profits* /he needed skills
and s!pervision co!ld %e ac:!ired %y means of s!ita%le salary*

Iowever, this is an administered !topia & not a socialist !topia*
Knlike the )ar-ian !topia, market mechanisms wo!ld still %e
employed in the Keynesian !topia to allocate reso!rces*
6ike socialist !topias, Keynes4 administered !topia is static and
contemplates little f!rther pro,ress* We mi,ht as well close the
patent office* t is %ased & like all socialist !topias & on total
i,norance of the inherent ineptness of ,overnment mana,ement
and administered systems* 5ee, 9overnment F!t!recast,7 Part ,
79overnment mana,ement*7

t i,nores the o%vio!s reality that his o%.ective is in any event
impossi%le to even temporarily reach* ?apital may %e f!n,i%le,
%!t capital assets are not* +s profits decline arithmetically, the
press!res of creative destr!ction increase e-ponentially &
renderin, efforts to reach s!ch an o%.ective l!dicro!s* ?apital
assets th!s m!st always %e scarce & offerin, ade:!ate profits for
efficient enterprise*
5ee, Keynes, 7/he 9eneral /heory of @mployment, nterest, O
)oney,7 Part , 7@lements of /he 9eneral /heory*7
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