Ethan J.

Convis

Professor Babcock

English 137H

19 November 2021

The Keynesian Revolution

 “The difficulty lies not so much in developing new ideas as in escaping from old ones”-

John Maynard Keynes

Both forms of economics, micro, and macro, affect our lives on a daily basis. The

microeconomics of our society are readily apparent every time we buy items or sell our labor for

money. The macroeconomics of a society can be harder to see but are of equal importance for the

safety and stability of a nation. Interest rates of the Federal Reserve, along with the policies from

Washington D.C., create a drastic ripple effect in terms of economic health for not only America,

but all of America’s trade partners as well. It's why economics has been an object of study for

nearly all of human history, and why, as trade has become more international, and the GDP of

the world appears to be growing nearly exponentially, economic schools have sprouted up, out of

the demand to analyze the data available and chart the best course of action forward. The policy

recommendations that come from these schools are often reflective of the times that they exist in.

When Adam Smith published “The Wealth of Nations” in 1776, the Enlightenment was

in full effect throughout Europe and across the sea to the American Colonies. The Continental

Congress was soon to declare independence from Great Britain, yet the future nation would draw

heavily on Smith’s text for leading their fledgling nation through times of economic hardship,

and for establishing currency. This new wave of thinking brought about new ideology and theory

about man, the divine, government, along with a bevy of other topics. A critical aspect of this

movement was the combination of economics with philosophy. Even if David Hume and John

Locke are known by current readers primarily for their works on philosophy, their economic

insights leave much to be explored by students in the modern era. “The Wealth of Nations”

imagined an economy that pursues individual liberty through a lack of governmental

intervention, along with a shift away from an inefficient mercantilist system. This idea would be
contrasted by future thinkers, such as Karl Marx, Leon Trotsky or Vladimir Lenin who favored a

redistributionist society, whereby complete government control of the means of production,

along with a redistributionist means of spreading wealth, painted a different set of policy

recommendations that the Smithian ideal.

Out of all the countries that have produced some of the greatest economists of all time,

Great Britain has few rivals. The kingdom produced thinkers such as prementioned Adam Smith,

John Stuart Mill, and John Maynard Keynes, all massively influential figures with wildly

different ideologies and works. John Stuart Mill furthered the ideals of workplace equality and

increased government intervention through workers’ rights legislation. The free market could not

always be trusted to provide the best outcome, and an economy with more socialistic elements

would be the ideal. These ideas would be further expounded upon by one of the most influential

economists of recent times, through the pen of John Maynard Keynes. Keynesian Economics

ushered in new ways of thinking about money and society, and tore down the dominant ideas of

the time, mainly through an advocation for the abolishment of the gold standard, along with

increased government intervention in economic policy.

John Maynard Keynes was born into the upper crust of society to wealthy parents and

high expectations. His father had published works on economics before and ignited a passion for

economic theory in his son. John studied at Eton and Cambridge, exclusive, high-class schools

whereby after he enrolled in the latter academic institution, he joined forces with a group of

powerful intellectuals and artists known as the Bloomsbury Group. This group’s motive was to

explore bold new ideas, and not conform to the status quo, or blindly rely on precedent in their

respective fields. The mantra of this group would no doubt inspire Keynes in his future

endeavors
 The dominant theory of the time was pioneered by Alfred Marshall (1842-1924).

Marshall was yet another great economist in a long line of British theorists, who expanded many

concepts. The Price Elasticity of Demand, which dictates how much demand will shift in

response to a change in price and is highly useful for when individual firms are attempting to

find maximum revenue. One of Marshall’s most critical points was that of the Price Level. A

Price Level how much consumers can expect to pay for a good at a given time. Marshall believed

that the quantity of money affected this relationship greatly and promoted the gold standard.

Keynes studied Marshall’s work, and pre 1914 accepted most of his theories as doctrine within

economics.

Keynes lived through three of some of the most turbulent times known to man. He

experienced the brutality of both World Wars and the hardship of the Great Depression.

However, after World War One, John Maynard Keynes became an influential figure on the

global stage. After the Central Powers agreed to a surrender, a formal treaty needed to be created

to negotiate the terms of the surrender. The Allied Powers were understandably upset at the cost

of the World War and the residents within wanted extreme costs to be inflicted on Germany for

their transgressions. Officials set a price tag of German reparations to 132 billion gold marks,

which is equivalent to a modern $269 billion dollars. Obviously, with their infrastructure in

shambles and many of their men dead through battles in the war, Germany was in no state to pay

off this massive financial burden. The Treaty of Versailles radically changed Keynes thinking

about macroeconomics. Keynes was so furious with the Treaty of Versailles, and the foolishness

of the Allied Powers in demanding such ludicrous sums, that he published “The Economic

Consequences of the Peace.” Once one reads past the title, it is clear that Keynes does not view

war as a good thing for the economy. He merely points out that Germany cannot pay the amount
demanded, and as such the government will likely collapse, and the Allies will receive nothing in

the form of monetary compensation. Keynes’s foresight here is nothing short of remarkable.

Nearly everything he warned of would come to fruition in the form of Adolf Hitler, a Nazified

Germany, and horrific death, destruction, and ruin. The essay documents a clear shift in

Keynes’s thinking and is described by Keynes biographer, Robert Skidelsky in the following

way.

'From the biographical point of view, The Economic Consequences of the Peace is a key

document. It marked a radical shift in Keynes's thought from the nineteenth-century assumption

of 'automatic' economic progress sustained by liberal institutions to a view of the future in which

prosperity would have to be strenuously won in the teeth of the adverse circumstances which the

war had created’

One of Keynes’s main objections was the supporting of the interwar gold standard. The

dominant economic view of the time was that to avoid hyperinflation of the currency,

government issued money needed to be backed up by gold. This item would keep prices stable,

and employment would eventually reach full capacity. Full employment is the goal of nearly

every economist, barring utopians who dream of a mechanized future where labor by the

majority is no longer needed. Adam Smith supported the idea that a free market, given enough

time, would eventually reach full employment. Potential deviation from this ideal would come

from workers in between jobs, those seeking education for more skilled employment, and

working age adults who chose retirement instead of employment. For this event to occur, there

needed to be no minimum wage or labor regulations, so the market could be left to its own

devices and decide what the value of specific kinds of labor was worth. Keynes, on the other
hand, believed that full employment could be reached without a gold standard backing up the

currency.

For millennia, societies have used coins to determine wealth and as a store of value. The

various currencies had value because the established government, and the people living under

said government agreed that the coins had value. It was not always this way. Humans have also

used various other means of determining wealth. Raw barter between citizens was rather useful

for most of history, as certain governments were at risk of invasion or collapse, and so the

currency they issued would be rendered worthless. If the currency itself was not made of a

precious metal, it would often be transmissible to a real amount of gold or silver somewhere in

the government’s coffers. This system gave the currency additional value, as raw gold and silver

can be traded to varying success to nearly every group on Earth, due to the versatility, rarity, and

transmissibility of the metal. To remove an exchange for gold is to make a currency “fiat,” the

money has value because the government and the people agree that it has value. Without this

agreement, a slip of paper with a number or a dull coin with an official’s face is inherently

worthless, but Keynes took it one step further.

In “A Tract on Monetary Reform,” Keynes lambasts the idea that gold has barely any

value extrinsic to society perception, declaring its supporters to be under the spell of “the

primitive passion for solid metal” and a “barbarous relic.” Even though gold can be used for

other applications in the modern age besides a display of status and wealth, such as electronic

components, these applications were far rarer in Keynes’s time, which led to this public

disparagement of the metal.

 Keynes furthered his essay to include a new policy recommendation, that the Bank of

England should be “regulating the supply of currency and credit with a view to maintaining […]

the stability of stabilizing the internal price level”

The Bank of England needed great control over the currency, and that the currency needed to be

easily malleable for Keynesian Economics to truly function and thrive. The ease in adjusting the

value of currency would be difficult if the money was tied to a specific amount of gold, and so

Keynes voiced his opposition.

This policy recommendation had consequences for the future. President Franklin Delano

Roosevelt would suspend the gold standard to stop the panic cash out of Americans liquefying

their earnings into blocks of metal and encourage investment in the American Economy. Later,

President Richard Nixon moved the United States Dollar (USD) away from the gold standard so

that the United States could respond to an increasing threat of inflation and boost the GDP of the

nation.

During Keynes’s time, prevailing economic theory was one of supply-side economics.

Say’s Law, which many economists accepted as a pure fact, stated that “Supply creates its own

demand.” It can be inferred that a way out of an economic slump, according to Say and other

theorists was simply to increase supply, and then the demand will follow. Keynes took a

different approach. That approach was focused primarily on demand and can be proven through

the example of the primary causes of a hypothetical recession.

When investors in the economy go through panic or fear, this often causes a liquidation

of investment in business, and spending dries up. Businesses rely on this spending, and without a

sufficient revenue stream, must close their doors and fire their workers. If this event happens on

a small scale, then the workers move on to new employment and the economy rebounds. No
catastrophe. However, if the crisis is nationwide, as was the case in 1929, then the workers have

nowhere to turn and more spending by these workers becomes scarcer. The cycle then repeats

itself until demand recovers and the economy is spurred on by this new growth. While the

Austrian school of economics would promote a hand off, laissez-faire approach to these

recessions, Keynes thought that this approach would do too little, too late. It also does not solve

the problem that given decades, if not centuries of time to a given society, we have yet to reach

this anarcho-capitalist utopia that other economists proclaimed would come eventually. Keynes

policy prescriptions were an increase in government expenditures, and the lowering of taxes in a

recession to spur economic growth. This policy prescription had profound effects on the United

States in the years to come.

Franklin Delano Roosevelt acted in ways that supported Keynes’s theory about the role

of government. After defeating the incumbent Herbert Hoover in a landslide election through his

promotion of increased spending on the campaign trail in response to the Great Depression

brought about by an unsustainable bubble in the securities market, FDR quickly went to work

establishing government programs to spur demand in the faltering economy. The New Deal

consisted of exactly the course of action Keynes recommended. The establishment of the

Civilian Conservation Corps and The Civil Works Administration is notable for using

government dollars to put eager young men back to work building civic infrastructure for the

country.

Experiencing a faltering economy, Ronald Reagan endorsed a large deficit in the

Congressional Budget. Traditional sensibility would be appalled by such an action, as orthodox

economists supported a pay-as-you-go model. Deficits are deemed necessary by Keynes to boost

aggregate demand. This deficit must be paid off in the future through increased taxes and a
governmental surplus, but the course of action Reagan took regarding government spending,

appears distinctly Keynesian.

In response to the meltdown of the financial world in 2008, President Obama and a supportive

Congress passed a broad and expansive stimulus program to soothe the pain of the massive

economic downturn. This would smooth out the boom bust cycle that seems inherent to capitalist

economies and move from an upward sloping line with huge peaks and troughs, to a line that is

far smoother. In response to the COVID-19 pandemic, and subsequent crash of the Dow Jones

Industrial Average along with the national GDP, President Donald Trump, a Republican, and a

congress nearly unanimously passed another round of stimulus in responses to the crisis. These

bills contained the purest way of increasing spending in the economy, through direct stimulus

checks given to eligible American taxpayers. This pumping of money into the economy did

create inflation, as economists across the political spectrum, including Keynes, observed that the

condition of inflation, where too much money chases too few goods, is brought about by

stimulus checks. However, economists such as Milton Friedman, who would disagree strongly

with Keynes on many issues, would agree that a certain amount of inflation was required to

encourage investment in the economy. Otherwise, if the dollar was gaining value day-by-day,

then investors would have every incentive to lock up their money in bank accounts. Through

fractional reserves, where a bank loans that money out to needy peoples and businesses, this

effect is somewhat diminished, but few advancements in civilization can match that of the joint-

stock company in terms of ensuring wealth.

The multiplier effect, devised by Keynes, explores a critical aspect of government

spending. What is the real cost of government spending? Keynes would argue that the amount
spent will be less than the addition to the GDP, and therefore more spending should be

encouraged. The idea complements the Keynesian model of a recession quite well. When

workers, government or otherwise receive money, they choose to either spend or save the dollars

they earn. Keynes denoted this as MPS (Marginal Propensity to Save) or MPC (Marginal

Propensity to Consume). This idea is usually represented as fractions of a dollar, for example

0.8:0.2 might represent a consumption to saving ratio of 4:1. This interaction of splitting a dollar

between saving and spending doesn’t happen just once, it occurs a near infinite number of times

over the course of a dollar’s life.

For example, a worker will be paid a hypothetical wage of $10 for an hour of labor at a

mine. He then goes home and puts away $2 for a rainy day. Then, the consumer goes out and

spends $8 on groceries. The supermarket then takes those $8, and invest it into more employees,

facilities, or wages, leading to more output, so more consumers can spend at their store. Hence,

money being spent on the worker’s labor at the mine, then causes money being spent by the

supermarket for new employees. Economists would doubt the efficiency of this multiplier, but

Keynesian economists would view this idea as proof that the government needed to take on a

more liberal spending policy in times when the economy needed a boost. This theory would lay

the groundwork for future government spending programs.

Keynesian Economics is certainly not the be-all-end-all monetary theory. Many great

economists had yet to gift the world with their insight. Milton Friedman had yet to create the

Chicago School and lead the monetarists into the future. Rothbard had yet to gather the Austrians

and advocate for more free market enterprise. With these thinkers, new criticisms of Keynesian

ideology inevitably arose. However, it can be observed that the American Public desires a

synthesis of Keynesian ideology, as expressed through their congressional representatives voting

in favor of large stimulus bills. These large spending bills would have been figments on one’s

imagination for most of American history, but the influential works of British Economist John

Maynard Keynes permanently changed the way the United States of America thinks about

money.
Citations: Britannica, The Editors of Encyclopaedia. "John Maynard Keynes". Encyclopedia
Britannica, 1 Jun. 2021, https://www.britannica.com/biography/John-Maynard-Keynes.
Accessed 19 November 2021.

Author, Unkown. “Alfred Marshall, 1842-1924.” Alfred Marshall,

https://www.hetwebsite.net/het/profiles/marshall.htm.

Carter, Zachary. The Price of Peace: Money, Democracy, and the Life of John Maynard Keynes.
Random House, 2020.

Evrensel, Ayse. “The Currency Standard of the Interwar Years (1918–1939).” Dummies,
https://www.dummies.com/education/finance/international-finance/the-currency-standard-
of-the-interwar-years-19181939/.

Kenton, Will. “Price Level.” Investopedia, Investopedia, 19 May 2021,

https://www.investopedia.com/terms/p/price_level.asp.

Pugh, Peter, and Chris Garrett. Introducing Keynesian Economics. Icon Books Ltd., 2000.

Raunchway, Eric. The Money Makers: How Roosevelt and Keynes Ended the Depression,
Defeated Fascism, and Secured a Prosperous Peace. Basic Books, 2015.

Sowell, Thomas. On Classical Economics. Yale University Press, 2006.

Heilbroner, Robert L. “The Man Who Made Us All Keynesians.” The New York Times, The New
York Times,
https://archive.nytimes.com/www.nytimes.com/books/98/12/06/specials/skidelsky-
keynes.html.