John Maynard Keynes

Dr Shujat Ali
“The ideas of economists and
political philosophers, both
when they are right and when
they are wrong are more
powerful than is commonly
understood. Indeed, the
world is ruled by little else.
Practical men, who believe
themselves to be quite
exempt from any intellectual
influences, are usually slaves
of some defunct economist.”
John Maynard Keynes The
General Theory 1936
 John Maynard Keynes(1883-1946): Man and his life
• An original, multifaceted personality with interests ranging from
economics, finance, journalism, arts and public policy amongst others

• Founder of Macroeconomics—aggregative analysis at economy level

• Author of The General Theory of Employment, Interest and

Money(1936) and a number other seminal texts.

• Architect of the post Second World War Bretton Woods Institutions

 Economics before Keynes
• Classical economists—Smith, Ricardo,Marx etc—were concerned
about growth in wealth of nations and its distribution between
landlords, Labor and capitalists.
• Neoclassical economists—J.S Mill, Marshall and Pigou—moved their
concern away from distributional issues towards efficient allocation of
scarce economic resources in a market demand-supply framework
with a focus on utility maximisation and cost minimisation.
• Both these set of economists believed in the laissez faire philosophy
of markets with no interference by government beyond the minimally
required functions. Th allocation of resources occurred through the
working of the “invisible hand” via self interest and competition.
 Economics before Keynes—Contd.
• They also believed in Say’s Law—Jean Baptiste Say(1767-1832), Traite
d’Economie Politique(1803)—according to which “ Supply creates its
own demand”, implying that production of goods generates sufficient
income to buy all goods that have been produced.
• Say’s Law rules out overproduction or shortage of overall demand for
goods. In this scheme of things, there can be no recession entailing
shortage of demand relative to supply of goods and thus no possibility
of persisting unemployment.
• Keynes inauguration of a new way of thinking in economics in the
context of circumstances that he faced in his time was in large measure
a repudiation of the Say’s Law as it could not explain the reality of the
Great Depression.
 Great Depression(1929-1939)
• World level economic downturn that began with the Stock market crash in
the US in October 1929 and lasted until about 1939.
• The longest and most serious depression ever experienced by the
industrialized Western world entailing fundamental changes in economy,
polity and society.
• The Great Depression caused large declines in output, large scale job
losses, numerous bank failures and serious deflation in United States and
many countries of Europe, amongst others.
• By 1933, when the Great Depression reached its lowest point, the US
unemployment rate rose from 3% in 1929 to 25% in 1933 when some 15
million Americans were unemployed and nearly half the country’s banks
had failed. Income in 1933 was lower than in 1922. In the UK the same
period saw unemployment double to 20%.
 Neoclassical Response to the Great Depression
• When the Great Depression hit the world beginning with the stock
market crash in 1929, neoclassical economists, with meant nearly all
economists of the time, looked around in disbelief and just stood
aside clueless.
• For them this was something to be waited out. Two of the leading
economists of the times, Joseph Schumpeter of Harvard and Lionel
Robbins of the London School of Economics came forward and urged
that nothing needs to be done. Let it run its course and that will cure
the malaise.
• “The cause was an accumulating poison in the system; the resulting
hardship was what extruded the poison and put the economy on the
way back to health”. J. K Galbraith. The History of Economics: the past
as the present. 1987.
 Keynes Response to the Great Depression
• Keynes set about breaking the shackles on neoclassic policy thinking
of the times, with its “do nothing” approach, through his writing and
public advocacy
• According to Keynes, contrary to classical mindset the modern
economy is not always moving towards equilibrium at full
employment; there can also be an “underemployment equilibrium”.
This means Say’s Law is no longer valid; there can be a shortage of
demand.
• He held that government can be the saviour and should take steps to
overcome it. Faced with the suffering of the millions in the depth of
the depression the canons of sound finance—balanced budgets—
should be set side to respond to the pressing challenges of the times.
 Keynesian Revolution: Main ideas/insights
• Aggregate demand—measured as the sum of spending by households,
businesses, and the government—most important driving force. It is influenced
by many economic decisions, in both public and private spheres subject to
coordination failure and possibly recessions/depression.
• Prices, and especially wages, respond slowly to changes in supply and demand,
resulting in periodic shortages and surpluses, especially of labor.
• Changes in aggregate demand have their greatest short-run effect on real
output and employment, not on prices.
• Keynesians believe that, because prices are somewhat rigid, fluctuations in any
component of spending—consumption, investment, or government
expenditures—cause output to change.
• Multiplier effect: an increase/decrease in spending causes output to change by
a multiple of the original amount of spending through second and third round
effects. If the fiscal multiplier is greater than one, then a one rupee increase in
government spending would result in an increase in output greater than one
rupee.
 Keynesian Revolution: Main ideas/insights

• Fiscal Policy via changes in government spending or taxes charged will

impact aggregate demand and can supplement the inadequacies of the
market for maintaining full employment and price stability.
• Money is Not Neutral in the short run. With disequilibrium and
unemployment, money is not neutral. Increasing the nominal money supply
will reduce the real interest rate. Investment, national income and product
expands.
• However fiscal policy is a more potent tool for aggregate demand
management than monetary policy.
 Comparison of Classical vs Keynes
• Classicals • Keynes
• Equilibrium • Disequilibrium
• Prices Adjust • Quantities Adjust
• Full Employment • Unemployment
• Supply-Oriented • Demand-Oriented
• Efficiency • Inefficiency
• No Countercyclical Policy • Countercyclical Policy
• Money Neutral • Money Not Neutral
Keynes on the role of the State for Investment
• “For my own part I am now somewhat sceptical of the success of a
merely monetary policy directed towards influencing the rate of
interest. I expect to see the State, which is in a position to calculate
the marginal efficiency of capital-goods on long views and on the
basis of the general social advantage, taking an ever greater
responsibility for directly organising investment; since it seems likely
that the fluctuations in the market estimation of the marginal
efficiency of different types of capital, calculated on the principles I
have described above, will be too great to be offset by any practicable
changes in the rate of interest.”
• General theory (1936) Chap 12 The State of Longterm expectation
•
Keynes on the role of the State for Investment
• “It seems unlikely that the influence of banking policy on the rate of
interest…
• …will be sufficient by itself to determine an optimum rate of
investment. I conceive, therefore, that a somewhat comprehensive
socialisation of investment will prove the only means of securing an
approximation to full employment; though this need not exclude all
manner of compromises and of devices by which public authority will
co-operate with private initiative. But beyond this no obvious case is
made out for a system of State Socialism which would embrace most
of the economic life of the community. It is not the ownership of the
instruments of production which it is important for the State to
assume. If the State is able to determine the aggregate amount of
resources devoted to augmenting the instruments and the basic rate
of reward to those who own them, it will have accomplished all that is
necessary…
The important thing
for Government is
not to do things
which individuals are
doing already, and
to do them a little
better or a little
worse; but to do
those things which
at present are not
done at all. John
Maynard Keynes.
The End of Laissez
Faire 1926 Part 4
Keynes insight on present day Finance
• “Speculators may do no harm as bubbles on a
steady stream of enterprise. But the position is
serious when enterprise becomes a bubble on
a whirlpool of speculation. When the capital
development of a country becomes a by-
product of the activities of a casino, the job is
likely to be ill done. The measure of success
attained by Wall Street, regarded as an
institution of which the proper social purpose
is to direct new investment into the most
profitable channels in terms of future yield,
cannot be claimed as one of the outstanding
triumphs of laissez-faire capitalism — which is
not surprising, if I am right in thinking that the
best brains of Wall Street have been in fact
directed towards a different object.”

• — John Maynard Keynes chap12 GT state of long

term expextation
 Economic Possibilities for our Grandchildren John Maynard Keynes (1930)

• “When the accumulation of wealth is no longer of high social importance, there

will be great changes in the code of morals. We shall be able to rid ourselves of
many of the pseudo-moral principles which have hag-ridden us for two hundred
years, by which we have exalted some of the most distasteful of human qualities
into the position of the highest virtues. We shall be able to afford to dare to
assess the money-motive at its true value. The love of money as a possession – as
distinguished from the love of money as a means to the enjoyments and realities
of life – will be recognised for what it is, a somewhat disgusting morbidity, one of
those semi-criminal, semi-pathological propensities which one hands over with a
shudder to the specialists in mental disease. All kinds of social customs and
economic practices, affecting the distribution of wealth and of economic rewards
and penalties, which we now maintain at all costs, however distasteful and
unjust they may be in themselves, because they are tremendously useful in
promoting the accumulation of capital, we shall then be free, at last, to discard”.
Thank You