The General Theory of Employment, Interest, and Money
John Maynard Keynes
The General Theory of Employment, Interest, and Money would change the landscape of economics and shape the post-war world economy.
Keynes begins the book by noting that, as a young economist, he had accepted the economics paradigm of his day. This ‘classical’ economics seemed to explain the workings of the modern economic world – but it had slowly dawned on Keynes that it did not.
The classical economists assumed that, because the use of resources in a society was efficient, employment would always take care of itself. If an economy slackened, the price of labour would go down, prompting manufacturers to hire again.
But in the real economy, Keynes observed, there will be times when a person is between jobs, unable to work or discouraged from trying to get work by the state of the economy.
Moreover, workers and employers bargain over nominal wages, not on ‘real’ wages. The result is that, if the price of labour across a whole economy went down, so would prices, so not much in the economy would change; there would be no self-correction. Therefore, ‘wage flexibility’ may not cure an ailing economy, but simply make the rich richer and the poor poorer.
There was another reason why Keynes distrusted lower wages as a solution to a stalled economy: anyone owing money would have less ability to repay it. Rather than getting an economy back on its feet by restoring equilibrium in production and consumption, declining wages could lead to a spiral of deflation, anaemic consumption and a credit crunch.
Yet the heart of Keynes’ thinking was not employment as such, but the problem of demand.
Classical economics was built on JB Say’s observation that ‘supply creates its own demand’. There can never be a lack of demand in an economy, or a glut of anything, because any money a producer earns is spent on buying more raw materials and other goods he needs.
But what happens, Keynes asked, when not all the savings a society accumulates are poured back into productive investment? Fear of uncertainty in the economy could make people hoard cash, or make bankers hesitant to lend and borrowers afraid to borrow. The economy would slump and unemployment lines grow.
This is where Keynes made his crucial break with classical economics: because of the role of uncertainty, and perhaps ungrounded fears, there will not always be a perfect dance between production and consumption.
Keynes wished to replace the classical ‘natural’ rate of interest with a rate that was optimised to achieve full employment. Such an ‘optimum’ rate would ensure that any benefits to capitalists and savers from rates were not at the expense of full employment.
Keynes joked that in bad economic times a government might as well bury banknotes in jars underground, then employ thousands of people to dig them up. Paying the workers may be a ‘waste’ in conventional terms, but it wouldn’t matter as the overall effect outweighs the cost.
Even as he was writing, Keynes’ shocking idea was being proven correct. In his first 100 days in office, Franklin D. Roosevelt took a scattergun approach to America’s near-dead economy, passing measures that shored up the banking system, cut red tape, devalued the dollar and funded huge infrastructure programmes.
For Keynes, governments had a responsibility to use the levers of monetary policy and fiscal policy to ensure aggregate demand stayed healthy and evened out the business cycle.
Towards the end of the General Theory, Keynes noted that if his proposed ‘central controls’ succeeded in stoking economic output such that full employment was achieved, there was no reason why a national economy should then not default to the classical model of market forces.
The Great Depression, Keynes said, needed a specific fix. There was no case for a wholesale reorganisation of production in any communistic sense, simply a need to create the environment that would ensure that all people who wanted to work could be productively employed.
What motivated Keynes to become an economist was that faulty thinking in economics could have devastating consequences. By exposing the anomalies of the existing paradigm, he created a new one, and despite many detractors, the Keynesian approach is still at the heart of today’s world economy.
Copyright © Tom Butler-Bowdon, 2017. The above is an abridged extract from 50 Economics Classics by Tom Butler-Bowdon, published by Nicholas Brealey Publishing.