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The General Theory Of Employment, Interest And ...



I have called this book the General Theory of Employment, Interest and Money, placing the emphasis on the prefix general. The object of such a title is to contrast the character of my arguments and conclusions with those of the classical theory of the subject, upon which I was brought up and which dominates the economic thought, both practical and theoretical, of the governing and academic classes of this generation, as it has for a hundred years past. I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.




The General Theory of Employment, Interest and ...



Keynes's economic theory is based on the interaction between demands for saving, investment, and liquidity (i.e. money). Saving and investment are necessarily equal, but different factors influence decisions concerning them. The desire to save, in Keynes's analysis, is mostly a function of income: the wealthier people are, the more wealth they will seek to put aside. The profitability of investment, on the other hand, is determined by the relation between the return available to capital and the interest rate. The economy needs to find its way to an equilibrium in which no more money is being saved than will be invested, and this can be accomplished by contraction of income and a consequent reduction in the level of employment.


In the classical scheme it is the interest rate rather than income which adjusts to maintain equilibrium between saving and investment; but Keynes asserts that the rate of interest already performs another function in the economy, that of equating demand and supply of money, and that it cannot adjust to maintain two separate equilibria. In his view it is the monetary role which wins out. This is why Keynes's theory is a theory of money as much as of employment: the monetary economy of interest and liquidity interacts with the real economy of production, investment and consumption.


Many of the quantities of interest, such as income and consumption, are monetary. Keynes often expresses such quantities in wage units (Chapter 4): to be precise, a value in wage units is equal to its price in money terms divided by W, the wage (in money units) per man-hour of labour. Therefore it is a unit expressed in hours of labour. Keynes generally writes a subscript w on quantities expressed in wage units, but in this account we omit the w. When, occasionally, we use real terms for a value which Keynes expresses in wage units we write it in lower case (e.g. y rather than Y).


This schedule is a characteristic of the current industrial process which Irving Fisher described as representing the 'investment opportunity side of interest theory';[8] and in fact the condition that it should equal S(Y,r) is the equation which determines the interest rate from income in classical theory. Keynes is seeking to reverse the direction of causality (and omitting r as an argument to S()).


Keynes proposes two theories of liquidity preference (i.e. the demand for money): the first as a theory of interest in Chapter 13 and the second as a correction in Chapter 15. His arguments offer ample scope for criticism, but his final conclusion is that liquidity preference is a function mainly of income and the interest rate. The influence of income (which really represents a composite of income and wealth) is common ground with the classical tradition and is embodied in the Quantity Theory; the influence of interest had also been noted earlier, in particular by Frederick Lavington (see Hicks's Mr Keynes and the "Classics"). Thus Keynes's final conclusion may be acceptable to readers who question the arguments along the way. However he shows a persistent tendency to think in terms of the Chapter 13 theory while nominally accepting the Chapter 15 correction.[9]


In Chapter 14 Keynes contrasts the classical theory of interest with his own, and in making the comparison he shows how his system can be applied to explain all the principal economic unknowns from the facts he takes as given. The two topics can be treated together because they are different ways of analysing the same equation.


If we wish to examine the classical system our task is made easier if we assume that the effect of the interest rate on the velocity of circulation is small enough to be ignored. This allows us to treat V as constant and solve the first and third equations (the 'first postulate' and the quantity theory) together, leaving the second equation to determine the interest rate from the result.[20] We then find that the level of employment is given by the formula


Keynes's theory of the trade cycle is a theory of the slow oscillation of money income which requires it to be possible for income to move upwards or downwards. If he had assumed that wages were constant, then upward motion of income would have been impossible at full employment, and he would have needed some mechanism to frustrate upward pressure if it arose in such circumstances.


In autumn 1932 he delivered lectures at Cambridge under the title 'the monetary theory of production' whose content was close to the Treatise except in giving prominence to a liquidity preference theory of interest. There was no consumption function and no theory of effective demand. Wage rates were discussed in a criticism of Pigou.[40]


His lectures in autumn of that year bore the title 'the general theory of employment'.[43] In these lectures Keynes presented the marginal efficiency of capital in much the same form as it took in Chapter 11, his 'basic chapter' as Kahn called it.[44] He gave a talk on the same subject to economists at Oxford in February 1935.


Just as the reception of The General Theory was encouraged by the 1930s experience of mass unemployment, its fall from favour was associated with the 'stagflation' of the 1970s. Although few modern economists would disagree with the need for at least some intervention, policies such as labour market flexibility are underpinned by the neoclassical notion of equilibrium in the long run. Although Keynes explicitly addresses inflation, The General Theory does not treat it as an essentially monetary phenomenon or suggest that control of the money supply or interest rates is the key remedy for inflation, unlike neoclassical theory.


Lastly, Keynes' economic theory was criticized by Marxian economists, who said that Keynes ideas, while good intentioned, cannot work in the long run due to the contradictions in capitalism. A couple of these contradictions to which Marxians point are the idea of full employment, which is seen as impossible under private capitalism; and the idea that government can encourage capital investment through government spending, when in reality government spending could be a net loss on profits.


This book is chiefly addressed to my fellow economists. I hopethat it will be intelligible to others. But its main purpose isto deal with difficult questions of theory, and only in thesecond place with the applications of this theory to practice.For if orthodox economics is at fault, the error is to be foundnot in the superstructure, which has been erected with great carefor logical consistency, but in a lack of clearness and ofgenerality in the pre misses. Thus I cannot achieve my object ofpersuading economists to re-examine critically certain of theirbasic assumptions except by a highly abstract argument and alsoby much controversy. I wish there could have been less of thelatter. But I have thought it important, not only to explain myown point of view, but also to show in what respects it departsfrom the prevailing theory. Those, who are strongly wedded towhat I shall call 'the classical theory', will fluctuate, Iexpect, between a belief that I am quite wrong and a belief thatI am saying nothing new. It is for others to determine if eitherof these or the third alternative is right. My controversialpassages are aimed at providing some material for an answer; andI must ask forgiveness If, in the pursuit of sharp distinctions,my controversy is itself too keen. I myself held with convictionfor many years the theories which I now attack, and I am not, Ithink, ignorant of their strong points.


The matters at issue are of an importance which cannot beexaggerated. But, if my explanations are right, it is my felloweconomists, not the general public, whom I must first convince.At this stage of the argument the general public, though welcomeat the debate, are only eavesdroppers at an attempt by aneconomist to bring to an issue the deep divergences of opinionbetween fellow economists which have for the time being almostdestroyed the practical influence of economic theory, and will,until they are resolved, continue to do so.


The relation between this book and my Treatise on Money[JMK vols. v and vi], which I published five years ago,is probably clearer to myself than it will be to others; and whatin my own mind is a natural evolution in a line of thought whichI have been pursuing for several years, may sometimes strike thereader as a confusing change of view. This difficulty is not madeless by certain changes in terminology which I have feltcompelled to make. These changes of language I have pointed outin the course of the following pages; but the generalrelationship between the two books can be expressed briefly asfollows. When I began to write my Treatise on Money I wasstill moving along the traditional lines of regarding theinfluence of money as something so to speak separate from thegeneral theory of supply and demand. When I finished it, I hadmade some progress towards pushing monetary theory back tobecoming a theory of output as a whole. But my lack ofemancipation from preconceived ideas showed itself in what nowseems to me to be the outstanding fault of the theoretical partsof that work (namely, Books III and IV), that I failed to dealthoroughly with the effects of changes in the level ofoutput. My so-called 'fundamental equations were an instantaneouspicture taken on the assumption of a given output. They attemptedto show how, assuming the given output, forces could developwhich involved a profit-disequilibrium, and thus required achange in the level of output. But the dynamic development, asdistinct from the instantaneous picture, was left incomplete andextremely confused. This book, on the other hand, has evolvedinto what is primarily a study of the forces which determinechanges in the scale of output and employment as a whole; and,whilst it is found that money enters into the economic scheme inan essential and peculiar manner, technical monetary detail fallsinto the background. A monetary economy, we shall find, isessentially one in which changing views about the future arecapable of influencing the quantity of employment and not merelyits direction. But our method of analysing the economic behaviourof the present under the influence of changing ideas about thefuture is one which depends on the interaction of supply anddemand, and is in this way linked up with our fundamental theory of value. Weare thus led to a more general theory, which includes theclassical theory with which we are familiar, as a special case. 041b061a72


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