Maynard Keynes, a British economist born on June 5th, 1983 brought such a revolution in the field of economics and politics that today modern economic fiscal and monetary policies are based upon his ‘Keynesian Economics’. His interest in economics initiated while part of his preparation for the civil service entrance examination of 1905, when he attributed very low marks in economics and according to Harrod (1951) “at least Keynes knew more economics than my examiners do” (Harrod, 1951, p. 121). While working as a civil servant, Keynes started working on a dissertation in 1905 which he attempted to utilise mathematics theory of probability that later he applied to unique events in a social context. In 1907 when it got completed after successfully resubmitting for his Cambridge fellowship, his further work was delayed till 1914 after which he published “A Treatise on Probability” in 1920 (Steele, 2001, p. 2).
After spending two years as a civil servant in the India Office and two years as a university lecturer at Cambridge, Keynes was elected to obtain for a fellowship at King’s College in 1910. Being a valuable member of the Royal Commission of Indian Finance and Currency, he published “Indian Currency and Finance” in 1913.
Keynes published work “The General Theory of Employment, Interest and Money” (1936) has had considered to be the most influential in moulding the thinking of professional economists and public policy makers than any other book in the whole history of economic thought in a comparable number of years. (Dillard, 1948, p. 1).
Keynes’s fundamental insight was that we are unable to calculate or assume our economic future therefore in such a world money offers psychological security against uncertainty. When uncertainty arises, people become pessimistic about future prospects and they could possibly decide to hoard their savings rather than invest them in businesses. Thus with no guarantee that all income earned will be spent, comes the notion that there is no natural tendency for all available resources to be employed (Raphael et al, 1997, p. 225).
Keynes philosophy driven economics was informed by his vision of the ‘good life’ and was permeated by his theory of probability. Being a product of an atheistic generation, he and his contemporaries saw themselves as replacing Christian ‘hocus-pocus’ by a rational system of ethics and conduct. But they used tools of thought inherited from the Christian past; and the structure of their thought was metaphysical (Raphael et al, 1997, p. 262).
Keynes proposed a solution for the British unemployment problem which took place in the 1920s by suggesting a framework of the quantity theory of money. He was aware of the fact that fluctuations in business activity could be prevented by appropriate monetary policy. The quantity theorists of Keynes’s day were monetary reformers who wanted to use the theory of money to stabilise economic activity. Since the quantity theory of money was the first theory of short-run macroeconomic stabilisation, therefore Keynes after realising that quantity theory of money is a theory relating the supply of money to the price level at which goods are bought, not to the quantity of goods produced Keynes, tried to use what they called the quantity theory of money to explain fluctuations in output. Keynes successfully did so, partly because of the observed correlation between monetary events and fluctuations in business activity, and partly because monetary policy offered the most promising parameter of action for those who wanted to manage, but not destroy, the capitalist system.
In the 1930s Keynes abandoned the quantity theory approach to the explanation of short-run fluctuations in output. In The General Theory money still retains its power to disturb the real economy. But its disturbing power arises from its function as a store of value rather than as a means of exchange. (Raphael et al, 1997, p. 278).
Keynes set out to save what he called ‘capitalistic individualism’ from the scourge of mass unemployment, which, he saw, if left unchecked, would make ‘authoritarian state systems’ the norm in the Western world. Keynes did not restrict himself to theory only; his practical economic policy bears even more deeply than economic theory the imprint of Keynes’ thought. A few renowned examples of public welcome of Keynes’ philosophy is in areas of governmental intervention, public investment, and economic policy. His work has been designed to fill the gaps in the private enterprise economy. Among his major achievements include: the economic policies of the New Deal, the special economic message of President Truman to Congress at the close of the second world war, the English, Canadian, and Australian ‘White Papers’ on unemployment policy, the Murray Full Employment Bill of 1945 and the Employment Act of 1946 in the United States, the provision in the new French Constitution which requires an annual employment budget, the newer thinking in the field of fiscal policy, the International Monetary Fund, and the International Bank for Reconstruction and Development. It appears that the trend in economic policy in those countries where private enterprise is still vigorous will be in the direction which Lord Keynes charted. Many of his ideas and most of his theoretical apparatus can be useful in socialist economies even though his fundamental social philosophy is anti-Marxian. (Dillard, 1948, p. 2)
Economics Vision of ‘Keynes’
By the term ‘classical economics’ Keynes meant traditional or orthodox principles of economics which have been handed down and generally accepted by academic economists. Axel Leijonhufvud regarding the ‘Keynesian Revolution’ mentions Keynes’s economical vision as an advanced attempt to integrate monetary theory and value theory. This not only revealed the communication problems within modern economic systems but also addressed the interrelationships between monetary policy and disequilibrium processes. (Steele, 2001, p. 20) According to Axel, “Classical economics refers to the orthodox presentation of a false economy where monetary variations drive prices at the level of marginal considerations of cost, and revenues are the forces of price determination at the level of the firm. However, Keynes’s analysis rejected the postulate derived from the Classical doctrine that there is no auctioneer to elicit and to disseminate a set of equilibrium prices.
Keynes General Theory
Keynes ‘General Theory’ added a new concept in the shape of the ‘principle of effective demand’ and was directly affected by the world depression in two ways. First, the depression undermined his faith in monetary policy, a radical break from his personal past. Despite the cheap money which followed sterling’s depreciation in 1931, recovery was very weak. Keynes concluded that ‘direct state intervention to promote and subsidise new investment’ might offer the only ‘means of escape from prolonged and perhaps interminable depression’.
Secondly, it shifted his attention, more than ever before, from Britain to the United States. The problematic of the Treatise on Money was that of a sclerotic economy with an overvalued exchange rate. American wages and prices were much more flexible than those in Britain, its foreign sector much smaller, yet its output collapse was much more dramatic. American events spurred Keynes to think more generally about the predicament of wealthy economies. Moreover, the fact that the slump was world-wide made the search for remedies involving devaluation, protection, or other ‘external’ elements irrelevant. The General Theory would try to explain how the closing of the investment frontier, combined with a high propensity to save and hoard, could make ‘involuntary’ unemployment endemic in rich Western societies at large. The ‘closed economy’ model of the General Theory and ‘fiscal’ Keynesianism can both be seen as products of the world slump (Raphael et al, 1997, p. 302).
Keynes Theory of Demand and Supply
Keynes’ general theory of employment focuses on the principle of effective demand, which embodies in a systematic manner the fundamental ideas on which economic theory of Keynes is based. Keynes appears to have been the first economist of recognised standing to make a serious case for a tariff as a means of increasing a nation’s level of income and employment. (Harris, 1947, p. 317) Keynes initiated the perception that employment is the outcome of demand and unemployment results where there is no demand or deficiency of demand. With the rise in employment, income increases therefore, in order to have sufficient demand to sustain an increase in employment there must be an increase in real investment equal to the gap between income and the consumption demand out of that income (Dillard, 1948, p. 29).
Keynes tried to base his macro-theory on microeconomic foundations highlighting social condition of individual’s behavior. He favored a market economy that was not neoclassical. Therefore in this respect, Keynes’s fundamental notion of decision making is considered uncertain for Keynes’s analysis of the working of a market economy in conditions of uncertainty, suggests that the crucial decisional units are entrepreneurs rather than generic optimising individuals. (Arestis et al, 2002, p. 5).
Keynes on Economic Policy
The ‘Keynesian Language’ literature and analysis of international trade has been enriched by ‘income analysis’ and by the introduction of the ‘export multiplier’. For general theory the ‘income effects’, formerly represented by shifts in the price-demand schedules, can more effectively be analysed by the aid of the Keynesian functions.
Monetary thinking was greatly influenced by Keynes long before the appearance of the General Theory. The Tract on Monetary Reform, the Treatise, and his work on the Macmillan Report were important stepping stones along a difficult new path which increasingly put English informed opinion far in the forefront with respect to applied monetary economics. (Felix, 1999, p. 54) Few shifts in accepted procedures and policies have occurred in monetary history so striking as those with respect to interest rate policy in the cycle. It had long been axiomatic that variation in the interest rate was appropriate cycle policy. Gradually, mainly due to Keynes’ thinking, attention shifted to the importance of the maintenance of a low rate of interest (Harris, 1947, p. 198).
The goal of monetary policy became directed more and more away from preoccupation with the short-term or commercial loan rate to the long-term rate, in line with the emphasis placed by Keynes upon long-term investment and governmental loan financing. The course of events, including war financing, hastened the adoption of Keynes’ ideas; but it is not altogether clear how rapidly or successfully the monetary authorities would have adapted themselves to the changing conditions, either in England and the British Dominions, or in the United States, had the ground not been prepared for them by Keynesian monetary thinking. At the approach of war, Keynes clearly enunciated the view that taxation and borrowing could not be adequate so long as the national income remained at low levels.
Keynes was as creative in administration as he was in theory. For every economic problem which interested him he had ready a ‘Keynes Plan’, drafted at lightning speed. The common feature of these plans which go back to his proposal for an Indian Central Bank in 1913 was praised by Marshall as a ‘prodigy of constructive work’. Keynes work was praised as it was always ahead of the intellectual orthodoxy of the moment they could be readily fitted to existing administrative arrangements. Keynes could thus present them as evolutionary developments of existing practice. The partial exception is his endorsement of a centrally directed public works programme in 1929, which would have required a revolution in government. Keynes’s own preference was to channel increased investment through the public utility corporations. He also favoured indirect (financial) to direct (physical) control over the economy, in order to retain the advantages of decentralised decision-making. This brought him into conflict with socialist methods, if not with some aspects of the socialist ideal (Raphael et al, 1997, p. 325).
With full employment assured through the big increase in state orders, the problem Keynes faced in 1939 was to transfer resources to the war effort without undue inflation, disincentive tax levels, or the bureaucratic controls associated with comprehensive physical planning. In the First World War, increased government purchases had caused prices to rise; rising prices had reduced the real incomes of the working class; the ‘windfall’ profits of entrepreneurs were commandeered by the government in the form of taxes and loans. The results were industrial unrest in the later stages of the war; a high cost of government borrowing, which increased the post-war debt burden; and the ownership by the wealthy of the national debt.
The new Keynes Plan was designed to overcome these problems with a centre-piece scheme for ‘deferred earnings’. Excess private purchasing power would be mopped up by a heavily progressive surcharge on all incomes above an exempted minimum, made up of direct taxes and compulsory saving. The latter, credited to individual accounts in the Post Office Saving Bank, would be released after the war in instalments to counteract the expected post-war slump. Keynes proposed to ‘provide for this deferred consumption without increasing the National Debt by a general capital levy after the war’ and to protect the poorest through family allowances. In estimating the size of the ‘inflationary gap’ the amount by which civilian consumption would need to be reduced to enable output to be transferred to the war effort without prices rising Keynes, in the absence of official national income statistics, offered estimates, based on the work of Colin Clark, of national output and taxable income, the division of total spending between the government and private sector, and income distribution, all in 1939 prices. It then became relatively easy to calculate how much ‘private outlay’ had to be reduced to accommodate any desired increase in ‘government outlay’ at these prices, as well as the sacrifice required from each section of the community (Raphael et al, 1997, p. 327).
Keynesian Analysis
The Keynesian analysis has profoundly shaken the faith, stubbornly held and not yet altogether abandoned, in the efficacy of flexible wage adjustments as appropriate cycle policy. Keynesian theory pushed still further off the stage the already dying “MV” type of monetary analysis. (Harris, 1947, p. 201) Followers of the MV analysis could never see why the ‘circular flow’, once a certain money supply had been created, should not continue on indefinitely. So the fiction had to be invented that there was a villain in the piece. The villain was the monetary authority who maliciously at periodic intervals interfered to curtail the volume of money. the Keynesian theoretical apparatus not only contributed to an understanding of the drastic and sudden collapse of the marginal efficiency of capital which often occurs at the crisis point in the boom. It also revealed the limited scope of monetary policy as a means of raising investment. Beyond this, Keynes supplied the most powerful test of analysis yet invented the consumption function with which to study and measure the cumulative process. The general Keynesian theory of income determination makes the MV analysis look like a curious contraption from the horse and buggy stage. (Harris, 1947, p. 201)
The General Theory contains the last systematic statement of Keynes on the subject of commercial policy. Yet it would clearly be misleading to omit reference to the later Keynes, whose views were to wield such wide influence during the war period. If Keynes had died in 1936, he might possibly have been classified, in the sphere of commercial policy, as an apologist for economic nationalism. Keynes of the war period was a consummate internationalist, and the apparent shift in his point of view appears to have been very largely the result of the change in the international environment.
References
Arestis Philip, Desai Meghnad & Dow Sheila, (2002) Methodology, Microeconomics and Keynes: Essays in Honor of Victoria Chick. Volume: 2: Routledge: London.
Dillard Dudley, (1948) The Economics of John Maynard Keynes: The Theory of a Monetary Economy: Prentice-Hall: New York.
Felix Daid, (1999) Keynes: A Critical Life: Greenwood Press: Westport, CT.
Harrod, R.F. (1951) The Life of John Maynard Keynes, London: Macmillan.
Harris E. Seymour, (1947) The New Economics: Keynes’ Influence on Theory and Public Policy: Alfred A. Knopf: New York.
Raphael D. D., Winch Donald & Skidelsky Robert, (1997) Three Great Economists: Smith, Malthus, Keynes: Oxford University Press: Oxford.
Steele G. R., (2001) Keynes and Hayek: The Money Economy: Routledge: London.