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The General Theory of Employment, Interest, and Money

The General Theory of Employment, Interest and Money was written by the English economist John Maynard Keynes. The book, generally considered to be his magnum opus, is largely credited with creating the terminology and shape of modern macroeconomics. Published in February 1936 it sought to bring about a revolution, commonly referred to as the "Keynesian Revolution", in the way economists thought - especially in relation to the proposition that a market economy tends naturally to restore itself to full employment after temporary shocks. Regarded widely as the cornerstone of Keynesian thought, the book challenged the established classical economics and introduced important concepts such as the consumption function, the multiplier, the marginal efficiency of capital and liquidity preference.

Overview

Although The General Theory was written in the aftermath of the Great Depression and was taken by many to justify the assumption by government of the responsibility for the achievement and maintenance of full employment, it is for the most part a highly abstract work of theory and by no means a tract on policy. Its full meaning and significance continues to be debated even today. As a book, it is a difficult read for a modern student of economics, although it is enlivened by some brilliant rhetorical passages, including the description of the stock market in Chapter 12 and the concluding chapter 24 on the (rather tentative) policy implications Keynes derived from his theory.

Contrary to popular belief, Keynes was by no means the first to advocate public works or deficit spending in a depression, but his book provides the theoretical framework within which temporary measures like the New Deal and longer term commitments to the welfare state can be justified. Keynes himself placed equal emphasis on redistributive taxation and a monetary policy of ‘cheap money’ as well as fiscal policy, and he did not believe governments should run deficits for current consumption, as opposed to public investment. He was by no means a socialist in the usual sense and did not advocate big government for its own sake. The central argument of the book is that the level of employment is determined, not by the price of labour as in neoclassical economics, but by the spending of money (aggregate demand). He argues that it is wrong to assume that competitive markets will, in the long run, deliver full employment or that full employment is the natural, self-righting, equilibrium state of a monetary economy. On the contrary, under-employment and under-investment are likely to be the natural state unless active measures are taken. 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. The implication of The General Theory is that a lack of competition is not the fundamental problem and measures to reduce unemployment by cutting wages or benefits are not only hard-hearted but ultimately futile. Keynes does not set out a detailed policy program in The General Theory, but he went on in practice to place great emphasis on the reduction of long-term interest rates and the reform of the international monetary system as structural measures needed to encourage both investment and consumption by the private sector.

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 Keynes explicitly addresses inflation, The General Theory does not treat it as an essentially monetary phenomenon nor suggest that control of the money supply or interest rates is the key remedy for inflation. This conflicts both with neoclassical theory and with the experience of pragmatic policy-makers. Furthermore the main Keynesian prescription for inflation, incomes policy, has lost credibility. Thus, far from being ‘general’, Keynes’s theory is now seen in many quarters as the special case.

Keynes and his followers

From the outset there has been controversy over what Keynes really meant and whether he was right. Many early reviews were highly critical. The success of what came to be known as ‘neoclassical synthesisKeynesian economics owed a great deal to the Harvard economists Alvin Hansen and Paul Samuelson, as well as to the Oxford economist Sir John Hicks. Hansen and Samuelson offered a lucid explanation of Keynes’s theory of aggregate demand with their elegant 45 degree ‘Keynesian cross’ diagram, while Hicks created the IS/LM diagram. Both of these diagrams can still be found in text-books.

Nevertheless, starting with Axel Leijonhufvud, this view of Keynesian economics came under increasing challenge and scrutiny and has now divided into two main camps.

The majority new consensus view, found in most current text-books and taught in all universities, is New Keynesian economics, which accepts the neoclassical concept of long-run equilibrium but allows a role for aggregate demand in the short run. New Keynesian economists pride themselves on providing microeconomic foundations for the sticky prices and wages assumed by Old Keynesian economics. They do not regard The General Theory itself as a helpful place to start.

The minority view is represented by Post Keynesian economists, all of whom accept Keynes’s fundamental critique of the neoclassical concept of long-run equilibrium, and some of whom think The General Theory has yet to be properly understood and repays further study.

Introductions to The General Theory

The earliest attempt to write a student guide was Robinson (1937) and the most successful (by numbers sold) was Hansen (1953). These are both quite accessible but Old Keynesian. An up-to-date Post Keynesian attempt, aimed mainly at graduate and advanced undergraduate students, is Hayes (2006). Paul Krugman has written an introduction to the 2007 Palgrave edition of The General Theory.

Famous quotations

"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 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." (p. 3)

"If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing. (p. 129)"

"It is better that a man should tyrannise over his bank balance than over his fellow citizens and whilst the former is sometimes denounced as being but a means to the latter, sometimes at least it is an alternative." (p. 374)

"... 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 influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil." (pp. 383-4))

Notes

References

  • Amadeo, Edward (1989) The principle of effective demand, Aldershot UK and Brookfield US: Edward Elgar
  • Chick, Victoria (1983) Macroeconomics after Keynes, Oxford: Philip Allan
  • Davidson, Paul (1972) Money and the Real World, London: Macmillan
  • Davidson, Paul (2002) Financial markets, money and the real world, Cheltenham UK and Northampton US: Edward Elgar
  • Hansen, Alvin (1953) A Guide to Keynes, New York: McGraw Hill
  • Harcourt, Geoff and Riach, Peter (eds) (1997) A ‘Second Edition’ of The General Theory, London: Routledge
  • Hayes, Mark (2006) The economics of Keynes: a New Guide to The General Theory, Cheltenham UK and Northampton US: Edward Elgar.
  • Keynes, John Maynard (1936) The General Theory of Employment, Interest and Money, London: Macmillan (reprinted 2007)
  • Lawlor, Michael (2006) The economics of Keynes in historical context, London: Palgrave Macmillan
  • Leijonhufvud, Axel (1968) Keynesian economics and the economics of Keynes, New York: Oxford University Press.
  • Minsky, Hyman (1975) John Maynard Keynes, New York: Columbia University Press
  • Patinkin, Don (1976) Keynes’s monetary thought, Durham NC: Duke University Press
  • Robinson, Joan (1937) Introduction to the theory of employment, London: Macmillan
  • Tily, Geoff (2007) Keynes's General Theory, the Rate of Interest and ‘Keynesian’ Economics, London: Palgrave Macmillan
  • Trevithick, James (1992) Involuntary unemployment, Hemel Hempstead: Simon & Schuster

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