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John Maynard Keynes

John Maynard Keynes



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John Maynard Keynes, an English native, professed economic concepts that form the headwaters of economic theory for many outstanding economists who succeeded him and is a testament to the magnitude and influence of his ideas.A youth of prodigious intellect, Keynes attended King’s College to study mathematics, and it was here that his interest in economics began.Keynes started a lectureship on economics that was funded by Alfred Marshall, and after being refused by Cambridge many times, he vowed a ban to build his reputation as an economist. Keynes` expertise was called upon after World War I as an adviser to the British chancellor of the Exchequer to the Treasury of Financial and Economic Questions where his responsibility was to design credit terms between Britain and its allies during the war.After his promotion in 1919 to the Senior Treasury Official, he resigned to write his first book entitled Economic Consequences of Peace, in which he criticized President Woodrow Wilson as being a "blind, deaf Don Quixote" and France`s Georges Clemenceau as a xenophobe with "one illusion — France, and one disillusion — mankind" for their insistence that Germany pay war reparations.In 1936, he published his most important book, A General Theory of Employment, Interest and Money, which revolutionized economic theory by showing how unemployment could occur involuntarily and how governments should engage in deficit spending to make up for the economic slowdowns caused when businesses reduce their investments.In 1934, Keynes paid a visit to President Franklin D. Roosevelt, where he was unsuccessful in persuading the president to engage in deficit spending to bring America out of its economic tailspin. As Keynesian theory would have predicted, the sharp decline in budget stimulus led to reversal in the economic recovery.It was not until the U.S. entered World War II that Roosevelt, having decided that he had no choice, reversed his long-held position of a balanced budget to one of using deficit spending to kick start the economy.The English economist died on April 21, 1946. Support for government spending to counter the effect of recessions is now widespread, but his disciplined expectation that during good times, governments would recoup their losses has proved too unpopular in practice.


John Maynard Keynes lived through a turbulent period of British history. He was born in 1883, a subject of Queen Victoria. He died in 1946, having lived through the Boer War, both World Wars, and a worldwide economic depression. His career timeline makes fascinating reading. In an eighteen-year period encompassing the Great Depression and World War 2, Keynes’s Chest Fund grew fivefold – a remarkable performance given that the UK stock market fell fifteen percent in the same period.

5. Early Life

Keynes was the first born of John Neville Keynes and Florence Ada Keynes. He was born on June 5, 1883, to an upper-middle-class family residing in Cambridge, England. Keynes’s father lectured moral sciences at the University of Cambridge and was also an economist while his mother was a local social reformer. Keynes began his schooling at the Perse School for Girls in kindergarten, but his poor health meant he was out of school for periods of time. After being tutored by his mother and a governess, Keynes joined St. Faith's preparatory school where he excelled in mathematics. A scholarship led him to Eton College and subsequently to King's College to pursue mathematics. Keynes graduated with a first class Bachelors in mathematics in 1904.


Weekly Topics

Week 1: Introduction Ch. 1, After the Gold Rush Ch. 2, Blood Money

Week 2: Ch. 3, Paris and Its Discontents Ch. 4, Consequences

Week 3: Ch. 5, From Metaphysics to Money Ch. 6, Prolegomena to a New Socialism

Week 4: Ch. 7, The Great Crash

Week 6: Ch. 9, The End of Scarcity

Week 7: Ch. 10, Came the Revolution

Week 8: Ch. 11, War and Revolution Ch. 12, Martyr to the Good Life

Week 9: Ch. 13: The Aristocracy Strikes Back

Week 10: Ch. 14, The Affluent Society and Its Enemies

Week 11: Ch. 15, The Beginning of the End

Week 12: Ch. 16, The Return of the Nineteenth Century

Week 13: Ch. 17, The Second Gilded Age


Contents

Pre-Keynesian macroeconomics Edit

Macroeconomics is the study of the factors applying to an economy as a whole. Important macroeconomic variables include the overall price level, the interest rate, the level of employment, and income (or equivalently output) measured in real terms.

The classical tradition of partial equilibrium theory had been to split the economy into separate markets, each of whose equilibrium conditions could be stated as a single equation determining a single variable. The theoretical apparatus of supply and demand curves developed by Fleeming Jenkin and Alfred Marshall provided a unified mathematical basis for this approach, which the Lausanne School generalized to general equilibrium theory.

For macroeconomics, relevant partial theories included the Quantity theory of money determining the price level and the classical theory of the interest rate. In regards to employment, the condition referred to by Keynes as the "first postulate of classical economics" stated that the wage is equal to the marginal product, which is a direct application of the marginalist principles developed during the nineteenth century (see The General Theory). Keynes sought to supplant all three aspects of the classical theory.

Precursors of Keynesianism Edit

Although Keynes's work was crystallized and given impetus by the advent of the Great Depression, it was part of a long-running debate within economics over the existence and nature of general gluts. A number of the policies Keynes advocated to address the Great Depression (notably government deficit spending at times of low private investment or consumption), and many of the theoretical ideas he proposed (effective demand, the multiplier, the paradox of thrift), had been advanced by various authors in the 19th and early 20th centuries. Keynes's unique contribution was to provide a general theory of these, which proved acceptable to the economic establishment.

An intellectual precursor of Keynesian economics was underconsumption theories associated with John Law, Thomas Malthus, the Birmingham School of Thomas Attwood, [9] and the American economists William Trufant Foster and Waddill Catchings, who were influential in the 1920s and 1930s. Underconsumptionists were, like Keynes after them, concerned with failure of aggregate demand to attain potential output, calling this "underconsumption" (focusing on the demand side), rather than "overproduction" (which would focus on the supply side), and advocating economic interventionism. Keynes specifically discussed underconsumption (which he wrote "under-consumption") in the General Theory, in Chapter 22, Section IV and Chapter 23, Section VII.

Numerous concepts were developed earlier and independently of Keynes by the Stockholm school during the 1930s these accomplishments were described in a 1937 article, published in response to the 1936 General Theory, sharing the Swedish discoveries. [10]

The paradox of thrift was stated in 1892 by John M. Robertson in his The Fallacy of Saving, in earlier forms by mercantilist economists since the 16th century, and similar sentiments date to antiquity. [11] [12]

Keynes's early writings Edit

In 1923 Keynes published his first contribution to economic theory, A Tract on Monetary Reform, whose point of view is classical but incorporates ideas that later played a part in the General Theory. In particular, looking at the hyperinflation in European economies, he drew attention to the opportunity cost of holding money (identified with inflation rather than interest) and its influence on the velocity of circulation. [13]

In 1930 he published A Treatise on Money, intended as a comprehensive treatment of its subject "which would confirm his stature as a serious academic scholar, rather than just as the author of stinging polemics", [14] and marks a large step in the direction of his later views. In it, he attributes unemployment to wage stickiness [15] and treats saving and investment as governed by independent decisions: the former varying positively with the interest rate, [16] the latter negatively. [17] The velocity of circulation is expressed as a function of the rate of interest. [18] He interpreted his treatment of liquidity as implying a purely monetary theory of interest. [19]

Keynes's younger colleagues of the Cambridge Circus and Ralph Hawtrey believed that his arguments implicitly assumed full employment, and this influenced the direction of his subsequent work. [20] During 1933, he wrote essays on various economic topics "all of which are cast in terms of movement of output as a whole". [21]

Development of The General Theory Edit

At the time that Keynes's wrote the General Theory, it had been a tenet of mainstream economic thought that the economy would automatically revert to a state of general equilibrium: it had been assumed that, because the needs of consumers are always greater than the capacity of the producers to satisfy those needs, everything that is produced would eventually be consumed once the appropriate price was found for it. This perception is reflected in Say's law [22] and in the writing of David Ricardo, [23] which states that individuals produce so that they can either consume what they have manufactured or sell their output so that they can buy someone else's output. This argument rests upon the assumption that if a surplus of goods or services exists, they would naturally drop in price to the point where they would be consumed.

Given the backdrop of high and persistent unemployment during the Great Depression, Keynes argued that there was no guarantee that the goods that individuals produce would be met with adequate effective demand, and periods of high unemployment could be expected, especially when the economy was contracting in size. He saw the economy as unable to maintain itself at full employment automatically, and believed that it was necessary for the government to step in and put purchasing power into the hands of the working population through government spending. Thus, according to Keynesian theory, some individually rational microeconomic-level actions such as not investing savings in the goods and services produced by the economy, if taken collectively by a large proportion of individuals and firms, can lead to outcomes wherein the economy operates below its potential output and growth rate.

Prior to Keynes, a situation in which aggregate demand for goods and services did not meet supply was referred to by classical economists as a general glut, although there was disagreement among them as to whether a general glut was possible. Keynes argued that when a glut occurred, it was the over-reaction of producers and the laying off of workers that led to a fall in demand and perpetuated the problem. Keynesians therefore advocate an active stabilization policy to reduce the amplitude of the business cycle, which they rank among the most serious of economic problems. According to the theory, government spending can be used to increase aggregate demand, thus increasing economic activity, reducing unemployment and deflation.

Origins of the multiplier Edit

The Liberal Party fought the 1929 General Election on a promise to "reduce levels of unemployment to normal within one year by utilising the stagnant labour force in vast schemes of national development". [24] David Lloyd George launched his campaign in March with a policy document, We can cure unemployment, which tentatively claimed that, "Public works would lead to a second round of spending as the workers spent their wages." [25] Two months later Keynes, then nearing completion of his Treatise on money, [26] and Hubert Henderson collaborated on a political pamphlet seeking to "provide academically respectable economic arguments" for Lloyd George's policies. [27] It was titled Can Lloyd George do it? and endorsed the claim that "greater trade activity would make for greater trade activity . with a cumulative effect". [28] This became the mechanism of the "ratio" published by Richard Kahn in his 1931 paper "The relation of home investment to unemployment", [29] described by Alvin Hansen as "one of the great landmarks of economic analysis". [30] The "ratio" was soon rechristened the "multiplier" at Keynes's suggestion. [31]

The multiplier of Kahn's paper is based on a respending mechanism familiar nowadays from textbooks. Samuelson puts it as follows:

Let’s suppose that I hire unemployed resources to build a $1000 woodshed. My carpenters and lumber producers will get an extra $1000 of income. If they all have a marginal propensity to consume of 2/3, they will now spend $666.67 on new consumption goods. The producers of these goods will now have extra incomes. they in turn will spend $444.44 . Thus an endless chain of secondary consumption respending is set in motion by my primary investment of $1000. [32]

Samuelson's treatment closely follows Joan Robinson's account of 1937 [33] and is the main channel by which the multiplier has influenced Keynesian theory. It differs significantly from Kahn's paper and even more from Keynes's book.

The designation of the initial spending as "investment" and the employment-creating respending as "consumption" echoes Kahn faithfully, though he gives no reason why initial consumption or subsequent investment respending shouldn't have exactly the same effects. Henry Hazlitt, who considered Keynes as much a culprit as Kahn and Samuelson, wrote that .

. in connection with the multiplier (and indeed most of the time) what Keynes is referring to as "investment" really means any addition to spending for any purpose. The word "investment" is being used in a Pickwickian, or Keynesian, sense. [34]

Kahn envisaged money as being passed from hand to hand, creating employment at each step, until it came to rest in a cul-de-sac (Hansen's term was "leakage") the only culs-de-sac he acknowledged were imports and hoarding, although he also said that a rise in prices might dilute the multiplier effect. Jens Warming recognised that personal saving had to be considered, [35] treating it as a "leakage" (p. 214) while recognising on p. 217 that it might in fact be invested.

The textbook multiplier gives the impression that making society richer is the easiest thing in the world: the government just needs to spend more. In Kahn's paper, it is harder. For him, the initial expenditure must not be a diversion of funds from other uses, but an increase in the total expenditure: something impossible – if understood in real terms – under the classical theory that the level of expenditure is limited by the economy's income/output. On page 174, Kahn rejects the claim that the effect of public works is at the expense of expenditure elsewhere, admitting that this might arise if the revenue is raised by taxation, but says that other available means have no such consequences. As an example, he suggests that the money may be raised by borrowing from banks, since .

. it is always within the power of the banking system to advance to the Government the cost of the roads without in any way affecting the flow of investment along the normal channels.

This assumes that banks are free to create resources to answer any demand. But Kahn adds that .

. no such hypothesis is really necessary. For it will be demonstrated later on that, pari passu with the building of roads, funds are released from various sources at precisely the rate that is required to pay the cost of the roads.

The demonstration relies on "Mr Meade's relation" (due to James Meade) asserting that the total amount of money that disappears into culs-de-sac is equal to the original outlay, [36] which in Kahn's words "should bring relief and consolation to those who are worried about the monetary sources" (p. 189).

A respending multiplier had been proposed earlier by Hawtrey in a 1928 Treasury memorandum ("with imports as the only leakage"), but the idea was discarded in his own subsequent writings. [37] Soon afterwards the Australian economist Lyndhurst Giblin published a multiplier analysis in a 1930 lecture (again with imports as the only leakage). [38] The idea itself was much older. Some Dutch mercantilists had believed in an infinite multiplier for military expenditure (assuming no import "leakage"), since .

. a war could support itself for an unlimited period if only money remained in the country . For if money itself is "consumed", this simply means that it passes into someone else's possession, and this process may continue indefinitely. [39]

Multiplier doctrines had subsequently been expressed in more theoretical terms by the Dane Julius Wulff (1896), the Australian Alfred de Lissa (late 1890s), the German/American Nicholas Johannsen (same period), and the Dane Fr. Johannsen (1925/1927). [40] Kahn himself said that the idea was given to him as a child by his father. [41]

Public policy debates Edit

As the 1929 election approached "Keynes was becoming a strong public advocate of capital development" as a public measure to alleviate unemployment. [42] Winston Churchill, the Conservative Chancellor, took the opposite view:

It is the orthodox Treasury dogma, steadfastly held . [that] very little additional employment and no permanent additional employment can, in fact, be created by State borrowing and State expenditure. [43]

Keynes pounced on a chink in the Treasury view. Cross-examining Sir Richard Hopkins, a Second Secretary in the Treasury, before the Macmillan Committee on Finance and Industry in 1930 he referred to the "first proposition" that "schemes of capital development are of no use for reducing unemployment" and asked whether "it would be a misunderstanding of the Treasury view to say that they hold to the first proposition". Hopkins responded that "The first proposition goes much too far. The first proposition would ascribe to us an absolute and rigid dogma, would it not?" [44]

Later the same year, speaking in a newly created Committee of Economists, Keynes tried to use Kahn's emerging multiplier theory to argue for public works, "but Pigou's and Henderson's objections ensured that there was no sign of this in the final product". [45] In 1933 he gave wider publicity to his support for Kahn's multiplier in a series of articles titled "The road to prosperity" in The Times newspaper. [46]

A. C. Pigou was at the time the sole economics professor at Cambridge. He had a continuing interest in the subject of unemployment, having expressed the view in his popular Unemployment (1913) that it was caused by "maladjustment between wage-rates and demand" [47] – a view Keynes may have shared prior to the years of the General Theory. Nor were his practical recommendations very different: "on many occasions in the thirties" Pigou "gave public support . to State action designed to stimulate employment". [48] Where the two men differed is in the link between theory and practice. Keynes was seeking to build theoretical foundations to support his recommendations for public works while Pigou showed no disposition to move away from classical doctrine. Referring to him and Dennis Robertson, Keynes asked rhetorically: "Why do they insist on maintaining theories from which their own practical conclusions cannot possibly follow?" [49]

Keynes set forward the ideas that became the basis for Keynesian economics in his main work, The General Theory of Employment, Interest and Money (1936). It was written during the Great Depression, when unemployment rose to 25% in the United States and as high as 33% in some countries. It is almost wholly theoretical, enlivened by occasional passages of satire and social commentary. The book had a profound impact on economic thought, and ever since it was published there has been debate over its meaning.

Keynes and classical economics Edit

Keynes begins the General Theory with a summary of the classical theory of employment, which he encapsulates in his formulation of Say's Law as the dictum "Supply creates its own demand".

Under the classical theory, the wage rate is determined by the marginal productivity of labour, and as many people are employed as are willing to work at that rate. Unemployment may arise through friction or may be "voluntary," in the sense that it arises from a refusal to accept employment owing to "legislation or social practices . or mere human obstinacy", but ". the classical postulates do not admit of the possibility of the third category," which Keynes defines as involuntary unemployment. [50]

Keynes raises two objections to the classical theory's assumption that "wage bargains . determine the real wage". The first lies in the fact that "labour stipulates (within limits) for a money-wage rather than a real wage". The second is that classical theory assumes that, "The real wages of labour depend on the wage bargains which labour makes with the entrepreneurs," whereas, "If money wages change, one would have expected the classical school to argue that prices would change in almost the same proportion, leaving the real wage and the level of unemployment practically the same as before." [51] Keynes considers his second objection the more fundamental, but most commentators concentrate on his first one: it has been argued that the quantity theory of money protects the classical school from the conclusion Keynes expected from it. [52]

Keynesian unemployment Edit

Saving and investment Edit

Saving is that part of income not devoted to consumption, and consumption is that part of expenditure not allocated to investment, i.e., to durable goods. [53] Hence saving encompasses hoarding (the accumulation of income as cash) and the purchase of durable goods. The existence of net hoarding, or of a demand to hoard, is not admitted by the simplified liquidity preference model of the General Theory.

Once he rejects the classical theory that unemployment is due to excessive wages, Keynes proposes an alternative based on the relationship between saving and investment. In his view, unemployment arises whenever entrepreneurs' incentive to invest fails to keep pace with society's propensity to save (propensity is one of Keynes's synonyms for "demand"). The levels of saving and investment are necessarily equal, and income is therefore held down to a level where the desire to save is no greater than the incentive to invest.

The incentive to invest arises from the interplay between the physical circumstances of production and psychological anticipations of future profitability but once these things are given the incentive is independent of income and depends solely on the rate of interest r. Keynes designates its value as a function of r as the "schedule of the marginal efficiency of capital". [54]

The propensity to save behaves quite differently. [55] Saving is simply that part of income not devoted to consumption, and:

. the prevailing psychological law seems to be that when aggregate income increases, consumption expenditure will also increase but to a somewhat lesser extent. [56]

Keynes adds that "this psychological law was of the utmost importance in the development of my own thought".

Liquidity preference Edit

Keynes viewed the money supply as one of the main determinants of the state of the real economy. The significance he attributed to it is one of the innovative features of his work, and was influential on the politically hostile monetarist school.

Money supply comes into play through the liquidity preference function, which is the demand function that corresponds to money supply. It specifies the amount of money people will seek to hold according to the state of the economy. In Keynes's first (and simplest) account – that of Chapter 13 – liquidity preference is determined solely by the interest rate r—which is seen as the earnings forgone by holding wealth in liquid form: [57] hence liquidity preference can be written L(r ) and in equilibrium must equal the externally fixed money supply .

Keynes’s economic model Edit

Money supply, saving and investment combine to determine the level of income as illustrated in the diagram, [58] where the top graph shows money supply (on the vertical axis) against interest rate. determines the ruling interest rate through the liquidity preference function. The rate of interest determines the level of investment Î through the schedule of the marginal efficiency of capital, shown as a blue curve in the lower graph. The red curves in the same diagram show what the propensities to save are for different incomes Y and the income Ŷ corresponding to the equilibrium state of the economy must be the one for which the implied level of saving at the established interest rate is equal to Î.

In Keynes's more complicated liquidity preference theory (presented in Chapter 15) the demand for money depends on income as well as on the interest rate and the analysis becomes more complicated. Keynes never fully integrated his second liquidity preference doctrine with the rest of his theory, leaving that to John Hicks: see the IS-LM model below.

Wage rigidity Edit

Keynes rejects the classical explanation of unemployment based on wage rigidity, but it is not clear what effect the wage rate has on unemployment in his system. He treats wages of all workers as proportional to a single rate set by collective bargaining, and chooses his units so that this rate never appears separately in his discussion. It is present implicitly in those quantities he expresses in wage units, while being absent from those he expresses in money terms. It is therefore difficult to see whether, and in what way, his results differ for a different wage rate, nor is it clear what he thought about the matter.

Remedies for unemployment Edit

Monetary remedies Edit

An increase in the money supply, according to Keynes's theory, leads to a drop in the interest rate and an increase in the amount of investment that can be undertaken profitably, bringing with it an increase in total income.

Fiscal remedies Edit

Keynes' name is associated with fiscal, rather than monetary, measures but they receive only passing (and often satirical) reference in the General Theory. He mentions "increased public works" as an example of something that brings employment through the multiplier, [59] but this is before he develops the relevant theory, and he does not follow up when he gets to the theory.

Later in the same chapter he tells us that:

Ancient Egypt was doubly fortunate, and doubtless owed to this its fabled wealth, in that it possessed two activities, namely, pyramid-building as well as the search for the precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance. The Middle Ages built cathedrals and sang dirges. Two pyramids, two masses for the dead, are twice as good as one but not so two railways from London to York.

But again, he doesn't get back to his implied recommendation to engage in public works, even if not fully justified from their direct benefits, when he constructs the theory. On the contrary he later advises us that .

. our final task might be to select those variables which can be deliberately controlled or managed by central authority in the kind of system in which we actually live . [60]

and this appears to look forward to a future publication rather than to a subsequent chapter of the General Theory.

Aggregate demand Edit

Keynes' view of saving and investment was his most important departure from the classical outlook. It can be illustrated using the "Keynesian cross" devised by Paul Samuelson. [61] The horizontal axis denotes total income and the purple curve shows C (Y ), the propensity to consume, whose complement S (Y ) is the propensity to save: the sum of these two functions is equal to total income, which is shown by the broken line at 45°.

The horizontal blue line I (r ) is the schedule of the marginal efficiency of capital whose value is independent of Y. The schedule of the marginal efficiency of capital is dependent on the interest rate, specifically the interest rate cost of a new investment. If the interest rate charged by the financial sector to the productive sector is below the marginal efficiency of capital at that level of technology and capital intensity then investment is positive and grows the lower the interest rate is, given the diminishing return of capital. If the interest rate is above the marginal efficiency of capital then investment is equal to zero. Keynes interprets this as the demand for investment and denotes the sum of demands for consumption and investment as "aggregate demand", plotted as a separate curve. Aggregate demand must equal total income, so equilibrium income must be determined by the point where the aggregate demand curve crosses the 45° line. [62] This is the same horizontal position as the intersection of I (r ) with S (Y ).

The equation I (r ) = S (Y ) had been accepted by the classics, who had viewed it as the condition of equilibrium between supply and demand for investment funds and as determining the interest rate (see the classical theory of interest). But insofar as they had had a concept of aggregate demand, they had seen the demand for investment as being given by S (Y ), since for them saving was simply the indirect purchase of capital goods, with the result that aggregate demand was equal to total income as an identity rather than as an equilibrium condition. Keynes takes note of this view in Chapter 2, where he finds it present in the early writings of Alfred Marshall but adds that "the doctrine is never stated to-day in this crude form".

The equation I (r ) = S (Y ) is accepted by Keynes for some or all of the following reasons:

  • As a consequence of the principle of effective demand, which asserts that aggregate demand must equal total income (Chapter 3).
  • As a consequence of the identity of saving with investment (Chapter 6) together with the equilibrium assumption that these quantities are equal to their demands.
  • In agreement with the substance of the classical theory of the investment funds market, whose conclusion he considers the classics to have misinterpreted through circular reasoning (Chapter 14).

The Keynesian multiplier Edit

Keynes introduces his discussion of the multiplier in Chapter 10 with a reference to Kahn's earlier paper (see below). He designates Kahn's multiplier the "employment multiplier" in distinction to his own "investment multiplier" and says that the two are only "a little different". [63] Kahn's multiplier has consequently been understood by much of the Keynesian literature as playing a major role in Keynes's own theory, an interpretation encouraged by the difficulty of understanding Keynes's presentation. Kahn's multiplier gives the title ("The multiplier model") to the account of Keynesian theory in Samuelson's Economics and is almost as prominent in Alvin Hansen's Guide to Keynes and in Joan Robinson's Introduction to the Theory of Employment.

Keynes states that there is .

. a confusion between the logical theory of the multiplier, which holds good continuously, without time-lag . and the consequence of an expansion in the capital goods industries which take gradual effect, subject to a time-lag, and only after an interval . [64]

and implies that he is adopting the former theory. [65] And when the multiplier eventually emerges as a component of Keynes's theory (in Chapter 18) it turns out to be simply a measure of the change of one variable in response to a change in another. The schedule of the marginal efficiency of capital is identified as one of the independent variables of the economic system: [66] "What [it] tells us, is . the point to which the output of new investment will be pushed . " [67] The multiplier then gives "the ratio . between an increment of investment and the corresponding increment of aggregate income". [68]

G. L. S. Shackle regarded Keynes' move away from Kahn's multiplier as .

. a retrograde step . For when we look upon the Multiplier as an instantaneous functional relation . we are merely using the word Multiplier to stand for an alternative way of looking at the marginal propensity to consume . [69]

which G. M. Ambrosi cites as an instance of "a Keynesian commentator who would have liked Keynes to have written something less 'retrograde ' ". [70]

The value Keynes assigns to his multiplier is the reciprocal of the marginal propensity to save: k = 1 / S '(Y ). This is the same as the formula for Kahn's mutliplier in a closed economy assuming that all saving (including the purchase of durable goods), and not just hoarding, constitutes leakage. Keynes gave his formula almost the status of a definition (it is put forward in advance of any explanation [71] ). His multiplier is indeed the value of "the ratio . between an increment of investment and the corresponding increment of aggregate income" as Keynes derived it from his Chapter 13 model of liquidity preference, which implies that income must bear the entire effect of a change in investment. But under his Chapter 15 model a change in the schedule of the marginal efficiency of capital has an effect shared between the interest rate and income in proportions depending on the partial derivatives of the liquidity preference function. Keynes did not investigate the question of whether his formula for multiplier needed revision.

The liquidity trap Edit

The liquidity trap is a phenomenon that may impede the effectiveness of monetary policies in reducing unemployment.

Economists generally think the rate of interest will not fall below a certain limit, often seen as zero or a slightly negative number. Keynes suggested that the limit might be appreciably greater than zero but did not attach much practical significance to it. The term "liquidity trap" was coined by Dennis Robertson in his comments on the General Theory, [72] but it was John Hicks in "Mr. Keynes and the Classics" [73] who recognised the significance of a slightly different concept.

If the economy is in a position such that the liquidity preference curve is almost vertical, as must happen as the lower limit on r is approached, then a change in the money supply makes almost no difference to the equilibrium rate of interest or, unless there is compensating steepness in the other curves, to the resulting income Ŷ. As Hicks put it, "Monetary means will not force down the rate of interest any further."

Paul Krugman has worked extensively on the liquidity trap, claiming that it was the problem confronting the Japanese economy around the turn of the millennium. [74] In his later words:

Short-term interest rates were close to zero, long-term rates were at historical lows, yet private investment spending remained insufficient to bring the economy out of deflation. In that environment, monetary policy was just as ineffective as Keynes described. Attempts by the Bank of Japan to increase the money supply simply added to already ample bank reserves and public holdings of cash. [75]

The IS–LM model Edit

Hicks showed how to analyze Keynes' system when liquidity preference is a function of income as well as of the rate of interest. Keynes's admission of income as an influence on the demand for money is a step back in the direction of classical theory, and Hicks takes a further step in the same direction by generalizing the propensity to save to take both Y and r as arguments. Less classically he extends this generalization to the schedule of the marginal efficiency of capital.

The IS-LM model uses two equations to express Keynes' model. The first, now written I (Y, r ) = S (Y,r ), expresses the principle of effective demand. We may construct a graph on (Y, r ) coordinates and draw a line connecting those points satisfying the equation: this is the IS curve. In the same way we can write the equation of equilibrium between liquidity preference and the money supply as L(Y ,r ) = and draw a second curve – the LM curve – connecting points that satisfy it. The equilibrium values Ŷ of total income and of interest rate are then given by the point of intersection of the two curves.

If we follow Keynes's initial account under which liquidity preference depends only on the interest rate r, then the LM curve is horizontal.

. modern teaching has been confused by J. R. Hicks' attempt to reduce the General Theory to a version of static equilibrium with the formula IS–LM. Hicks has now repented and changed his name from J. R. to John, but it will take a long time for the effects of his teaching to wear off.

Hicks subsequently relapsed. [76]

Active fiscal policy Edit

Keynes argued that the solution to the Great Depression was to stimulate the country ("incentive to invest") through some combination of two approaches:

  1. A reduction in interest rates (monetary policy), and
  2. Government investment in infrastructure (fiscal policy).

If the interest rate at which businesses and consumers can borrow decreases, investments that were previously uneconomic become profitable, and large consumer sales normally financed through debt (such as houses, automobiles, and, historically, even appliances like refrigerators) become more affordable. A principal function of central banks in countries that have them is to influence this interest rate through a variety of mechanisms collectively called monetary policy. This is how monetary policy that reduces interest rates is thought to stimulate economic activity, i.e., "grow the economy"—and why it is called expansionary monetary policy.

Expansionary fiscal policy consists of increasing net public spending, which the government can effect by a) taxing less, b) spending more, or c) both. Investment and consumption by government raises demand for businesses' products and for employment, reversing the effects of the aforementioned imbalance. If desired spending exceeds revenue, the government finances the difference by borrowing from capital markets by issuing government bonds. This is called deficit spending. Two points are important to note at this point. First, deficits are not required for expansionary fiscal policy, and second, it is only change in net spending that can stimulate or depress the economy. For example, if a government ran a deficit of 10% both last year and this year, this would represent neutral fiscal policy. In fact, if it ran a deficit of 10% last year and 5% this year, this would actually be contractionary. On the other hand, if the government ran a surplus of 10% of GDP last year and 5% this year, that would be expansionary fiscal policy, despite never running a deficit at all.

But – contrary to some critical characterizations of it – Keynesianism does not consist solely of deficit spending, since it recommends adjusting fiscal policies according to cyclical circumstances. [77] An example of a counter-cyclical policy is raising taxes to cool the economy and to prevent inflation when there is abundant demand-side growth, and engaging in deficit spending on labour-intensive infrastructure projects to stimulate employment and stabilize wages during economic downturns.

Keynes's ideas influenced Franklin D. Roosevelt's view that insufficient buying-power caused the Depression. During his presidency, Roosevelt adopted some aspects of Keynesian economics, especially after 1937, when, in the depths of the Depression, the United States suffered from recession yet again following fiscal contraction. But to many the true success of Keynesian policy can be seen at the onset of World War II, which provided a kick to the world economy, removed uncertainty, and forced the rebuilding of destroyed capital. Keynesian ideas became almost official in social-democratic Europe after the war and in the U.S. in the 1960s.

The Keynesian advocacy of deficit spending contrasted with the classical and neoclassical economic analysis of fiscal policy. They admitted that fiscal stimulus could actuate production. But, to these schools, there was no reason to believe that this stimulation would outrun the side-effects that "crowd out" private investment: first, it would increase the demand for labour and raise wages, hurting profitability Second, a government deficit increases the stock of government bonds, reducing their market price and encouraging high interest rates, making it more expensive for business to finance fixed investment. Thus, efforts to stimulate the economy would be self-defeating.

The Keynesian response is that such fiscal policy is appropriate only when unemployment is persistently high, above the non-accelerating inflation rate of unemployment (NAIRU). In that case, crowding out is minimal. Further, private investment can be "crowded in": Fiscal stimulus raises the market for business output, raising cash flow and profitability, spurring business optimism. To Keynes, this accelerator effect meant that government and business could be complements rather than substitutes in this situation.

Second, as the stimulus occurs, gross domestic product rises—raising the amount of saving, helping to finance the increase in fixed investment. Finally, government outlays need not always be wasteful: government investment in public goods that is not provided by profit-seekers encourages the private sector's growth. That is, government spending on such things as basic research, public health, education, and infrastructure could help the long-term growth of potential output.

In Keynes's theory, there must be significant slack in the labour market before fiscal expansion is justified.

Keynesian economists believe that adding to profits and incomes during boom cycles through tax cuts, and removing income and profits from the economy through cuts in spending during downturns, tends to exacerbate the negative effects of the business cycle. This effect is especially pronounced when the government controls a large fraction of the economy, as increased tax revenue may aid investment in state enterprises in downturns, and decreased state revenue and investment harm those enterprises.

Views on trade imbalance Edit

In the last few years of his life, John Maynard Keynes was much preoccupied with the question of balance in international trade. He was the leader of the British delegation to the United Nations Monetary and Financial Conference in 1944 that established the Bretton Woods system of international currency management. He was the principal author of a proposal – the so-called Keynes Plan – for an International Clearing Union. The two governing principles of the plan were that the problem of settling outstanding balances should be solved by 'creating' additional 'international money', and that debtor and creditor should be treated almost alike as disturbers of equilibrium. In the event, though, the plans were rejected, in part because "American opinion was naturally reluctant to accept the principle of equality of treatment so novel in debtor-creditor relationships". [78]

The new system is not founded on free trade (liberalisation [79] of foreign trade [80] ) but rather on regulating international trade to eliminate trade imbalances. Nations with a surplus would have a powerful incentive to get rid of it, which would automatically clear other nations' deficits. [81] Keynes proposed a global bank that would issue its own currency—the bancor—which was exchangeable with national currencies at fixed rates of exchange and would become the unit of account between nations, which means it would be used to measure a country's trade deficit or trade surplus. Every country would have an overdraft facility in its bancor account at the International Clearing Union. He pointed out that surpluses lead to weak global aggregate demand – countries running surpluses exert a "negative externality" on trading partners, and posed far more than those in deficit, a threat to global prosperity. Keynes thought that surplus countries should be taxed to avoid trade imbalances. [82] In "National Self-Sufficiency" The Yale Review, Vol. 22, no. 4 (June 1933), [83] [84] he already highlighted the problems created by free trade.

His view, supported by many economists and commentators at the time, was that creditor nations may be just as responsible as debtor nations for disequilibrium in exchanges and that both should be under an obligation to bring trade back into a state of balance. Failure for them to do so could have serious consequences. In the words of Geoffrey Crowther, then editor of The Economist, "If the economic relationships between nations are not, by one means or another, brought fairly close to balance, then there is no set of financial arrangements that can rescue the world from the impoverishing results of chaos." [85]

These ideas were informed by events prior to the Great Depression when – in the opinion of Keynes and others – international lending, primarily by the U.S., exceeded the capacity of sound investment and so got diverted into non-productive and speculative uses, which in turn invited default and a sudden stop to the process of lending. [86]

Influenced by Keynes, economic texts in the immediate post-war period put a significant emphasis on balance in trade. For example, the second edition of the popular introductory textbook, An Outline of Money, [87] devoted the last three of its ten chapters to questions of foreign exchange management and in particular the 'problem of balance'. However, in more recent years, since the end of the Bretton Woods system in 1971, with the increasing influence of Monetarist schools of thought in the 1980s, and particularly in the face of large sustained trade imbalances, these concerns – and particularly concerns about the destabilising effects of large trade surpluses – have largely disappeared from mainstream economics discourse [88] and Keynes' insights have slipped from view. [89] They are receiving some attention again in the wake of the financial crisis of 2007–08. [90]

Keynes's ideas became widely accepted after World War II, and until the early 1970s, Keynesian economics provided the main inspiration for economic policy makers in Western industrialized countries. [6] Governments prepared high quality economic statistics on an ongoing basis and tried to base their policies on the Keynesian theory that had become the norm. In the early era of social liberalism and social democracy, most western capitalist countries enjoyed low, stable unemployment and modest inflation, an era called the Golden Age of Capitalism.

In terms of policy, the twin tools of post-war Keynesian economics were fiscal policy and monetary policy. While these are credited to Keynes, others, such as economic historian David Colander, argue that they are, rather, due to the interpretation of Keynes by Abba Lerner in his theory of functional finance, and should instead be called "Lernerian" rather than "Keynesian". [91]

Through the 1950s, moderate degrees of government demand leading industrial development, and use of fiscal and monetary counter-cyclical policies continued, and reached a peak in the "go go" 1960s, where it seemed to many Keynesians that prosperity was now permanent. In 1971, Republican US President Richard Nixon even proclaimed "I am now a Keynesian in economics." [92]

Beginning in the late 1960s, a new classical macroeconomics movement arose, critical of Keynesian assumptions (see sticky prices), and seemed, especially in the 1970s, to explain certain phenomena better. It was characterized by explicit and rigorous adherence to microfoundations, as well as use of increasingly sophisticated mathematical modelling.

With the oil shock of 1973, and the economic problems of the 1970s, Keynesian economics began to fall out of favour. During this time, many economies experienced high and rising unemployment, coupled with high and rising inflation, contradicting the Phillips curve's prediction. This stagflation meant that the simultaneous application of expansionary (anti-recession) and contractionary (anti-inflation) policies appeared necessary. This dilemma led to the end of the Keynesian near-consensus of the 1960s, and the rise throughout the 1970s of ideas based upon more classical analysis, including monetarism, supply-side economics, [92] and new classical economics.

However, by the late 1980s, certain failures of the new classical models, both theoretical (see Real business cycle theory) and empirical (see the "Volcker recession") [93] hastened the emergence of New Keynesian economics, a school that sought to unite the most realistic aspects of Keynesian and neo-classical assumptions and place them on more rigorous theoretical foundation than ever before.

One line of thinking, utilized also as a critique of the notably high unemployment and potentially disappointing GNP growth rates associated with the new classical models by the mid-1980s, was to emphasize low unemployment and maximal economic growth at the cost of somewhat higher inflation (its consequences kept in check by indexing and other methods, and its overall rate kept lower and steadier by such potential policies as Martin Weitzman's share economy). [94]

Schools Edit

Multiple schools of economic thought that trace their legacy to Keynes currently exist, the notable ones being neo-Keynesian economics, New Keynesian economics, post-Keynesian economics, and the new neoclassical synthesis. Keynes's biographer Robert Skidelsky writes that the post-Keynesian school has remained closest to the spirit of Keynes's work in following his monetary theory and rejecting the neutrality of money. [95] [96] Today these ideas, regardless of provenance, are referred to in academia under the rubric of "Keynesian economics", due to Keynes's role in consolidating, elaborating, and popularizing them.

In the postwar era, Keynesian analysis was combined with neoclassical economics to produce what is generally termed the "neoclassical synthesis", yielding neo-Keynesian economics, which dominated mainstream macroeconomic thought. Though it was widely held that there was no strong automatic tendency to full employment, many believed that if government policy were used to ensure it, the economy would behave as neoclassical theory predicted. This post-war domination by neo-Keynesian economics was broken during the stagflation of the 1970s. [97] There was a lack of consensus among macroeconomists in the 1980s, and during this period New Keynesian economics was developed, ultimately becoming- along with new classical macroeconomics- a part of the current consensus, known as the new neoclassical synthesis. [98]

Post-Keynesian economists, on the other hand, reject the neoclassical synthesis and, in general, neoclassical economics applied to the macroeconomy. Post-Keynesian economics is a heterodox school that holds that both neo-Keynesian economics and New Keynesian economics are incorrect, and a misinterpretation of Keynes's ideas. The post-Keynesian school encompasses a variety of perspectives, but has been far less influential than the other more mainstream Keynesian schools. [99]

Interpretations of Keynes have emphasized his stress on the international coordination of Keynesian policies, the need for international economic institutions, and the ways in which economic forces could lead to war or could promote peace. [100]

Keynesianism and liberalism Edit

In a 2014 paper, economist Alan Blinder argues that, "for not very good reasons," public opinion in the United States has associated Keynesianism with liberalism, and he states that such is incorrect. For example, both Presidents Ronald Reagan (1981-89) and George W. Bush (2001-09) supported policies that were, in fact, Keynesian, even though both men were conservative leaders. And tax cuts can provide highly helpful fiscal stimulus during a recession, just as much as infrastructure spending can. Blinder concludes, "If you are not teaching your students that 'Keynesianism' is neither conservative nor liberal, you should be." [101]

The Keynesian schools of economics are situated alongside a number of other schools that have the same perspectives on what the economic issues are, but differ on what causes them and how best to resolve them. Today, most of these schools of thought have been subsumed into modern macroeconomic theory.

Stockholm School Edit

The Stockholm school rose to prominence at about the same time that Keynes published his General Theory and shared a common concern in business cycles and unemployment. The second generation of Swedish economists also advocated government intervention through spending during economic downturns [102] although opinions are divided over whether they conceived the essence of Keynes's theory before he did. [103]

Monetarism Edit

There was debate between monetarists and Keynesians in the 1960s over the role of government in stabilizing the economy. Both monetarists and Keynesians agree that issues such as business cycles, unemployment, and deflation are caused by inadequate demand. However, they had fundamentally different perspectives on the capacity of the economy to find its own equilibrium, and the degree of government intervention that would be appropriate. Keynesians emphasized the use of discretionary fiscal policy and monetary policy, while monetarists argued the primacy of monetary policy, and that it should be rules-based. [104]

The debate was largely resolved in the 1980s. Since then, economists have largely agreed that central banks should bear the primary responsibility for stabilizing the economy, and that monetary policy should largely follow the Taylor rule – which many economists credit with the Great Moderation. [105] [106] The financial crisis of 2007–08, however, has convinced many economists and governments of the need for fiscal interventions and highlighted the difficulty in stimulating economies through monetary policy alone during a liquidity trap. [107]

Marxian economics Edit

Some Marxist economists criticized Keynesian economics. [108] For example, in his 1946 appraisal [109] Paul Sweezy—while admitting that there was much in the General Theory's analysis of effective demand that Marxists could draw on—described Keynes as a prisoner of his neoclassical upbringing. Sweezy argued that Keynes had never been able to view the capitalist system as a totality. He argued that Keynes regarded the class struggle carelessly, and overlooked the class role of the capitalist state, which he treated as a deus ex machina, and some other points. While Michał Kalecki was generally enthusiastic about the Keynesian revolution, he predicted that it would not endure, in his article "Political Aspects of Full Employment". In the article Kalecki predicted that the full employment delivered by Keynesian policy would eventually lead to a more assertive working class and weakening of the social position of business leaders, causing the elite to use their political power to force the displacement of the Keynesian policy even though profits would be higher than under a laissez faire system: The erosion of social prestige and political power would be unacceptable to the elites despite higher profits. [110]

Public choice Edit

James M. Buchanan [111] criticized Keynesian economics on the grounds that governments would in practice be unlikely to implement theoretically optimal policies. The implicit assumption underlying the Keynesian fiscal revolution, according to Buchanan, was that economic policy would be made by wise men, acting without regard to political pressures or opportunities, and guided by disinterested economic technocrats. He argued that this was an unrealistic assumption about political, bureaucratic and electoral behaviour. Buchanan blamed Keynesian economics for what he considered a decline in America's fiscal discipline. [112] Buchanan argued that deficit spending would evolve into a permanent disconnect between spending and revenue, precisely because it brings short-term gains, so, ending up institutionalizing irresponsibility in the federal government, the largest and most central institution in our society. [113] Martin Feldstein argues that the legacy of Keynesian economics–the misdiagnosis of unemployment, the fear of saving, and the unjustified government intervention–affected the fundamental ideas of policy makers. [114] Milton Friedman thought that Keynes's political bequest was harmful for two reasons. First, he thought whatever the economic analysis, benevolent dictatorship is likely sooner or later to lead to a totalitarian society. Second, he thought Keynes's economic theories appealed to a group far broader than economists primarily because of their link to his political approach. [115] Alex Tabarrok argues that Keynesian politics–as distinct from Keynesian policies–has failed pretty much whenever it's been tried, at least in liberal democracies. [116]

In response to this argument, John Quiggin, [117] wrote about these theories' implication for a liberal democratic order. He thought that if it is generally accepted that democratic politics is nothing more than a battleground for competing interest groups, then reality will come to resemble the model. Paul Krugman wrote "I don’t think we need to take that as an immutable fact of life but still, what are the alternatives?" [118] Daniel Kuehn, criticized James M. Buchanan. He argued, "if you have a problem with politicians - criticize politicians," not Keynes. [119] He also argued that empirical evidence makes it pretty clear that Buchanan was wrong. [120] [121] James Tobin argued, if advising government officials, politicians, voters, it's not for economists to play games with them. [122] Keynes implicitly rejected this argument, in "soon or late it is ideas not vested interests which are dangerous for good or evil." [123] [124]

Brad DeLong has argued that politics is the main motivator behind objections to the view that government should try to serve a stabilizing macroeconomic role. [125] Paul Krugman argued that a regime that by and large lets markets work, but in which the government is ready both to rein in excesses and fight slumps is inherently unstable, due to intellectual instability, political instability, and financial instability. [126]

New classical Edit

Another influential school of thought was based on the Lucas critique of Keynesian economics. This called for greater consistency with microeconomic theory and rationality, and in particular emphasized the idea of rational expectations. Lucas and others argued that Keynesian economics required remarkably foolish and short-sighted behaviour from people, which totally contradicted the economic understanding of their behaviour at a micro level. New classical economics introduced a set of macroeconomic theories that were based on optimizing microeconomic behaviour. These models have been developed into the real business-cycle theory, which argues that business cycle fluctuations can to a large extent be accounted for by real (in contrast to nominal) shocks.

Beginning in the late 1950s new classical macroeconomists began to disagree with the methodology employed by Keynes and his successors. Keynesians emphasized the dependence of consumption on disposable income and, also, of investment on current profits and current cash flow. In addition, Keynesians posited a Phillips curve that tied nominal wage inflation to unemployment rate. To support these theories, Keynesians typically traced the logical foundations of their model (using introspection) and supported their assumptions with statistical evidence. [127] New classical theorists demanded that macroeconomics be grounded on the same foundations as microeconomic theory, profit-maximizing firms and rational, utility-maximizing consumers. [127]

The result of this shift in methodology produced several important divergences from Keynesian macroeconomics: [127]


Treatise on Money and the General Theory of Employment, Interest and Money – 1927 to 1939

DateEvent
1927 Keynes continues working in his academic and bursarial duties at King’s College, a variety of business roles and his editorial and journalistic activities. He takes a less prominent role in public life as he develops ideas and drafts his next major work – A Treatise on Money.
Summer 1929 Keynes is made Fellow of the British Academy.
October 1929 Led by Wall Street, the world’s stock markets crash, heralding an economic depression.
4 November 1929Keynes joins the government’s Macmillan Committee of Enquiry into Finance and Industry.
30 January 1930Keynes joins the Economic Advisory Council, set up to report to the government on economic policy.
10 May 1930Keynes writes in the Nation:

He meets President Roosevelt who writes to Felix Frankfurter, “I had a grand talk with K and liked him immensely…”


John Maynard Keynes

S o influential was John Maynard Keynes in the middle third of the twentieth century that an entire school of modern thought bears his name. Many of his ideas were revolutionary almost all were controversial. Keynesian economics serves as a sort of yardstick that can define virtually all economists who came after him.

Keynes was born in Cambridge and attended King’s College, Cambridge, where he earned his degree in mathematics in 1905. He remained there for another year to study under alfred marshall and arthur pigou , whose scholarship on the quantity theory of money led to Keynes’s Tract on Monetary Reform many years later. After leaving Cambridge, Keynes took a position with the civil service in Britain. While there, he collected the material for his first book in economics, Indian Currency and Finance, in which he described the workings of India’s monetary system. He returned to Cambridge in 1908 as a lecturer, then took a leave of absence to work for the British Treasury. He worked his way up quickly through the bureaucracy and by 1919 was the Treasury’s principal representative at the peace conference at Versailles. He resigned because he thought the Treaty of Versailles was overly burdensome for the Germans.

After resigning, he returned to Cambridge to resume teaching. A prominent journalist and speaker, Keynes was one of the famous Bloomsbury Group of literary greats, which also included Virginia Woolf and Bertrand Russell. At the 1944 Bretton Woods Conference, where the International Monetary Fund was established, Keynes was one of the architects of the postwar system of fixed exchange rates (see Foreign Exchange ). In 1925 he married the Russian ballet dancer Lydia Lopokova. He was made a lord in 1942. Keynes died on April 21, 1946, survived by his father, John Neville Keynes, also a renowned economist in his day.

Keynes became a celebrity before becoming one of the most respected economists of the century when his eloquent book The Economic Consequences of the Peace was published in 1919. Keynes wrote it to object to the punitive reparations payments imposed on Germany by the Allied countries after World War I. The amounts demanded by the Allies were so large, he wrote, that a Germany that tried to pay them would stay perpetually poor and, therefore, politically unstable. We now know that Keynes was right. Besides its excellent economic analysis of reparations, Keynes’s book contains an insightful analysis of the Council of Four (Georges Clemenceau of France, Prime Minister David Lloyd George of Britain, President Woodrow Wilson of the United States, and Vittorio Orlando of Italy).

Keynes wrote: “The Council of Four paid no attention to these issues [which included making Germany and Austro-Hungary into good neighbors], being preoccupied with others—Clemenceau to crush the economic life of his enemy, Lloyd George to do a deal and bring home something which would pass muster for a week, the President to do nothing that was not just and right” (chap. 6, para. 2).

In the 1920s Keynes was a believer in the quantity theory of money (today called monetarism ). His writings on the topic were essentially built on the principles he had learned from his mentors, Marshall and Pigou. In 1923 he wrote Tract on Monetary Reform, and later he published Treatise on Money, both on monetary policy . His major policy view was that the way to stabilize the economy is to stabilize the price level, and that to do that the government’s central bank must lower interest rates when prices tend to rise and raise them when prices tend to fall.

Keynes’s ideas took a dramatic change, however, as unemployment in Britain dragged on during the interwar period, reaching levels as high as 20 percent. Keynes investigated other causes of Britain’s economic woes, and The General Theory of Employment, Interest and Money was the result.

Keynes’s General Theory revolutionized the way economists think about economics. It was pathbreaking in several ways, in particular because it introduced the notion of aggregate demand as the sum of consumption, investment , and government spending and because it showed (or purported to show) that full employment could be maintained only with the help of government spending. Economists still argue about what Keynes thought caused high unemployment. Some think he attributed it to wages that take a long time to fall. But Keynes actually wanted wages not to fall, and in fact advocated in the General Theory that wages be kept stable. A general cut in wages, he argued, would decrease income, consumption, and aggregate demand. This would offset any benefits to output that the lower price of labor might have contributed.

Why shouldn’t government, thought Keynes, fill the shoes of business by investing in public works and hiring the unemployed? The General Theory advocated deficit spending during economic downturns to maintain full employment. Keynes’s conclusion initially met with opposition. At the time, balanced budgets were standard practice with the government. But the idea soon took hold and the U.S. government put people back to work on public works projects. Of course, once policymakers had taken deficit spending to heart, they did not let it go.

Contrary to some of his critics’ assertions, Keynes was a relatively strong advocate of free markets. It was Keynes, not adam smith , who said, “There is no objection to be raised against the classical analysis of the manner in which private self-interest will determine what in particular is produced, in what proportions the factors of production will be combined to produce it, and how the value of the final product will be distributed between them.” 1 Keynes believed that once full employment had been achieved by fiscal policy measures, the market mechanism could then operate freely. “Thus,” continued Keynes, “apart from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest, there is no more reason to socialise economic life than there was before” (p. 379).

Little of Keynes’s original work survives in modern economic theory. His ideas have been endlessly revised, expanded, and critiqued. Keynesian economics today, while having its roots in The General Theory, is chiefly the product of work by subsequent economists including john hicks , james tobin , paul samuelson , Alan Blinder, robert solow , William Nordhaus, Charles Schultze, walter heller , and arthur okun . The study of econometrics was created, in large part, to empirically explain Keynes’s macroeconomic models. Yet the fact that Keynes is the wellspring for so many outstanding economists is testament to the magnitude and influence of his ideas.


Keynes’s book is essentially correct with regard to its most important arguments. But it was, and remains today, largely misunderstood.

“Economic Consequences” is majestically written — Keynes was close to the iconoclastic Bloomsbury cohort of artists and writers, and his incisive, candid portrayals of the peacemakers (Georges Clemenceau, David Lloyd George and Woodrow Wilson) reflected the no-holds-barred influence of Lytton Strachey’s recently celebrated “Eminent Victorians.” The book was also wildly controversial for its assessments of the capacity of Germany to pay the reparations demanded by the victorious Allied powers.

Keynes’s book is essentially correct with regard to its most important arguments. But it was, and remains today, largely misunderstood. The enduring contributions of the book are to be found not in Keynes’ first dissenting clause (his “objection the treaty”), but in the second, about “the economic problems of Europe.” Keynes was sounding an alarm about the fragility of the European order.

Keynes argued that while many Europeans were celebrating a new era in the continent’s economy, too much of what emerged from the war rested on longstanding, underappreciated and elaborately enmeshed networks and foundations. “Unstable elements, already present when war broke out,” he wrote, had been obliterated by years of total war — but then not replaced with something more stable. Reconstituting the general economic order, not exacting shortsighted retribution, was the imperative of the day. This, he believed, was the critical failure of the “peace” — not just Versailles, but the entire political and economic framework in which it was written.

And so when economists and historians, then and ever since, zeroed in on questions about, say, whether Keynes underestimated Germany’s capacity to pay its war reparations — they miss the larger point. Keynes could have surely been wrong. But his arguments about the crisis facing Europe, and about what the treaty failed to do, were exactly right.

Keynes recognized that the war had “so shaken this system as to endanger the life of Europe altogether.” But the treaty “includes no provisions for the economic rehabilitation of Europe — nothing to make the defeated Central empires into good neighbors, nothing to stabilize the new states of Europe,” nothing to restore “the disordered finances of France and Italy.” Forcing Germany into, essentially, servitude, he argued, “will sow the decay of the whole of civilized life of Europe.”

Keynes was well positioned to grasp the severity of this most perilous macroeconomic muddle. At the Treasury during the war, he had the task of larder of British finance to keep the war effort afloat. At the Paris Peace Conference he was the official representative of the Treasury in addition, as the responsibilities of chancellor of the Exchequer, Austen Chamberlain, required him to stay in Britain, Keynes was deputized to represent him on the Supreme Economic Council.

Arriving in Paris on Jan. 10, he was quickly thrown into the maelstrom. Dispatched to meet with German financiers, the young Treasury man negotiated the terms of an emergency shipment of food to Germany, then on the brink of mass starvation.

Keynes would later describe those events in one of his finest long-form essays, “Dr. Melchior: A Defeated Enemy,” which he first read over two meetings in the privacy of the Memoir Club of Cambridge and Bloomsbury intimates. Virginia Woolf returned home from the second gathering and wrote an effusive note singing its literary praises it was one of two brilliant works (“My Early Beliefs” was the other) that Keynes requested to be published posthumously.

His scene-setting has a cinematic quality:

A moment later we were called back to our saloon, since the German financiers were announced. The railway carriage was small, and both we and they were numerous. How were we to behave? Ought we to shake hands? We crushed together at one end of the carriage with a small bridge-table between us and the enemy. They pressed into the carriage, bowing stiffly. We bowed stiffly also, for some of us had never bowed before. We nervously made a movement as though to shake hands and then didn’t. I asked them, in a voice intended to be agreeable, if they all spoke English.

With some inspired back-channel improvisation, Keynes brought these modest, prefatory negotiations to a successful conclusion. The broader peace process, however, was a catastrophe — and Keynes had a front-row seat.

As the historian Eric Weitz described, German representatives reacted “with stunned disbelief” at the terms presented to them when the details became public back home, the reaction was shock and anger. The two sides had bled each other white during the war, fighting to a stalemate until the late entry of the distant United States decisively tipped the balance of power. Germany, with no foreign troops on its soil, imagined it was bargaining for the loser’s share of a negotiated peace, not submitting to what amounted to unconditional surrender: colonies stripped, territory lost, navy sunk, army disbanded, reparations imposed.

Keynes, as he would write in “Economic Consequences” and emphasize repeatedly in the wake of its publication, was concerned “not with the justice of the treaty,” but with its “wisdom and with its consequences.” Behind the scenes, he fought for a more farsighted approach.

A flickering moment in April saw hope that his “grand scheme” might be embraced: modest reparations (with Britain’s share ceded to other victims of German aggression), cancellation of all inter-Allied war debts (America would bear the brunt of that burden), the establishment of a European free trade zone (to sidestep likely chaos in international commerce from the confused patchwork of new nations emerging in the east), and a new international loan to nurse the continent through a difficult period of economic disequilibrium.

This bordered on political naïveté: The Americans would not easily part with their money, nor the French with their vengeance. And in the elections of 1918, British politicians had famously (if fatuously) promised to hold Germany accountable for the full cost of the war, one promising to squeeze the country like a lemon “until the pips squeak.”

But for Keynes, the stakes were so high as to demand the effort. Historians have focused on his light-handed reparations proposal, but in the moment he was even more exercised over the issue of inter-Allied debts. Those obligations, he wrote in an internal Treasury brief, were “a menace to financial stability everywhere,” imposed a “crushing burden,” and would be “a constant source of international friction.” An international financial order that was little more than a tangle of debts and reparations could hardly “last a day.”

On May 14, 1919, he sent an anguished note to his mother, telling her of his plans to resign, but hung on, “so sick at what goes on,” for three more weeks. He submitted his formal letter of resignation to Prime Minister Lloyd George on June 5, returned home to lick his wounds, and then channeled his passions into writing “Economic Consequences.”

Keynes waged an intellectual campaign alongside his book, which, despite its runaway success, did little to influence the foreign policies of the relevant powers. Writing in the magazine Everybody’s Monthly to an American audience, he echoed the arguments found on the first page of his book: “Germany bears a special and peculiar responsibility for the war” and “for its universal and devastating character.” But the treaty “leaves Europe more unsettled than it found it,” and interest, not vengeance, must guide policy. It “will be a disaster for the world if America isolates herself,” he added.

In the preface to the French edition of the book he asked rhetorically, “Will France be safe because her sentries stand on the Rhine” yet “bloodshed, misery and fanaticism prevail from the Rhine eastwards through two continents?”

Few listened. The Americans’ brief flirtation with Wilsonian internationalism yielded to a resurgence of nationalism and nativism. Prioritizing domestic demands over global concerns, the United States stubbornly and shortsightedly added to Europe’s economic woes with an unyielding stance on the question of war debts.

France sought to enforce the treaty as written, going so far as to occupy the Ruhr Valley region in January 1923, in response to Germany’s failure to meet its reparation obligations. The occupation, which lasted two and a half years and was met with passive resistance and hyperinflation, seemed to prove Keynes’s point.

The balance of the 1920s limped along, with glimmers of progress and cooperation doing little to overcome the big problems Keynes had identified at the outset — fragile finances and political anxieties simmering just below the surface. One strong push would send it all tumbling down, and the 1931 global financial crisis, worsened by France’s search for political advantage as Austria and Germany’s banks teetered, did just that.

As Keynes noted at the time, “The shattering German crisis of 1931, which took the world more by surprise than it should, was in essence a banking crisis, though precipitated, no doubt, by political events and political fears.”

Those politics meant that the crisis was not contained. It spiraled out of control, sending the world economy tumbling into the depths of the Great Depression, and contributing directly to the rise of fascism in Germany and Japan.

“Men will not always die quietly,” Keynes warned in “The Economic Consequences of the Peace,” and “in their distress may overturn the remnants of organization, and submerge civilization itself.” A generation later, the American diplomat George F. Kennan would argue that the foreign policy horrors of the 1930s could be traced to the “lost opportunities” of the 1920s. Keynes would surely have agreed.

Jonathan Kirshner is a professor of political science and international studies at Boston College.


John Maynard Keynes

John Maynard Keynes, Baron Keynes of Tilton, CB FBA (1883–1946) was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments. He greatly refined earlier work on the causes of business cycles, and advocated the use of fiscal and monetary measures to mitigate the adverse effects of economic recessions and depressions. His ideas are the basis for the school of thought known as Keynesian economics, as well as its various offshoots.

Keynes's early romantic and sexual relationships were almost exclusively with men. At Eton and at King's College, Cambridge, Keynes had been prolific in his homosexual activity significant among these early partners were Dillwyn Knox and Daniel Macmillan. Keynes was open about his homosexual affairs, and between 1901 and 1915 kept separate diaries in which he tabulated his many sexual encounters. Keynes's relationship and later close friendship with Macmillan was to be fortuitous through Dan, Macmillan & Co first published his Economic Consequences of the Peace. Attitudes in the Bloomsbury Group, in which Keynes was avidly involved, were relaxed about homosexuality. Keynes, together with writer Lytton Strachey, had reshaped the Victorian attitudes of the influential Cambridge Apostles "since [their] time, homosexual relations among the members were for a time common", wrote Bertrand Russell. One of Keynes's greatest loves was the artist Duncan Grant, whom he met in 1908. Like Grant, Keynes was also involved with the writer Lytton Strachey, though they were for the most part love rivals, and not lovers. Keynes had won the affections of Arthur Hobhouse, as well as Grant, both times falling out with a jealous Strachey for it. Strachey had previously found himself put off by Keynes, not least because of his manner of "treat[ing] his love affairs statistically".


John Maynard Keynes and International Relations: Economic Paths to War and Peace

Donald Markwell, John Maynard Keynes and International Relations: Economic Paths to War and Peace. Oxford: Oxford University Press, 2006. xv + 320 pp. $85 (hardcover), ISBN: 0-19-829236-8.

Reviewed for EH.Net by Michael S. Lawlor, Department of Economics, Wake Forest University.

This book will be of interest to economists in general, and to Keynes specialists in particular. It focuses on the topic of the international relations views expressed by Keynes over his long career, from his involvement in the First World War as a Treasury official and as Lloyd George’s economic advisor at the Paris Peace Conference through his interwar position as a prominent analyst of international monetary problems to the part he played in the British Treasury during the Second World War. There he was very influential on the policies of how Britain would pay for the war, the form that the post-war international payment systems would take under the Bretton Woods system, and the negotiation of the terms of the American post-war loan to Britain in 1946, shortly before his death.

The fact that this book solely focuses on this limited facet of Keynes’s multi-dimensional career, that Markwell is a political scientist and therefore uses much non-economic material, consisting mostly of primary internal memoranda from the Treasury office and other governmental units, and that he frames his arguments in terms of the secondary scholarship on international relations in political science ? both of which are unfamiliar territory for most economists ? adds to the freshness and usefulness of this study. It should also be added ? and I don’t think Markwell would disagree ? that some of the debates and contexts for Keynes’s activities in this regard have already been well discussed in both Robert Skidelsky’s (2000) and Donald Moggridge’s (1992) biographies of Keynes. These books provide a thorough background and context for the many issues, events and personalities surrounding Keynes’s involvement in international relations. I would suggest one of these volumes for further reading to those who find this to be an area of interest. Markwell’s book goes beyond them, and is a useful companion to them, in its bringing together the various strands of Keynes’s ideas, writings and activities with respect to international relations in one place. This treatment adds focus to the material in a way that Keynes’s biographers, necessarily more focused on the grand sweep of his career, were not able to do.

More broadly, this book is instructive to this reviewer for the opportunity it offers to ponder the importance of context for the application of some of the fundamental tenets of economic theory. Ironically, perhaps this is precisely because of Markwell’s lack of focus on economics and due to his use of the aforementioned wealth of policy evidence on Keynes’s extensive involvement in government and international affairs. Markwell’s analysis requires the economic reader to follow Keynes into the task of applying economic theory to knotty problems of international politics and thereby to think hard about the validity of the abstract nature of economic principles in various real geopolitical scenarios of great import (like the two World Wars), to consider what role economic factors may play in the development of hostilities between nations, and to consider seriously the compatibility of microeconomic truths with macroeconomic truths when their application is not just a hypothetical example, but a real live political circumstance.

To first take up the issue of the contextual nature of the application of economics to political situations consider the situation that Keynes, and all western economists and political analysts, faced in the period from the end of the First World War, through the slump and depression of the thirties. What concerned them most was the question of how to re-create the era of rising prosperity and smoothly functioning world trade that had characterized Europe and America in the period before 1914. From the end of the First World War and the Paris Peace Conference on, Keynes was one of the first and most prominent (but by no means the only) international figures who felt that this goal required a lasting peace that would allow Germany to regain its rightful place, for reasons of geography and size, as the economic engine of Europe.

This was Keynes’s message in the book that first made him internationally famous, The Economic Consequences of the Peace. This book, as Markwell shows, grew from Keynes’s fears that restoring prosperity to Europe was wholly lost sight of in the blind rush to revengefully heap reparations and crippling terms of defeat upon a prostrate Germany. Keynes’s sometimes over-the-top criticism of the principals at the conference ? with Lloyd George, George Clemenceau and Woodrow Wilson coming particularly under extensive personal attack, some thought bordering on ridicule ? stemmed from the fact that Keynes believed that their actions, as opposed to their hypocritical words, would lead to an unstable peace.

Thus, at some risk to his own influence and career, Keynes quit his role in the negotiation of the Paris peace treaty and returned to England to hastily write his reaction to that experience in the form of The Economic Consequences. It was a book that both criticized the leaders of England and France for cowardice, in being unwilling to challenge the popular clamor for revenge upon Germany, and that laid bare the flaws of the peace terms that the French and British political leaders had, Keynes thought, bamboozled President Wilson into signing. These plans, he felt, were counterproductive of a lasting peace and unrealizable to boot, because Germany could never meet its reparations obligations so long as its internal economy was crippled by the terms forced upon it by the treaty.

All this is well known to Keynes scholars and to students of the World War One period. What Markwell adds is context and detail to Keynes important role in the struggle to win both the war and the peace. What can be learned by all economists from his experience is that the dire nature of the post-war European economies, particularly those of the losing Axis powers, could not automatically be reversed unless attention was paid both to their immediate needs in the form of relief aid of one kind or another and also to their more long-term need to foster investment and trading institutions that would ensure the growth and permanence of economic prosperity. In asking how this would be achieved, Markwell classifies the nature of Keynes’s arguments at this crucial historical juncture as a species of a “liberal-idealist” one.

At the end of 1918, Keynes had a clear view of some of the elements of the post-war order he wished to see. His liberal-idealist faith in free trade, on which he had been brought up, was unshaken. He had urged the abandonment of inter-Allied debt and Britain’s forgoing her share of reparations, which he hoped would go to assist the new states. He had urged a moderate approach to reparations and clearly wished the defeated powers to be treated so that they would not need assistance to avoid starvation, unemployment, anarchy, or perhaps Bolshevism. The fundamental views which underlay his action at the peace conference, and which were to be expounded in The Economic Consequences, were already formed and were shared by many others (p. 53).

Thus Keynes began his career, as many economists have before and since his time, as a solid proponent of free trade as the primary means to bring about international peace. This brings us to the second issue raised above: to what extent, and how, are economic factors causative of acrimony and war between nations? Any modern economist could profit by considering this question in light of Markwell’s book. Here, Markwell writes, Keynes’s view matured over the course of his career. The standard argument pits free trade against imperialism. Free trade, it is thought in the standard liberal argument, may have peaceful benefits as an unintended consequence, if it make customers out of potential enemies. Moreover, since mutually beneficial gains for any two countries can be shown (and this is one of the principle lessons of a liberal economics) to lead to rising prosperity for both trading partners, there is a potential for any two countries to both benefit from trade. Trade, so this argument goes, would make traders reluctant to upset trading by aggression and war, and so free trade may tend to reduce international aggression and war.

On the other side, the argument of imperialism starts from the premise that it is beneficial for a country to run a favorable balance of trade, and an expanding export market, in that this tends to keep manufacturers and producers of tradable goods and services at home in a prosperous and expanding state. By this argument developed countries (note not firms directly, but perhaps state action spurred by firms) will seek means to maximize export opportunities in particular and may also vie to receive exclusive preferences for their goods and services in these markets, as well as trying to ensure scarce inputs to the production process, such as raw materials and/or natural resources that are in short supply at home. How is this accomplished? By the argument of imperialism, it is accomplished by military and diplomatic maneuvers that allow powerful states to dominate weaker states and to assemble official or semi-official trading empires.

The economic analysts of the liberal tradition in England ? Smith, Ricardo, Burke, Mill, and Marshall ? can be identified as the major proponents of the former idea. Dissenters from this tradition both in England and on the continent ? like Hobson, Lenin and Luxembourg ? can be identified with various twists on the latter idea in Keynes’s time. Markwell makes it clear that Keynes early in his career came down exclusively on the side of the liberal conception of free trade ? hence his categorizing of Keynes’s earliest arguments into those of a “liberal-idealist” camp. He recognized and believed in the potential of free trade to promote peace and harmony among nations, and he thought that by reestablishing Germany’s power to participate in trade with it neighbors, a lasting peace could be established in Europe after World War One.

It must be said, though, that the history of Europe and the world in the nineteenth century and leading up to the war in 1914, offered evidence supportive to both sides of this debate. On the one hand Britain, France, Germany and in fact most of Europe, had all grown prosperous in this period by trading with other nations, particularly was this so in the case of Britain, a small island economy with vast global trading interests. But each had also sought to carve out for itself some exclusive markets for its exports, and some exclusive sources of raw material for it own producers, through the conquest of overseas empires. This vying for power internationally had become so commonplace among European governments that part of this activity became known in England by the playful title of the “The Great Game.”

But imperialism and empire were not topics that engaged Keynes, either by upbringing or by temperament. In order to reassert the classical liberal argument he had been brought up on in this context he, like many of his fellow British liberals, made a crucial distinction between empires and exclusive trading blocks. “Empires,” according to Keynes (in 1903), need not lead to exclusive trading blocks. An empire that was founded and run on proper political principles, as he thought was the case of the British Empire, could lead to a loose confederation of states for which association with Britain was “to provide facilities for the growth under freedom and justice without molestation from abroad of these young nations … [W]hen a country becomes part of the Empire it is free to pursue it own destiny, in its own way. Because our ideal is democratic” (p. 19).

This somewhat condescending (to the colonial countries) and benign view of empires was in sharp contrast to both the imperialism theorist’s view of empires, as well as to those of other English political and ideological leaders (of the so called “Round Table”) who, after World War One, wanted to work for the imperial unity and exclusivity of trade relations between the various members of the British Empire. Keynes criticized the notion that empires necessarily would form into exclusive trading blocks that excluded all others, and that empires should lead to this state of affairs. He excoriated the latter in particular, exemplified for Keynes by the “German dream of Mittel-Europa.” It was a conception of empire based on “exclusivity” and the attempt to “monopolize” for the home country producers’ markets for their exports and sources of food and raw materials. This, he lamented, led to new frontiers “between greedy, jealous, immature, and economically incomplete, nationalist states” (p. 20). Worse, competing for such imperial preferences by nation-states, such as the British Round Table thinkers advocated, could lead to conflict and war.

Thus, the question that formed the international relations context in which Keynes wrote during and immediately after the First World War, was whether war could only stem from a perverse international policy in pursuing the potential gains from free trade (what Markwell calls the liberal-idealist position) or whether war was a natural outcome that could be expected from an inevitable imperialist-capitalism by which states would naturally vie for national power by assembling competitive exclusionary trading blocks (what Markwell identifies as the “realist” view).. Keynes, at this stage, as we have seen, favored the first argument ? that free trade only caused war when it was perversely pursued along the lines of imperial, exclusive terms. If trade and empires could be based on openness of markets and democracy, such as British experience in the pre-war period showed to Keynes was possible, then empires could be a beneficial source of cosmopolitanism and peace.

So what did Keynes at this early stage in his development think were the economic causes of war? Wars could result, said the younger, classical liberal Keynes, from “impoverishment, population pressure, penetration by foreign capital and the ‘competitive struggle for markets'” (p. 3). Note this fits our conclusion in the previous paragraph, by carefully excluding free-trade from those causes, so long as it is not pursued in exclusionary terms. So the interesting questions for economists today ? trained to believe unreflectively and in the abstract in the eternal verity of the potential for mutual gains from trade ? to take from this study of Keynes are as follows: Are there some possible circumstances under which this gain will not automatically arise in the context of actual situations of international relations? Does economic theory itself suggest conditions in which we may want to abandon a dogmatic attachment to what seems like a species of economic Truth? It turns out that the historical analog to these questions in the present case is “how did Keynes’s view of the role of economics in international relations evolve over his career?”

One way to answer these questions is by following Markwell in identifying three further stages in Keynes’s evolution in this regard ? identified as his “early liberal institutional, protectionist and mature liberal institutionalist” (p. 3) positions. All three stages could be thought of as instances where Keynes did not so much abandon the above-listed catalogue of the potential economic causes of war, but rather thought of extensions to the first cause ? economic “impoverishment.” His extensions were of two varieties. First in the 1920’s, and again in the 1930’s, Keynes suggested extensions from the contextual perspective of then current national and international events. Later in the 1930’s, and from the theoretical perspective of his General Theory, he suggested further, more economically fundamental extensions to this factor. Put another way, as he matured in terms of both experience and theoretical framework, he added to this list of the potential economic causes of war the crucial factors of monetary disorder, trade imbalances and unemployment. Even later, with special reference to Hitler and Germany, he added that there is no proper economic cause that extended to a nation’s possible reaction to “impoverishment” by embracing what he called a “brigand.” That is to say, economics had no explanation or remedy for a nation that was led by “a madman or a gambler” that was willing to risk war for personal power (p. 198). (Markwell convincingly shows on pp. 197-203 that Keynes was never pro-German or an appeaser, as he has sometimes been accused.)

Let us take the first stage of the evolution of Keynes’s views to begin. As Britain suffered through the slump of the twenties and as most of the West similarly suffered though the worse experience of the Great Depression in the thirties, Keynes came to blame these continued difficulties in restoring prosperity on the lack of existence a of well-functioning international monetary order. In particular, he was convinced that the gold standard had become a shackle on Britain, and on western expansion in general, because it forced weakened economies, such as he identified Britain as being since the First World War, to run a high-interest-rate policy for international reasons (to protect its gold reserves) that was wholly inconsistent with a needed internal low-interest-rate policy to restore employment and prosperity. This again deviated from the belief that free trade would automatically restore prosperity in any political context. In this case, and barring international agreement on an alternative system that bitter experience had taught him was not likely, it would be better for Britain to unilaterally either peg its pound below its pre-war parity rate ? and by such a devaluation encourage the output of its exporters – or, as eventually transpired in 1931, to abandon the gold standard altogether.

Even as this was his best counsel on short-term policy, Markwell shows Keynes was continuously preoccupied in this period, roughly 1922-1932, with finding a solution to the question of what possible type of international arrangement could be agreed upon by many nations and managed with some high degree of efficiency that would not rely upon what Keynes considered the immiserating and trade-inhibiting policies of the gold standard [1].

So the second-stage of the development of Keynes’s views on international relations was that he came to feel strongly that a return to the pre-1914 prosperity in Europe required the adoption by international agreement of an alternative to the former gold standard that would attract wide participation. This could only happen, he thought, if there were strong international leadership (which he long looked for from the U.S., as far back as the end of the First World War, but did not actually witness until World War Two). Moreover, Markwell clearly shows that in all of his many writings and participation in conferences devoted to this topic, Keynes was very fluid and pragmatic about the form that such a system should take. He was willing to compromise his own vision of a U.S./British-led system of managed (flexible) fixed exchange rates and the form that a managed stock of international liquidity reserves and payment media would take, if it would encourage wider agreement. (He stressed that the search for unanimity was an evil to be avoided.)

This fluidity as to details was to serve him well when he was negotiating with America during the Second World War over Lend-Lease and especially the post-war monetary system in that the Americans had firmly held demands and alternative plans of their own, which when added to Britain’s weak financial position, meant that Keynes was forced to negotiate from a distinctly weak position. Thus, the 1923-30 period was the stage of Keynes’s developing international relations views that Markwell calls “early liberal institutionalist.” Free trade could be beneficial, he was saying, but only if a properly functioning international monetary institution was adopted.

Briefly, we proceed on to the third stage of Keynes’s views on the economic element in international relations. Here the question becomes more starkly the universal nature of the coincidence of free trade and peaceful international relations. This stage arose out of Keynes’s participation on the Macmillan Committee on Trade and Finance (1929-31), the Economic Advisory Council set up by Ramsey McDonald, and particularly its Committee of Economists (created in July 1930, and to which also belonged William Beveridge, A. C. Pigou and Lionel Robbins) and in the pages of the political affairs journal that he headed at the time, the New Statesman. All of this activity arose from the need to respond to the international crisis that arose from the Great Depression and its particular impact on Britain.

In this and the fourth stage of Keynes’s grappling with international relations questions, Markwell emphasizes continuity in Keynes’s evolving views. The economist in me wants to call the first issue one of political context and, therefore not economically fundamental. But Markwell makes a good case that the last two stages of Keynes’s thought in this regard should be seen as merging into, and reinforcing, one another. The fourth phase he identifies is the period after 1933, sometime between 1934 and 1936, depending on when one judges Keynes to have been in control of the central propositions of his General Theory.

To go back, we should start with describing the third stage of Keynes’s views that Markwell describes as his “protectionist” phase. This occurred when, in the early years of the Great Depression, 1929-33, and to quite a bit of controversy, Keynes advocated protectionist measures for Britain, especially higher tariff barriers, as a way of combating the British unemployment of that period. He contextualized this recommendation by arguing that this unemployment had unfortunately occurred within a world system where the gold standard made the pursuit of free trade for “creditor” countries (such as Britain was since 1914) a road to even higher domestic unemployment than it was already experiencing. This was because, in order to maintain its balance of payments, it was forced to run a high-interest rate policy and deflation to protect its reserves. In this circumstance, and again barring a better international monetary system that seemed so impossible to him at that dark stage in history, Keynes gave a limited endorsement to British protectionist policy in the then-current economic emergency and for the short term. One detects almost a reluctance on his part to do so. And, indeed, his about-face was controversial enough on the Economists Committee that Robbins found it necessary to both author a dissenting minority report, attack Keynes’s position in the press and later author, with Beveridge and other LSE economists, a book defending free trade even in this context (Beveridge et al. 1931).[2] Consider Markwell’s comment on Keynes in this period: “Keynes’s renunciation of free trade came, hesitantly, and then boldly, in proposals, first, for emergency tariffs, and, secondly, for greater national self-sufficiency and economic isolation. Keynes moved from admitting that the classical connection between free trade and peace was an argument against a tariff, but one outweighed by the economic emergency through saying that his proposed tariffs could also help international amity to denying that free trade did in fact promote peace” (p. 153).

His argument in the context of such an economic emergency as the Great Depression seems to have been analogous to the old saw that “the patient cannot stand the cure.” He thought that Britain was in such a crisis with regard to unemployment, that her money wages were too rigid for deflation to work its classic role in bring down costs, that the gold standard had so limited the range within which domestic economic policy had to maneuver, and that so many other countries were reacting to this crises by erecting tariff barriers of their own (effectively exporting their unemployment problems to Britain), that he had become “reluctantly convinced” (p.154) that protectionism was the best temporary policy Britain could pursue in this circumstance.

Economists, and particularly specialists in macroeconomics and in Keynes’s thought, might immediately wonder if the drafting of the General Theory of Employment, Interest and Money did not have a profound effect on Keynes’s ideas on this question. Less historically minded economists might also wonder if, and how, the perspective of macroeconomics might alter one’s view of the universal argument for the benefits from trade. Again the history of Keynes’s own international relations positions offers examples of him facing exactly this question. Consequently, the fourth and last stage that Markwell identifies in Keynes’s evolving views on international relations ? what he calls the “mature liberal institutionalist” phase ? was based on just this issue. Again depending on when one judges the proposition of the General Theory to have been drafted, in some period during the middle part of the 1930s, Keynes developed a more fundamental economic theory framework in which to argue the point about protectionism that we have seen him making on pragmatic policy grounds in the early years of the Great Depression. In the General Theory and after, Keynes insisted that the question of the economic causes of war and the advisability of protectionist, anti-trade measures depended on how close the economy was to full employment ? and this extended to his advice to the government during the Second World War, when he judged the economy to have met this condition. Short of this internal goal, Keynes said that countries were unlikely to reap the potential benefits from free trade described by classic liberal economics. This was because the temptation was too strong for any one country to erect tariff barriers around itself to boost the demand for domestic producers. It was Keynes’s view that the policies of many nations since 1929 offered examples of this. Since competitive attempts to export domestic unemployment to another country eventually ended in lowering employment in them all, protectionist policies became a second best solution in this context. Better that each county should act in isolation from international forces to raise domestic employment to its full potential, by lowering interest rates and bolstering demand for domestic industry in any way possible. According to Keynes, “if our central controls succeed in establishing an aggregate volume of output corresponding to full employment as nearly as practicable, the classical theory comes into it own again from this point onwards” (p. 186).

Here we can quote Markwell to the effect that Keynes hereby modified his position on the economic causes of war in a fundamental way:

In short, Keynes’s argument was both that laissez-faire did not have the tendency to peace claimed for it, and that a reformed capitalism along the lines he advocated would much improve the prospects for peace. Keynes said that ‘the new system might be more favourable to peace than the old has been.’ It is not clear whether by this Keynes meant simply that past causes of war would be absent, or that with these gone and free trade, some of the mechanisms classical liberals claimed were the means by which free trade actively promoted peace would work again. Such mechanisms included the creation by trade of vested interests in peace, and the promotion of moral solidarity between nations trading with each other.

Here is the final issue that modern economists might profit from pondering as a result of reading this book. Keynes was saying in the 1930s that countries had first to ensure full employment before they could anticipate the mutual economic gains and the possible peace dividends that trade holds out. If the economic system of a free-market economy does not automatically tend toward full employment, but needs to be managed to attain this goal consistently through time (and surely this is the basic lesson of macroeconomics even to this day), then it is a mistake to think and preach that free trade is some sort of divinely given cure for all economic ills, in all contexts, domestic and foreign.

Keynes, of course, should not be looked on as an infallible guide in pondering this issue. He was fallible in judgment even within the field of international relations that Markwell surveys here. For one, his self confidence about his cleverness in designing policy fixes often led to disastrous negotiations on his part with his official American counterparts during the Second World War. Harry Hopkins, the special advisor to U.S. President Franklin Roosevelt, reportedly expressed this irritation in his comment that Keynes was “one of those fellows that just knows all the answers” (Chandavarkar, 2001).

Moreover he showed a complete lack of understanding of the American political process. Used to dealing exclusively with ministers and their Whitehall staff in the more centralized English system, he was dismayed by the power of individual Congressman. Also, not only was Keynes unnecessarily rude to these Congressman, who he often gave the impression that he considered them provincial and beneath him, but his haughty behavior was also unwise, in that those very Congressmen could hold up American aid for British needs. He similarly accused the White House and State Department of being too timid in its relations with Congress, not realizing that the American Constitution gave Congress control of appropriations, whatever the White House may have negotiated for with the British.

But Keynes’s faults were more than outweighed by his many talents. Keynes’s insight into how economies work, combined with his ability to understand and exert influence over the process of policy creation, is unlikely to be seen again in today’s era of extreme specialization. As such, modern economists, whether they agree with his judgments or not, can learn valuable lessons in the political economy of policy application from following his career in international relations in the context of numerous actual international crises. Markwell does a fine job in showing, over numerous issues, how difficult and how much skill is required to apply economic reasoning in the realm of international relations. Markwell’s greatest attraction for an economist is that he shows how Keynes pursued this activity with skill and subtlety in the context of many of the weightiest geopolitical issues to face the West in the twentieth century. It is one measure of Keynes’s and others’ ultimate success in this context that it is hard now to even imagine Germany and England at war. We, as economists, can learn a great deal from a recounting of his experiences in establishing this peaceful and prosperous state of affairs in Europe. Perhaps it might even make us a bit humble to contemplate that it may be in large part due to Keynes’s own work both in economics and politics, to the wisdom of the architecture and implementation of the Marshall Plan, which was surely in the spirit of Keynes’s ideas, and to the way in which economies have been managed since his time, that we have the luxury of not facing his unpalatable choice between free trade and full employment.

1. Also note that Keynes therefore wanted to destroy what he considered a “barbarous relic” of the nineteenth century, the belief that the gold standard operated “automatically” to restore international imbalances and that this meant it would encourage trade. Alternatively, a major message of Keynes throughout this period was that the gold standard was not, in fact, operating automatically by the pre-war rules of the game in the period after World War One because the U.S. and the Federal Reserve System refused to let its own eventual control of the majority of the world’s monetary gold cause U.S. prices to rise. Keynes thought this unfairly forced upon all other “creditor” nations the problems, noted above, of choosing to abandon international monetary arrangements, to competitively devalue its currency or to run a ruinous deflation.

2. It is instructive to modern economists that Robbins later, in his autobiography (Robbins, 1971), recanted his opposition to Keynes during those depression years.

Chandavarkar, A. 2001. “A Fresh Look at Keynes: Robert Skidelsky’s Trilogy.” Finance and Development, Vol. 38, no. 4, December.

Moggridge, Donald. 1992. Maynard Keynes: An Economist’s Biography, Routledge.

Robbins, Lionel C. 1971. Autobiography of an Economist, Macmillan.

Skidelsky, Robert. 2000. John Maynard Keynes: Fighting for Britain, Macmillan.

Michael S. Lawlor is Professor of Economics, Wake Forest University, Winston-Salem, North Carolina. His most recent publication on Keynes is The Economics of Keynes in Historical Context: An Intellectual History of the General Theory (2006).


John Maynard Keynes - History

Place of Birth: Cambridge, England

Date of Birth: June 5 th , 1883

Place of Death:Firle, East Sussex, England

Date of Death: April 21 st , 1946 (Age 62)

Occupation: Political Economy, Probablility 8

John Maynard Keynes was born on June 5 th , 1883 in Cambridge, England. He was born into the British Empire at its height, at a time when Britain was the most economically and militarily powerful state in the world. Keynes’ family was of the middle-upper class, with his father being an economist and his mother a social reformer. 1

He attended the University of Cambridge from 1902-1906, receiving a degree in mathematics. He also studied philosophy and attended lectures on economics. 1

In 1909, Keynes published his first economic article in the “Economic Journal” and in 1911 he became the editor. He was appointed to and served the “Royal Commission on Indian Currency” 2 .

In 1914, on the eve of the First World War, Keynes was called to London to provide economic advice to the British government. He joined the Treasury in 1915, and was appointed “Companion of the Order of the Bath” for his service during the war. This appointment would play a large role in his future duties to the government. In 1919, he was appointed the financial representative of the Treasury for the Paris Peace Conference. 3

During the peace conference, he argued unsuccessfully against the harsh reparations and trade sanctions imposed against Germany. He correctly believed that this would lead to the rise of extremism in Germany and, disgusted at the outcome of the conferences, resigned in 1919. 4 The course of history would prove him to be correct, with the rise of the Nazi party and the calamity in Europe culminating in Second World War.

He went on to become globally famous after the publication of his work “The Economic Consequences Of the Peace”, which with commendable accuracy predicted the disasters that were to befall upon Germany during the 1920s. He remained influential for the remainder of the 1920s, notably for speaking against the “gold standard” and in support of economic interventionism 2 .

He influenced both the American and British governments during the 1930s and published his most famed work, the “General Theory of Employment, Interest, and Money”. His work influenced the American government and helped to bring Britain and America out of the global depression, often referred to as the “Great Depression”. 5

During the Second World War, he advised governments on their wartime spending and published a book on the topic, “How to Pay for the War”. He was involved in the formation of the World Bank and International Monetary Foundation, which remain active to this day. 6

After the War, he continued to advise and negotiate on behalf of the British government until his death in Firle, East Sussex, England in 1946. He was 62 years old. 7

Keynes left a lasting legacy and his influence on world economics is profound. To this day, he remains an influential figure, and ideas have evolved into what is now known as Keynesian economics.


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