File Name: general theory of employment interest and money .zip
Chapter 7. Chapter 8. The Propensity to Consume: I. The Objective Factors. Chapter 9.
It caused a profound shift in economic thought, giving macroeconomics a central place in economic theory and contributing much of its terminology  — the " Keynesian Revolution ". It had equally powerful consequences in economic policy, being interpreted as providing theoretical support for government spending in general, and for budgetary deficits, monetary intervention and counter-cyclical policies in particular.
It is pervaded with an air of mistrust for the rationality of free-market decision making. Keynes denied that an economy would automatically adapt to provide full employment even in equilibrium, and believed that the volatile and ungovernable psychology of markets would lead to periodic booms and crises. The General Theory is a sustained attack on the classical economics orthodoxy of its time. It introduced the concepts of the consumption function , the principle of effective demand and liquidity preference , and gave new prominence to the multiplier and the marginal efficiency of capital.
The central argument of The General Theory is that the level of employment is determined not by the price of labour, as in classical economics , but by the level of aggregate demand. If the total demand for goods at full employment is less than the total output, then the economy has to contract until equality is achieved.
Keynes thus denied that full employment was the natural result of competitive markets in equilibrium. In this he challenged the conventional 'classical' economic wisdom of his day. I believe myself to be writing a book on economic theory which will largely revolutionize — not I suppose, at once but in the course of the next ten years — the way the world thinks about its economic problems. I can't expect you, or anyone else, to believe this at the present stage.
But for myself I don't merely hope what I say,— in my own mind, I'm quite sure. I have called this book the General Theory of Employment, Interest and Money , placing the emphasis on the prefix general. The object of such a title is to contrast the character of my arguments and conclusions with those of the classical theory of the subject, upon which I was brought up and which dominates the economic thought, both practical and theoretical, of the governing and academic classes of this generation, as it has for a hundred years past.
I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium.
Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.
Keynes's main theory including its dynamic elements is presented in Chapters , 18, and 22, which are summarised here. A shorter account will be found in the article on Keynesian economics. The remaining chapters of Keynes's book contain amplifications of various sorts and are described later in this article.
The classical view for which Keynes made Say a mouthpiece held that the value of wages was equal to the value of the goods produced, and that the wages were inevitably put back into the economy sustaining demand at the level of current production.
Hence, starting from full employment, there cannot be a glut of industrial output leading to a loss of jobs. As Keynes put it on p. Say's Law depends on the operation of a market economy.
If there is unemployment and if there are no distortions preventing the employment market from adjusting to it then there will be workers willing to offer their labour at less than the current wage levels, leading to downward pressure on wages and increased offers of jobs.
The classics held that full employment was the equilibrium condition of an undistorted labour market, but they and Keynes agreed in the existence of distortions impeding transition to equilibrium. The classical position had generally been to view the distortions as the culprit  and to argue that their removal was the main tool for eliminating unemployment.
Keynes on the other hand viewed the market distortions as part of the economic fabric and advocated different policy measures which as a separate consideration had social consequences which he personally found congenial and which he expected his readers to see in the same light. The distortions which have prevented wage levels from adapting downwards have lain in employment contracts being expressed in monetary terms; in various forms of legislation such as the minimum wage and in state-supplied benefits; in the unwillingness of workers to accept reductions in their income; and in their ability through unionisation to resist the market forces exerting downward pressure on them.
Keynes accepted the classical relation between wages and the marginal productivity of labour, referring to it on page 5  as the "first postulate of classical economics" and summarising it as saying that "The wage is equal to the marginal product of labour".
A system can be analysed on the assumption that W is fixed i. All three assumptions had at times been made by classical economists, but under the assumption of wages fixed in money terms the 'first postulate' becomes an equation in two variables N and p , and the consequences of this had not been taken into account by the classical school.
Keynes proposed a 'second postulate of classical economics' asserting that the wage is equal to the marginal disutility of labour. This is an instance of wages being fixed in real terms. He attributes the second postulate to the classics subject to the qualification that unemployment may result from wages being fixed by legislation, collective bargaining, or 'mere human obstinacy' p6 , all of which are likely to fix wages in money terms.
Keynes's economic theory is based on the interaction between demands for saving, investment, and liquidity i. Saving and investment are necessarily equal, but different factors influence decisions concerning them. The desire to save, in Keynes's analysis, is mostly a function of income: the wealthier people are, the more wealth they will seek to put aside. The profitability of investment, on the other hand, is determined by the relation between the return available to capital and the interest rate.
The economy needs to find its way to an equilibrium in which no more money is being saved than will be invested, and this can be accomplished by contraction of income and a consequent reduction in the level of employment. In the classical scheme it is the interest rate rather than income which adjusts to maintain equilibrium between saving and investment; but Keynes asserts that the rate of interest already performs another function in the economy, that of equating demand and supply of money, and that it cannot adjust to maintain two separate equilibria.
In his view it is the monetary role which wins out. This is why Keynes's theory is a theory of money as much as of employment: the monetary economy of interest and liquidity interacts with the real economy of production, investment and consumption. Keynes sought to allow for the lack of downwards flexibility of wages by constructing an economic model in which the money supply and wage rates were externally determined the latter in money terms , and in which the main variables were fixed by the equilibrium conditions of various markets in the presence of these facts.
Many of the quantities of interest, such as income and consumption, are monetary. Keynes often expresses such quantities in wage units Chapter 4 : to be precise, a value in wage units is equal to its price in money terms divided by W, the wage in money units per man-hour of labour. Keynes generally writes a subscript w on quantities expressed in wage units, but in this account we omit the w. When, occasionally, we use real terms for a value which Keynes expresses in wage units we write it in lower case e.
As a result of Keynes's choice of units, the assumption of sticky wages, though important to the argument, is largely invisible in the reasoning. If we want to know how a change in the wage rate would influence the economy, Keynes tells us on p.
The relationship between saving and investment, and the factors influencing their demands, play an important role in Keynes's model. Saving and investment are considered to be necessarily equal for reasons set out in Chapter 6 which looks at economic aggregates from the viewpoint of manufacturers.
The discussion is intricate, considering matters such as the depreciation of machinery, but is summarised on p. Provided it is agreed that income is equal to the value of current output, that current investment is equal to the value of that part of current output which is not consumed, and that saving is equal to the excess of income over consumption Book III of the General Theory is given over to the propensity to consume, which is introduced in Chapter 8 as the desired level of expenditure on consumption for an individual or aggregated over an economy.
The demand for consumer goods depends chiefly on the income Y and may be written functionally as C Y. Saving is that part of income which is not consumed, so the propensity to save S Y is equal to Y—C Y. Keynes discusses the possible influence of the interest rate r on the relative attractiveness of saving and consumption, but regards it as 'complex and uncertain' and leaves it out as a parameter.
His seemingly innocent definitions embody an assumption whose consequences will be considered later. Since Y is measured in wage units, the proportion of income saved is considered to be unaffected by the change in real income resulting from a change in the price level while wages stay fixed.
Keynes acknowledges that this is undesirable in Point 1 of Section II. In Chapter 9 he provides a homiletic enumeration of the motives to consume or not to do so, finding them to lie in social and psychological considerations which can be expected to be relatively stable, but which may be influenced by objective factors such as 'changes in expectations of the relation between the present and the future level of income' p The marginal propensity to consume , C' Y , is the gradient of the purple curve, and the marginal propensity to save S' Y is equal to 1—C' Y.
Keynes states as a 'fundamental psychological law' p96 that the marginal propensity to consume will be positive and less than unity. Keynes's account is not clear until his economic system has been fully set out see below.
In Chapter 10 he describes his multiplier as being related to the one introduced by R. Kahn in Keynes's account of his own mechanism in the second para of p. By the end of the chapter on the multiplier, he uses his much quoted "digging holes" metaphor, against laissez-faire. In his provocation Keynes argues that "If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the banknotes up again" It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing".
Book IV discusses the inducement to invest, with the key ideas being presented in Chapter The 'marginal efficiency of capital' is defined as the annual revenue which will be yielded by an extra increment of capital as a proportion of its cost. The 'schedule of the marginal efficiency of capital' is the function which, for any rate of interest r, gives us the level of investment which will take place if all opportunities are accepted whose return is at least r.
This schedule is a characteristic of the current industrial process which Irving Fisher described as representing the 'investment opportunity side of interest theory';  and in fact the condition that it should equal S Y,r is the equation which determines the interest rate from income in classical theory.
Keynes is seeking to reverse the direction of causality and omitting r as an argument to S. He interprets the schedule as expressing the demand for investment at any given value of r, giving it an alternative name: "We shall call this the investment demand-schedule He also refers to it as the 'demand curve for capital' p For fixed industrial conditions, we conclude that 'the amount of investment Keynes and the "Classics" '.
Keynes proposes two theories of liquidity preference i. His arguments offer ample scope for criticism, but his final conclusion is that liquidity preference is a function mainly of income and the interest rate.
The influence of income which really represents a composite of income and wealth is common ground with the classical tradition and is embodied in the Quantity Theory ; the influence of interest had also been noted earlier, in particular by Frederick Lavington see Hicks's Mr Keynes and the "Classics".
Thus Keynes's final conclusion may be acceptable to readers who question the arguments along the way. However he shows a persistent tendency to think in terms of the Chapter 13 theory while nominally accepting the Chapter 15 correction. It should be obvious that the rate of interest cannot be a return to saving or waiting as such. For if a man hoards his savings in cash, he earns no interest, though he saves just as much as before. On the contrary, the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with liquidity for a specified period.
By analogous reasoning he could deny that wages are the reward for labor, or that profit is the reward for risk-taking, because labor is sometimes done without anticipation or realization of a return, and men who assume financial risks have been known to incur losses as a result instead of profits.
Keynes goes on to claim that the demand for money is a function of the interest rate alone on the grounds that:. The rate of interest is Frank Knight commented that this seems to assume that demand is simply an inverse function of price. This is where, and how, the quantity of money enters into the economic scheme.
And specifically it determines the rate of interest, which therefore cannot be determined by the traditional factors of 'productivity and thrift'. Chapter 15 looks in more detail at the three motives Keynes ascribes for the holding of money: the 'transactions motive', the 'precautionary motive', and the 'speculative motive'. He considers that demand arising from the first two motives 'mainly depends on the level of income' p , while the interest rate is 'likely to be a minor factor' p Keynes treats the speculative demand for money as a function of r alone without justifying its independence of income.
He says that The structure of Keynes's expression plays no part in his subsequent theory, so it does no harm to follow Hicks by writing liquidity preference simply as L Y,r.
This book was originally published by Macmillan in It gave way to an entirely new approach where employment, inflation and the market economy are concerned. John Maynard Keynes is one of the most influential economists of modern times. Educated at Cambridge University, he returned to teach at, and become a fellow of, Kings College, Cambridge. In Keynes joined the UK Treasury and acted as an advisor to government for many years. His ideas are now known the world over as Keynesian economics. Skip to main content Skip to table of contents.
There is no doubt that Keynes's The General Theory of Employment, Interest, and. Money (GT) significantly influenced the economics profession and economic.
It caused a profound shift in economic thought, giving macroeconomics a central place in economic theory and contributing much of its terminology  — the " Keynesian Revolution ". It had equally powerful consequences in economic policy, being interpreted as providing theoretical support for government spending in general, and for budgetary deficits, monetary intervention and counter-cyclical policies in particular. It is pervaded with an air of mistrust for the rationality of free-market decision making. Keynes denied that an economy would automatically adapt to provide full employment even in equilibrium, and believed that the volatile and ungovernable psychology of markets would lead to periodic booms and crises.
Keynes asserted that the link between the money stock and the level of national income was weak and that the effect of the money supply on prices was virtually nil—at least…. It was only later, in The General Theory of Employment, Interest and Money , that Keynes provided an economic basis for government jobs programs as a solution to high unemployment. The General Theory , as it has come to be called, is one of the most influential economics books in history, yet…. This insight, combined with a growing consensus that government should try to stabilize employment, has led to much…. In his General Theory of Employment, Interest and Money —36 he endeavoured to show that a capitalist economy with its decentralized market system does not automatically generate full employment and stable prices and that governments should pursue deliberate stabilization policies. There has been much controversy among economists….
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