General Theory of Employment Interest and Money

The General Theory of Employment, Interest and Money was written by the English economist John Maynard Keynes

John Maynard Keynes

John Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...

. The book, generally considered to be his magnum opus

Masterpiece

Masterpiece in modern usage refers to a creation that has been given much critical praise, especially one that is considered the greatest work of a person's career or to a work of outstanding creativity, skill or workmanship....

, is largely credited with creating the terminology and shape of modern macroeconomics

Macroeconomics

Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy...

. Published in February 1936 it sought to bring about a revolution, commonly referred to as the "Keynesian Revolution

Keynesian Revolution

The Keynesian Revolution was a fundamental reworking of economic theory concerning the factors determining employment levels in the overall economy. The revolution was set against the then orthodox economic framework: neoclassical economics....

", in the way economists thought – especially in relation to the proposition that a market economy tends naturally to restore itself to full employment after temporary shocks. Regarded widely as the cornerstone of Keynesian thought, the book challenged the established classical economics

Classical economics

Classical economics is widely regarded as the first modern school of economic thought. Its major developers include Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Malthus and John Stuart Mill....

and introduced important concepts such as the consumption function

Consumption function

In economics, the consumption function is a single mathematical function used to express consumer spending. It was developed by John Maynard Keynes and detailed most famously in his book The General Theory of Employment, Interest, and Money. The function is used to calculate the amount of total...

, the multiplier

Multiplier (economics)

In economics, the fiscal multiplier is the ratio of a change in national income to the change in government spending that causes it. More generally, the exogenous spending multiplier is the ratio of a change in national income to any autonomous change in spending In economics, the fiscal...

, the marginal efficiency of capital, the principle of effective demand

Effective demand

In economics, effective demand in a market is the demand for a product or service which occurs when purchasers are constrained in a different market. It contrasts with notional demand, which is the demand that occurs when purchasers are not constrained in any other market...

and liquidity preference

Liquidity preference

In macroeconomic theory, Liquidity preference refers to the demand for money, considered as liquidity. The concept was first developed by John Maynard Keynes in his book The General Theory of Employment, Interest and Money to explain determination of the interest rate by the supply and demand...

Background

Keynes's previous work paved the way for The General Theory. Keynes and other Cambridge economists developed the Cambridge cash-balance theory, a precursor for the concept of liquidity preference

Liquidity preference

that was central to Keynes's later theory. Keynes's A Treatise on Probability
A Treatise on Probability
A Treatise on Probability was published by John Maynard Keynes while at Cambridge University in 1921. The Treatise attacked the classical theory of probability and proposed a "logical-relationist" theory instead...

investigated the nature of uncertainty. Keynes's ideas about economic decision making and hesitancy in investment under uncertainty in The General Theory can be traced directly to his Treatise.

Although The General Theory was written during the Great Depression

Great Depression

The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...

and was taken by many to justify the assumption by government of the responsibility for the achievement and maintenance of full employment

Full employment

In macroeconomics, full employment is a condition of the national economy, where all or nearly all persons willing and able to work at the prevailing wages and working conditions are able to do so....

, it is for the most part a highly abstract work of theory and by no means a tract on policy. Its full meaning and significance continues to be debated even today.

As a book, its style differs from modern mainstream economic texts because its concepts are expressed almost entirely in prose with little explicit mathematical modelling, following the practice of Alfred Marshall

Alfred Marshall

Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...

and his other successors in 1930s Cambridge, England. This approach is neither accident nor shortcoming, indeed Keynes (a mathematician by training) criticizes the use of mathematics in economics to hide fluffy arguments behind mathematical notation. The book is enlivened by some brilliant rhetorical passages, including the description of the stock market in Chapter 12 and the concluding chapter 24 on the (rather tentative) policy implications Keynes derived from his theory.

Summary

The central argument of The General Theory is that the level of employment is determined, not by the price of labour as in neoclassical economics

Neoclassical economics

Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...

, but by the spending of money (aggregate demand

Aggregate demand

In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...

). He argues that it is wrong to assume that competitive

Perfect competition

In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...

markets will, in the long run, deliver full employment or that full employment is the natural, self-righting, equilibrium state of a monetary economy. On the contrary, under-employment and under-investment are likely to be the natural state unless active measures are taken. One implication of The General Theory is that a lack of competition

Perfect competition

is not the fundamental problem and measures to reduce unemployment by cutting wages or benefits are not only hard-hearted but ultimately futile.

Keynes sought to do nothing less but upend the conventional economic wisdom. He mailed a letter to his friend George Bernard Shaw

George Bernard Shaw

George Bernard Shaw was an Irish playwright and a co-founder of the London School of Economics. Although his first profitable writing was music and literary criticism, in which capacity he wrote many highly articulate pieces of journalism, his main talent was for drama, and he wrote more than 60...

on New Year's Day, 1935:

"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."

Preface

Keynes wrote four prefaces, to the English, German, Japanese and French editions, each with a slightly different emphasis.
In the English preface, he addresses the book to his fellow economists, yet mentions he hopes it will be helpful to others who read it. He also claims that the connection between this book and his Treatise on Money, written five years earlier, will most likely be clearer to him than anyone else, and that any contradictions should be viewed as an evolution of thought.

Book I: Introduction

The first book introduced what Keynes asserted would be a book that changed the way the world thinks.

Chapter 1: The General Theory (only half a page long) consists simply of this radical claim:

"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." (p. 3)

Chapter 2: The Postulates of the Classical Economics
Chapter 3: The Principle of Effective Demand

Book II: Definitions and Ideas

Chapter 4: The Choice of Units
Chapter 5. Expectation as Determining Output and Employment
Chapter 6. The Definition of Income, Saving and Investment
Chapter 7. The Meaning of Saving and Investment Further Considered

Book III: The Propensity to Consume

Book III moves to cover what causes people to consume, and therefore stimulate economic activity. In a depression the government, he argued, needs to kick start the economy's motor by doing anything necessary. In Chapter 10 he says,

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

Chapter 8. The Propensity to Consume: I. The Objective Factors
Chapter 9. The Propensity to Consume: II. The Subjective Factors
Chapter 10. The Marginal Propensity to Consume and the Multiplier

Book IV: The Inducement to Invest

The marginal efficiency of capital

Marginal efficiency of capital

The marginal efficiency of capital is that rate of discount which would equate the price of a fixed capital asset with its present discounted value of expected income....

is the relationship between the prospective yield of an investment and its supply price or replacement cost. Keynes says on page 135: "I define the marginal efficiency of capital

Marginal efficiency of capital

The marginal efficiency of capital is that rate of discount which would equate the price of a fixed capital asset with its present discounted value of expected income....

as being equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price."

http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch11.htmChapter 11. The marginal efficiency of capital
Marginal efficiency of capital
The marginal efficiency of capital is that rate of discount which would equate the price of a fixed capital asset with its present discounted value of expected income....

]
Chapter 12. The State of Long-term Expectation
Chapter 13. The General Theory of the Rate of Interest
Chapter 14. The Classical Theory of the Rate of Interest
Chapter 15. The Psychological and Business Incentives to Liquidity
Chapter 16. Sundry Observations on the Nature of Capital
Chapter 17. The Essential Properties of Interest and Money
Chapter 18. The General Theory of Employment Re-stated

Chapter 20. The Employment Function
Chapter 21. The Theory of Prices

Book VI: Short Notes Suggested by the General Theory

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

"... the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil." (pp. 383–4))

Chapter 22. Notes on the Trade Cycle
Chapter 23. Notes on Merchantilism, the Usury Laws, Stamped Money and Theories of Under-consumption
Chapter 24: Concluding Notes on the Social Philosophy towards which the General Theory might Lead

Reception

Keynes did not set out a detailed policy program in The General Theory, but he went on in practice to place great emphasis on the reduction of long-term interest rates and the reform of the international monetary system as structural measures needed to encourage both investment and consumption by the private sector.

Criticisms

From the outset there has been controversy over what Keynes really meant. Many early reviews were highly critical.

The success of what came to be known as ‘neoclassical synthesis

Neoclassical synthesis

Neoclassical synthesis is a postwar academic movement in economics that attempts to absorb the macroeconomic thought of John Maynard Keynes into the thought of neoclassical economics...

’ Keynesian economics

Keynesian economics

Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...

owed a great deal to the Harvard economist Alvin Hansen

Alvin Hansen

Alvin Harvey Hansen , often referred to as "the American Keynes," was a professor of economics at Harvard, a widely read author on current economic issues, and an influential advisor to the government who helped create the Council of Economic Advisors and the Social security system...

and MIT economist Paul Samuelson

Paul Samuelson

Paul Anthony Samuelson was an American economist, and the first American to win the Nobel Memorial Prize in Economic Sciences. The Swedish Royal Academies stated, when awarding the prize, that he "has done more than any other contemporary economist to raise the level of scientific analysis in...

, as well as to the Oxford economist Sir John Hicks

John Hicks

Sir John Richard Hicks was a British economist and one of the most important and influential economists of the twentieth century. The most familiar of his many contributions in the field of economics were his statement of consumer demand theory in microeconomics, and the IS/LM model , which...

. Hansen and Samuelson offered a lucid explanation of Keynes’s theory of aggregate demand

Aggregate demand

with their elegant 45 degree Keynesian cross

Keynesian cross

In the Keynesian cross diagram , a desired total spending curve is drawn as a rising line since consumers will have a larger demand with a rise in disposable income, which increases with total national output...

diagram, while Hicks created the IS/LM

IS/LM model

The IS/LM model is a macroeconomic tool that demonstrates the relationship between interest rates and real output in the goods and services market and the money market...

diagram. Both of these diagrams can still be found in textbooks.

Just as the reception of The General Theory was encouraged by the 1930s experience of mass unemployment, its fall from favour was associated with the ‘stagflation

Stagflation

In economics, stagflation is a situation in which the inflation rate is high and the economic growth rate slows down and unemployment remains steadily high...

’ of the 1970s. Although few modern economists would disagree with the need for at least some intervention, policies such as labour market flexibility

Labour market flexibility

Labour market flexibility refers to the speed with which labour markets adapt to fluctuations and changes in society, the economy or production.-Definition:In the past, the most common definition of labour market flexibility was the neo-liberal definition...

are underpinned by the neoclassical

Neoclassical economics

notion of equilibrium in the long run. Although Keynes explicitly addresses inflation

Inflation

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...

, The General Theory does not treat it as an essentially monetary phenomenon nor suggest that control of the money supply or interest rates is the key remedy for inflation. This conflicts both with neoclassical

Neoclassical economics

theory and with the experience of pragmatic policy-makers. Furthermore, the main Keynesian

Keynesian economics

prescription for inflation, incomes policy

Incomes policy

Incomes policies in economics are economy-wide wage and price controls, most commonly instituted as a response to inflation, and usually below market level.Incomes policies have often been resorted to during wartime...

, has lost credibility.

Henry Hazlitt

Henry Hazlitt

Henry Stuart Hazlitt was an American economist, philosopher, literary critic and journalist for such publications as The Wall Street Journal, The Nation, The American Mercury, Newsweek, and The New York Times...

criticized, paragraph by paragraph, Keynes' General Theory in The Failure of the New Economics
The Failure of the New Economics
The Failure of the "New Economics" is a book by Henry Hazlitt offering a detailed critique of John Maynard Keynes' work The General Theory of Employment, Interest and Money .-Overview:...

.

Endorsement

Many of the innovations introduced by The General Theory continue to be central to modern macroeconomics

Macroeconomics

Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy...

. For instance, the idea that recessions reflect inadequate aggregate demand and that Say's Law

Say's law

Say's law, or the law of market, is an economic principle of classical economics named after the French businessman and economist Jean-Baptiste Say , who stated that "products are paid for with products" and "a glut can take place only when there are too many means of production applied to one kind...

(in Keynes's formulation, that "supply creates its own demand

Supply creates its own demand

"Supply creates its own demand" is the formulation of Say's law by John Maynard Keynes, and is considered by him one of the defining characteristics of classical economics...

") does not hold in a monetary economy. President Richard Nixon famously said in 1971 (ironically, shortly before Keynesian economics

Keynesian economics

fell out of fashion) that "We are all Keynesians now", a phrase often repeated by Nobel laureate Paul Krugman

Paul Krugman

Paul Robin Krugman is an American economist, professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and an op-ed columnist for The New York Times...

. Nevertheless, starting with Axel Leijonhufvud

Axel Leijonhufvud

Axel Leijonhufvud is a Swedish economist, currently professor emeritus at the University of California Los Angeles and professor at the University of Trento, Italy....

, this view of Keynesian economics

Keynesian economics

came under increasing challenge and scrutiny and has now divided into two main camps.

The majority new consensus view, found in most current text-books and taught in all universities, is New Keynesian economics

New Keynesian economics

New Keynesian economics is a school of contemporary macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of New Classical macroeconomics.Two main assumptions define the New...

, which accepts the neoclassical

Neoclassical economics

concept of long-run equilibrium but allows a role for aggregate demand

Aggregate demand

in the short run. New Keynesian economists pride themselves on providing microeconomic foundations for the sticky prices and wages assumed by Old Keynesian economics. They do not regard The General Theory itself as helpful to further research. The minority view is represented by Post Keynesian

Post-Keynesian economics

Post Keynesian economics is a school of economic thought with its origins in The General Theory of John Maynard Keynes, although its subsequent development was influenced to a large degree by Michał Kalecki, Joan Robinson, Nicholas Kaldor and Paul Davidson...

economists, all of whom accept Keynes’s fundamental critique of the neoclassical

Neoclassical economics

concept of long-run equilibrium, and some of whom think The General Theory has yet to be properly understood and repays further study.

In 2011, the book was placed on Time Magazine's top 100 non-fiction

Non-fiction

Non-fiction is the form of any narrative, account, or other communicative work whose assertions and descriptions are understood to be fact...

books written in English since 1923.

Introductions to The General Theory

The earliest attempt to write a student guide was Robinson

Joan Robinson

Joan Violet Robinson FBA was a post-Keynesian economist who was well known for her knowledge of monetary economics and wide-ranging contributions to economic theory...

(1937) and the most successful (by numbers sold) was Hansen

Alvin Hansen

(1953). These are both quite accessible but adhere to the Old Keynesian

Keynesian economics

school of the time. An up-to-date Post Keynesian

Post-Keynesian economics

attempt, aimed mainly at graduate and advanced undergraduate students, is Hayes (2006). Paul Krugman

Paul Krugman

(a New Keynesian

New Keynesian economics

) has written an introduction to the 2007 Palgrave Macmillan

Palgrave Macmillan

Palgrave Macmillan is an international academic and trade publishing company, headquartered in Basingstoke, Hampshire, England, United Kingdom and with offices in New York, Melbourne, Sydney, Hong Kong, Delhi, Johannesburg. It was created in 2000 when St...

edition of The General Theory.

Enduring Importance
Sylvia Nasar
Sylvia Nasar
Sylvia Nasar is a German-born American economist and author, best known for her biography of John Forbes Nash, A Beautiful Mind.- Early life and history :...

, author of A Beautiful Mind' and a history of economics,' explained how important The General Theory was.

What made the General Theory so radical was Keynes's proof that it was possible for a free market economy to settle into states in which workers and machines remained idle for prolonged periods of time.... The only way to revive business confidence and get the private sector spending again was by cutting taxes and letting business and individuals keep more of their income so they could spend it. Or, better yet, having the government spend more money directly, since that would guarantee that 100 percent of it would be spent rather than saved. If the private sector couldn't or wouldn't spend, the government would have to do it. For Keynes, the government had to be prepared to act as the spender of last resort, just as the central bank acted as the lender of last resort.

External links

Introduction by Paul Krugman to The General Theory of Employment, Interest and Money, by John Maynard Keynes
Full text online. (with footnotes)
Full text PDF book. (with footnotes, typeset)
Online text in screen-friendly format. (lacks footnotes)
Foreword to the German Edition of the General Theory/Vorwort Zur Deutschen Ausgabe

The source of this article is wikipedia, the free encyclopedia. The text of this article is licensed under the GFDL.

Background

Summary

Preface

Book I: Introduction

Book II: Definitions and Ideas

Book III: The Propensity to Consume

Book IV: The Inducement to Invest

Book VI: Short Notes Suggested by the General Theory

Reception

Criticisms

Endorsement

Introductions to The General Theory

Enduring Importance

See also

External links