John Maynard Keynes' Insights

In 1925, Winston Churchill, then Chancellor of the Exchequer, returned Britain to the gold standard at the pre-war exchange rate. It was a mistake that was eventually to discredit the very idea of a gold standard, and it produced unemployment in Britain, whereas most other industrial countries enjoyed a boom in the 1920s. Churchill's decision to return to gold at the old parity overvalued the pound and made British goods too expensive for foreigners. Britain was forced off the gold standard in 1931 against the background of world monetary disorder, the great crash of 1929 in America, and mounting protectionism everywhere. All through the 1920s, Keynes had been engaged on a major academic work which became the Treatise on Money, published in 1930. It was Keynes' first attempt at a detailed analysis of the changes in the general level of prices. In this effort, he largely accepted and built on the orthodox Crompton theory of money, developing the insights of his Cambridge mentor, Alfred Marshall, one of the great economists of the Victorian era. His magisterial principles of economics provided two generations of English economists with a veritable bible of economic truth. The Treatise on Money was brutally reviewed. It was criticized on purely technical grounds, but also because it analyzed business cycles largely in terms of prices. Within a year, Keynes decided to work on a new book, which was to become, five years later, the General Theory of Employment, Interest, and Money, the book for which he's now best remembered. The orthodox view that Keynes now challenged assumed that the economy works on an autopilot, so that if it is jolted off course by shock to the system, resulting in depression and unemployment, it soon recovers its equilibrium, thus restoring full employment. Keynes rejected this orthodox belief and replaced it by an explanation of unemployment as a normal characteristic of a capitalist economy, adding that only public works, financed by borrowing rather than taxing, can succeed in generating full employment. The British Treasury believed it was a matter of dogma that major public works, like those of President Roosevelt in America, destroy as much employment as they create. Keynes categorically denied this Treasury view, as it was called, and claimed that unemployment could only be eradicated by deliberate government action. Because saving and investment is done by different people for different reasons, there's no guarantee that the two will be the same. What then brings them into harmony, or, as economists love to say, into equilibrium? If savings are larger than investment, this depresses the rate of interest, and that automatically lowers savings and raises investment, until the two are equal. It works just as well the other way around, when investment is bigger than savings. But instead, Keynes argued, it is variations in income itself that bring savings into equilibrium with investment. And moreover, it is investment that is always the active partner in your relationship. When investment goes up, this causes a multiplied increase in income. That makes consumption go up, but never by as much as income. And that difference, in turn, generates the savings to match the initial increase in investment. Consumption, investment, and savings form a circular flow in which business firms pay out wages, rent, and interest to households to produce goods and services, and households pay out money to business firms to buy goods and services. Business firms cannot expect their sales to consumers to be as large as the total of their outgoings, because the public will want to save some of its income. These savings therefore leak out of the circular flow. That doesn't matter, provided that businessmen are at the same time injecting a sufficient amount of additional payment for new investment. The total amount of income flowing around the circular flow will go up when businessmen try to invest more than consumers are saving, and it will go down when consumers try to save more than businessmen are investing. And a given amount of private or public spending is capable of raising national income by at least as much, and perhaps by even more, and in this way can eliminate any amount of unemployment. That is the central message that Keynes brought to economics. The superstition that the budget must be balanced at all times, once it is debunked, takes away one of the bulwarks that every society must have against expenditure out of control. We have taken away a belief in the intrinsic necessity of balancing the budget, if not in every year, in every short period of time. And he was the right kind of an economist as an economic scientist, from my point of view. So far as economic policy is concerned, I think that goes along with his interest in the general intellectual climate. In that respect, I think he's had a very bad influence, because he encouraged the tendency of the intellectual community to believe that, A, the way to solve all problems was to have government solve them, and B, the way to have government solve the problems was to put intellectuals in charge of it. In that respect, in promoting that notion that it was government you had to look at to solve the problem, rather than the private activities of individuals, private voluntary activities, that compulsion was preferable in many cases to voluntary cooperation, and that the intellectuals had a special claim to be the person who turned the dials and pulled the levers of power. In those respects, I think The closing paragraph of the General Theory contained one of the most quoted statements that Keynes ever made. The ideas of economists and political philosophers, both when they're right and when they're wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men who believe themselves to be exempt from any intellectual influence are usually the slaves of some defunct economist. Madmen in authority who hear voices in the air are distilling that frenzy from some academic scribbler of a few years back.