Monday, October 19, 2009

Economic Philosopher #2 John Maynard Keynes



As I researched on John Maynard Keynes’s life and work, I was able to point out that most of his theories were quite situational and relative to factual cases. The reason for that is because in his life time, there were crucial events like the First and Second World War and the Great Depression which struck the world. Those events were in fact so influential in terms of economy. Before those events struck the world, the most of countries’ economic system was capitalism proposed by Adam Smith and other classical economist (Keynes called them ‘classical’). However as they had gone through those disastrous events (especially Great Depression), they faced the problems of capitalism especially in market economy. No, in fact most of them would not realize the problems. It was Keynes who realized the errors of classical economic system. He begins his book “General Theory of Employment, Interest, and d Money (1936)”, he shows his bold object and I quote:

“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.” -Keynes (1936)

Actually, he does not deny everything about classical theory. However he confidently points out the errors of classical theory and boldly suggests his idea as “general”. Therefore, even though he is not strong opponent of classical theory, Capitalism, his ideas and suggestions are seemingly quite critical against it.

Keynes’ remarkable books were published generally after he experienced various worldly problems so most of them were written thoroughly base on his practical experiences and accurate view points as a witness of the events. “The Economic Consequences of Peace (1919)” was published after the Treaty of Versailles, and his masterpiece “General Theory of Employment, Interest, and Money (1936)” was also published after he experienced the Great Depression.

I strongly believe that in order to fully understand Keynes’ theories, it is quite necessary to grasp the errors of classical theories that were shown in historical context and background when Keynes was living. Indeed, studying his theories requires not only economic knowledge but also historical knowledge.

As the one of the best economists among whom has ever existed, Keynes fearlessly challenges Classical theory that has been respected and advocated for a long time by various countries and people. John Maynard Keynes, who chose to be practical rather than to be theoretical, ends the introduction of his book “General Theory (1936)” by stating that:

“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 (1936)


The Life and Work of John Maynard Keynes

John Maynard Keynes, (5 June 1883 – 21 April 1946) was a British economist whose ideas have been a central influence on modern macroeconomics, both in theory and practice. He advocated interventionist government policy, by which governments would use fiscal and monetary measures to mitigate the adverse effects of business cycles, economic recessions, and depressions. His ideas are the basis for the school of thought known as Keynesian economics, and its various offshoots.

John Maynard Keynes was born in Cambridge to a middle class family. His parents were both an intellectual. His father, John Neville Keynes was a lecturer of Cambridge University and his mother, Florence Ada Keynes was a local social reformer. So he would receive his father’s support in terms of expert coaching financial help.

Keynes had his early education at home and in kindergarten. He attended St Faith's preparatory school as a day pupil from 1892-1897. Teachers described Keynes as brilliant, but on occasion, careless and lacking in determination. His health was often poor during this period, leading to several long absences.

Keynes won a scholarship to study at Eton, where he displayed talent in a wide range of subjects, particularly mathematics, classics and history. Despite his middle class background, Keynes mixed easily with upper class pupils. In 1902 Keynes left Eton for King's College, Cambridge, to study mathematics. It was time when Keynes became interested in Economy as he met Alfred Marshall who considered Keynes as a future great economist.

In his school, he was known as very active student. He was interested in philosophy especially ethical system of G.E Moor. At the same time, he was also a member of the semi-secretive Cambridge Apostle society. It was a sort of group in which the number of members was as small as not more than 12 and that pursued elitism. As he acted as a member of elite group, he became an advocate of elitism.

Like many members, Keynes retained a bond to the club after graduating and continued to attend occasional meetings throughout his life. Before leaving Cambridge, Keynes became the President of the Cambridge University Liberal Club. In May 1904 he received a first class B.A. in mathematics. Aside from a few months spent on holidays with family and friends, Keynes continued to involve himself with the university over the next two years. He took part in debates, further studied philosophy and attended economics lectures informally as a graduate student. He also studied for his 1905 Tripos and 1906 Civil Service exams. Keynes was always confident he could find a solution to whatever problem he turned his attention to, and retained a lasting faith in the ability of government officials to do good.

Keynes began his civil service in October 1906, as a clerk in the India office. However, he was not interested in the India office, so he resigned his position and went back to Cambridge to work on probability theory. It was the time when Keynes published his first professional economics article in Economics Journal in 1909. Then By 1913 he had published his first book, Indian Currency and Finance. He was then appointed to the Royal Commission on Indian Currency and Finance– the same topic as his book – where Keynes showed considerable talent at applying economic theory to practical problems.

In January 1915 Keynes took up an official government position at the Treasury. Among his responsibilities were the design of terms of credit between Britain and its continental allies during the war, and the acquisition of scarce currencies. According to economist Robert Lekachman, Keynes's "nerve and mastery became legendary" due to his performance of these duties, as in the case where he managed to assemble — with difficulty — a small supply of Spanish pesetas.

In 1919, when the First World War ended, the countries that had involved in the war gathered in Versailles to settle the matter after the war. Keynes was also there as a financial representative for the Treasury. His experience at Treaty of Versailles was so influential for him to sketch his idea and future outlook. Actually, Keynes strongly opposed the Articles agreed in the Treaty of Versailles especially about huge reparation imposed on Germany. Through his book, “The Economic Consequences of Peace”(1919) He insisted that Germany was not able to pay reparation required by allied powers and those harsh punishments would give chance an instigator to lead uprising. Keynes's predictions of disaster were borne out when the German economy suffered the hyperinflation of 1923, and again by the collapse of the Weimar Republic and the outbreak of World War II

After returning to Cambridge, he published his Treatise on Probability (1921). where he dismantled the classical theory of probability and launched what has since become known as the "logical-relationist" theory of probability. Keynes's work caused something of a stir, arousing the young Cantabrigian logician, Frank P. Ramsey, to outline his own "subjective" theory of probability.

Throughout the 1920s, Keynes remained active in public policy debates, channeled mainly through his numerous articles in the Nation and Atheneum, a Liberal-Labour weekly magazine which he helped purchase in 1923 (it was absorbed by the New Statesman in 1931). The best of Keynes public policy writings was collected in his Essays in Persuasion (1931). He was on the forefront of the battle against returning Britain to the gold standard on a pre-war parity (e.g. 1925). This led him to author two famous pieces in condemnation of laissez-faire economic policy (1925,1926). In 1929, he wrote an election pamphlet with Hubert D. Henderson advocating the use of public works to reduce unemployment and condemning the Treasury's fear of "budget deficits". In 1929, he also entered into a small debate with Bertil Ohlin and Jacques Rueff on German reparations problem. He also found time to marry the Russian ballerina, Lydia Lopokova in 1925

Keynes' magnum opus the General Theory of Employment, Interest and Money was published in 1936. It was indexed by Keynes's student, later the economist David Bensusan-Butt. The work served as a theoretical justification for the interventionist policies Keynes favored for tackling a recession. The General Theory challenged the earlier neo-classical economic paradigm, which had held that provided it was unfettered by government interference, the market would naturally establish full employment equilibrium.

During World War II, Keynes argued in How to Pay for the War, published in 1940, that the war effort should be largely financed by higher taxation and especially by compulsory saving (essentially workers loaning money to the government), rather than deficit spending, in order to avoid inflation. In June 1942, Keynes was rewarded for his service with an hereditary peerage in the King's Birthday Honours. On 7 July his title was gazetted as Baron Keynes, of Tilton in the County of Sussex, and he took his seat in the House of Lords on the Liberal Party benches. In the mid-1944 negotiations that established the Bretton Woods system. The Keynes-plan, concerning an international clearing-union argued for a radical system for the management of currencies. He proposed the creation of a common world unit of currency, the Bancor and of new global institutions — a world central bank and the International Clearing Union. His idea founded the two new institutions, later known as the World Bank and IMF, as a compromise that primarily reflected the American vision.

Throughout his life Keynes worked energetically for the benefit both of the public and his friends – even when his health was poor he laboured to sort out the finances of his old college and to try to design an international monetary system that would benefit the whole world at Bretton Woods. Keynes suffered his final series of fatal heart attacks during negotiations for an Anglo-American loan he was trying to secure on favourable terms for Great Britain from the United States, a process he described as "absolute hell". Keynes died at Tilton, his farmhouse home near Firle, East Sussex, on 21 April 1946, a few weeks after returning from America.


Classical Economist vs Keynes

One economist has said that Keynesian revolution is the legacy of the 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. It was the longest, most widespread, and deepest depression of the 20th century, and is used in the 21st century as an example of how far the world's economy can decline. The depression originated in the United States, triggered by the stock market crash of October 29, 1929 (known as Black Tuesday), but quickly spread to almost every country in the world. (Wikipedia)

Compared to Classical economic theories, Keynes’ ideas were generally intuitive. As a witness of the Great Depression, he viewed the phenomena of the Great Depression quite differently with Classical economists. At the time, Keynes’ ideas were quite shocking and revolutionary because in some way, he upset the classical theories which were mostly prevalent and respected at the time. I would like to briefly points out different concepts between Classical economist and Keynes:

Price: Classical- Flexible Keynsian- Sticky
Period: Classical- Long Keynesian- Short
Main body: Classical- Market Keynesian- Government
Focus on: Classical- Supply Keyensian- Demand

The Great Depression was a case of deflation. Deflation according to Chambers Dictionary is a reduction in the amount of money available in a country, resulting in lower levels of economic activity, industrial output and employment, and a lower rate of increase in wages and prices. In simply way, the Great Depression, a deflation would be cyclically explained:

Fall of consumer’s expenditure à Decrease in aggregate demand à Excess stock à Decrease in manufacturing à Decrease in demand of labor à Unemployment à Family income decreases à fall of expenditure

The most important and noticeable difference between Classical economists and Keynes is the view on flexibility of price. Classical economists believe that prices decided in market were flexible. According to them, when there is more demand than supply price immediately rises, and when there is more supply than demand, price immediately falls. To sum up the price is controlled flexibly by invisible hand and it will be of course taking place with long term. It is the ability of market economy. Therefore, if their assumption is true, there will never be excess demand and supply and unemployment. Base on these assumptions, classical economists insisted autonomy of market system even during the Great Depression. They say if there is deflation or inflation, invisible hand of market will control it and it will be ok. However Keynes thinks it differently. He criticizes them by saying that “The long run is a misleading guide to current affairs. In the long run we are all dead.” According to him, price is sticky at least for short term so there may be excess supply and unemployment. Accordingly, even when there is more supply than demand price may not fall and excess supply may continue. So what Keynes proposes as a solution to fall of price is to deal with demand.


It is bad to save too much

If we closely look into the phenomena of deflation in America, we would understand Keynes emphasizing matter of demand. Let us go back to the cycle of deflation. How can we cut off this cycle? Deflation simply means that there are products to buy but people are not able to buy it because they do not have money. They do not have money because they do not have a job. Yes, indeed the first problem that must be settled to escape from deflation is unemployment.

Let us go deeper. As long as price is sticky at least for a short time, we have to deal with quantity. We have to increase quantity of product produced so that we can employ the people. They will earn money. As long as they have money they will buy things and demand increases. Then they escape from deflation.

People during the Great Depression tried to raise the prices of commodities by restricting their supply. It seemed to be reasonable because they had excess stock. According to the classical theory, when there is less supply than demand the price rises. However Keynes says that “restriction is worse than useless.” (Keynes, 1933)

Then he in his book “The Means to Prosperity (1933)” proposes five ways to raise prices and employment. I would like to present four of them and I quote:

1. For commodities as a whole there can be no possible means of raising their prices except by increasing expenditure upon them more rapidly than their supply comes upon the market,

2. Expenditure can only be increased if the public spend a larger proportion of the incomes they already have, or if their aggregate spending power is increased in some other way.

3. There are narrow limits to increasing expenditure out of existing incomes,—whether by saving less or by increased personal expenditure of a capital nature. Anyone who can afford to spend more should be encouraged to do so, particularly if he has opportunities to spend on new capital or semi-capital objects. we must aim at increasing aggregate spending power. If we can achieve this, it will partly serve to raise prices and partly to increase employment.

4. Putting on one side the special case of people who can earn their incomes by actually producing gold, it is broadly true to say that aggregate spending power within a country can only be raised either (i.) by increasing the loan-expenditure of the community; or (ii.) by improving the foreign balance so that a larger proportion of current expenditure again becomes income in the hands of home producers. By means of public works the Labour Government—though rather half-heartedly and in adverse attendant circumstances—attempted the first.

These four means of raising price and employment are simply saying that it is bad to say too much. He strongly insists that people, the consumers and government should spend and increase expenditure. However, during the Great Depression, people had already lost their ability to consume. They had nothing to spend. Therefore, it was the government that must increase expenditure and input capitals to deflated economy. But the problem was that for a long time government had not been allowed to interfere in economy. It was because of Classical economists who insisted autonomy of market and minimizing of interference of government.

Keynes had recognized several problem of classical theory which was dependent on market. Classical economists believed that the market economy was enabled to regulate prices and quantity of commodities by so-called invisible hand which refers to people’s behavior in their own interest. (Wikipedia) Great Depression happened primarily because of unstable prices and quantity of commodities. Classical economists believed that market with invisible hand, was going to regulate prices and quantity of commodities and everything would soon be ok. However, Keynes did not rely on the ability of market and insisted interference of government as long as people were not available to spend and increase expenditure.


New Deal

The New Deal was the name that United States President Franklin D. Roosevelt gave to a complex package of economic programs he effected between 1933 and 1935 with the goals of what historians call the 3 Rs, of giving Relief to the unemployed and badly hurt farmers, Reform of business and financial practices, and promoting Recovery of the economy during the Great Depression. (Wikipedia)

Keynes believed that the remedy for the Great Depression was increasing of expenditure. It could be done by increasing consumer’s income. In order to increase consumer’s income unemployment problem must be settled. Since market was not able to handle unemployment problem, the government had to handle it. Government would spend money and begin national business to provide people a job.

Franklin D. Roosevelt was the one who accepted Keynes’ idea. After he was elected as a president of the United States he drastically gave up the principle of Laissez-Faire and promoted interference of government. Simply New Deal was the trial to produce employment. So the government headed by Roosevelt then began programs to raise employment once again for instance national business to provide people a job. I would like to briefly list notable programs have been done by New Deal:

1. Reconstruction Finance Corporation a Hoover agency expanded under Jesse Holman Jones to make large loans to big business. Ended in 1954;

2. Civilian Conservation Corps (CCC), 1933-1942: employed young men to perform unskilled work in rural areas; under United States Army supervision; separate program for Native American;

3. Public Works Administration (PWA), 1933: built large public works projects; used private contractors (did not directly hire unemployed);

4. Civil Works Administration (CWA), 1933-34: provided temporary jobs to millions of unemployed;

5. Works Progress Administration (WPA), 1935: a national labor program for more than 2 million unemployed; created useful construction work for unskilled men; also sewing projects for women and arts projects for unemployed artists, musicians and writers. (Wikipedia)

The active interference of government headed by Roosevelt raised employment. And people would again act as a consumer and expenditure and demand increased. Indeed, Keynes’ idea was proven by New Deal, the breakthrough of the Great Depression.

Government expenditure (National program & Business) à Employment à Increase in Consumer’s income à Increase in demand à balance in supply and demand à Stability in price and quantity of goods à Recovery

To sum up, the solution to the Great Depression proposed by John Maynard Keynes was to spend and increase expenditure. And it was done by government’s active interference. This proposal was quite shocking and opposite of classical idea. However, history proves that it was the key to recovery from the Great Depression. Indeed, the Great Depression could be overcome by revolutionary economical reform. So we call Keynes’ ideas “Revolution”


John Maynard Keynes (1936) General Theory of Employment, Interest and Money Basingstoke, Hampshire: Palgrave Macmillan

John Maynard Keynes. Library Economics Liberty Retrieved on 2 October 2, 2009 from

John Maynard Keynes, 1883-1946. Retrieved on 2 October 2009 from

John Maynard Keynes (September 30, 2009). In Wikipedia. The Free Encyclopedia Retrieved 00:07 September 30, 2009 from

The Economic Consequences of Peace (May 11, 2009). In Wikipedia. The Free Encyclopedia Retrieved 18:37 May 11, 2009 from

John Maynard Keynes (1933) The Means to Prosperity London: Macmillan

Deflation Chambers Dictionary (1996). Edinburgh: Chambers

Great Depression (October 5, 2009). In Wikipedia. The Free Encyclopedia Retrieved 12:39 October 5, 2009 from

New Deal (October 1, 2009). In Wikipedia. The Free Encyclopedia Retrieved 17:57 October 1, 2009 from

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