“But, above all, individualism, if it can be purged of its defects and its abuses, is the best safeguard of personal liberty in the sense that, compared with any other system, it greatly widens the field for the exercise of personal choice. It is also the best safeguard of the variety of life, which emerges precisely from this extended field of personal choice, and the loss of which is the greatest of all losses of the homogeneous or totalitarian state,” (p.380).

“While, therefore, the enlargement of the functions of government...would seem...to be a terrific encroachment on individualism, I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the conditions of the successful functioning of individual initiative,” (p.372).

• Important to read Keynes in his own words

  • Very famous quotes and passages
  • Yet hard to put together, many interpretations of Keynes
  • Much like Smith or Marshall

• A lot of what people consider “Keynesian economics” is not in Keynes!

• Next class we will see how various schools of thought interpreted & responded to Keynes

  • Neo-Keynesians/neoclassicals (Samuelson, Hicks, Hansen, Lerner, Solow, Tobin)
  • Austrians (Mises, Hayek)
  • Post-Keynesians (Robinson, Sraffa, Leijonhufvud, Davidson)
  • Monetarists (Friedman, Sargent)
  • New Classicals (Lucas, Prescott, Kydland, Modigliani, Barro)
  • New Keynesians (Mankiw, Krugman, Stiglitz, Akerlof, Summers, Yellen)

“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,” (Chapter 1).

• Perhaps his most important claim: markets do not fundamentally guarantee full employment of resources

  • denial of Say’s Law
  • a focus on aggregate demand deficiencies
  • focus on how income

• Theory of consumption

  • Marginal propensity to consume (income)
  • The multiplier

• Theory of money

  • Liquidity preference theory of money demand
  • inequality of saving and investment
  • “animal spirits” and psychology guiding investment

• Arguments for fiscal policy

  • The multiplier
  • Government stimulating aggregate demand

“The idea that we can safely neglect the aggregate demand function is fundamental to the Ricardian economics, which underlie what we have been taught for more than a century. Malthus, indeed, had vehemently opposed Ricardo’s doctrine that it was impossible for effective demand to be deficient; but vainly. For, since Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to furnish an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain. Not only was his theory accepted by the city, by statesmen and by the academic world. But controversy ceased; the other point of view completely disappeared; it ceased to be discussed. The great puzzle of Effective Demand with which Malthus had wrestled vanished from economic literature. You will not find it mentioned even once in the whole works of Marshall, Edgeworth and Professor Pigou, from whose hands the classical theory has received its most mature embodiment. It could only live on furtively, below the surface, in the underworlds of Karl Marx, Silvio Gesell or Major Douglas.”

“The completeness of the Ricardian victory is something of a curiosity and a mystery. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely on the whole to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority,”

“Thus, given the propensity to consume and the rate of new investment, there will be only one level of employment consistent with equilibrium; since any other level will lead to inequality between the aggregate supply price of output as a whole and its aggregate demand price. This level cannot be greater than full employment, i.e. the real wage cannot be less than the marginal disutility of labour. But there is no reason in general for expecting it to be equal to full employment. The effective demand associated with full employment is a special case, only realised when the propensity to consume and the inducement to invest stand in a particular relationship to one another. This particular relationship, which corresponds to the assumptions of the classical theory, is in a sense an optimum relationship. But it can only exist when, by accident or design, current investment provides an amount of demand just equal to the excess of the aggregate supply price of the output resulting from full employment over what the community will choose to spend on consumption when it is fully employed.”

• (Neo)classicals: interest rates equilibrate savings & investment

  • Smith/Ricardo: a decision to save is a decision to invest/consume but often by different people

• Keynes: while saving can equal investment, they are very different decisions driven by different motivations:

  • Saving: determined by (psychological?) marginal propensity to consume new income; wealthier save more
  • Investment: determined by “marginal efficiency of capital” (return to capital), which is the interest rate

• Keynes: income level equilibrates savings & Investment

  • equilibrium: money being saved = money invested
  • if saving > investment, national income contracts until equilibrated (with less employment)

“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.” (Ch. 13)

“The rate of interest is...the "price" which equilibrates the desire to hold wealth in the form of cash with the available quantity of cash.”

“The fundamental psychological law ... is that men are disposed, as a rule and on average, to increase their consumption as their income increases, but not as much as the increase in their income...”

“Let us define, then, dCdY as the marginal propensity to consume.

“This quantity is of considerable importance, because it tells us how the next increment of output will have to be divided between consumption and investment. For ΔY=ΔC+ΔI, where ΔC and ΔI are the increments of consumption and investment; so that we can write ΔY=kΔI, where 1−1k is equal to the marginal propensity to consume.

“Let us call k the investment multiplier. It tells us that, when there is an increment of aggregate investment, income will increase by an amount which is k times the increment of investment.” (Chapter 10)

“[The stock speculator is concerned] not with what an investment is really worth to a man who buys it ‘for keeps’, but with what the market will value it at, under the influence of mass psychology, three months or a year hence...”

“This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional;– it can be played by professionals amongst themselves. Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity. For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs – a pastime in which he is victor who says Snap neither too soon nor too late, who passed the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops.” (Chapter 12).

“[P]rofessional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees.” (Chapter 12)