Friday, 18 November 2011

Keynes - Seminar Summary

The General Theory of Employment, Interest and Money by John Maynard Keynes is widely considered one of the most influential texts in the world of finance and economics. After it was published in 1936, it became a benchmark for future economic thought, exploring ideas including the effects of government intervention, supply and demand and the issues associated with unemployment. The text was revolutionary as it explained that full employment could only be maintained with the support of government spending and investment. 'Successful investing', as he described it, was nothing more than 'anticipating the anticipations of others'


Born in 1883, Keynes was a British economist. His father was also an economist, as well as a philosopher teaching at Cambridge University. His mother was educated at Newnham College and became the City's first female mayor. Keynes became one of the most respected economists of the century following the publication of his book 'The Economic Consequences of the Peace' in 1919. The fact that even today Keynes' theories and ideas are being revised and expanded is a true sign of the impact he had in the field.

Before looking further at the General Theory, it's worth clarifying the meaning behind terms that repeat themselves throughout the text. First of all - Capitalism. Capitalism, put simply, is a system (both economic and political) in which the trade patterns of a country are controlled by private owners for profit. Keyne's also refers to the idea of interest. Interest is defined as: "The fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets." Keyne's himself described capitalism as "the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone."



Spending money on the military is a way of injecting aggregate demand

In Paul Krugman's review of the General Theory, followers and supporters of Keynes' work are referred to as Keynesians. Keynesians believe that aggregate demand is influenced by a host of economic decisions. Aggregate demand is the amount of money people are willing to spend to satisfy 'wants', not needs. This will increase if wages increase and / or if savings decrease and / or if less is spent on investment and import. A good way of injecting aggregate demand is by spending money on the military and other public services. Education and the NHS are other strong examples. Demand can also be increased by convincing people to spend their savings, yet if interest rates are cut low, people will not save.

Keynesian's also believe that changes in demand have their greatest short run effect on employment, not prices. If something is less in demand, for example a product, then the workforce needed to produce the produce will be smaller. Furthermore, prices respond slowly to supply and demand and unemployment itself is also subject to demand.

The General Theory of Employment, Interest and Money was written during times of mass unemployment, in what some referred to as the 'interwar period'. The Great Depression was an economic slump that affected North America, Europe and a host of other regions around the world. It was the longest depression experienced by the Western World, lasting until around 1939. In Keynes view, the solution to the Great Depression involved reducing interest rates and exercising government investment in infrastructure. Many economists are of the opinion that only large rates of U.S defence spending in preparation for WWII ended the depression. Keyne's himself suggested that to lift the recession the US central bank would have to expand the supply of money.

Keynes also argued that unemployment could be solved with a 'narrow and technical solution', adding that adequate effective demand was achievable if government policies became less intrusive. Critics questioned the British economist when he said that free markets and minimal government intervention were the way forward. Krugman himself describes the General Theory as "a work of informed, disciplined radicalism". Government intervention can come in a number of forms. The idea of a minimum wage, for example, is a concept introduced through this manner. Classical economists would argue that any form of government intervention is the cause of unemployment, however.

In his review of the text, Paul Krugman summarises the theories put forward in the General Theory into 4 key points, the first of which states: "Economies can do and often do suffer from an overall lack of demand, which leads to involuntary unemployment". The idea here is that if a product isn't particularly popular, efforts to actually produce the product will slump, which means the workforce behind the product are likely to lose work.

The second point put forward says: "The economy's automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully". This means that the long term effects of demand fall are severe, but the economy will stabilise the drop if its 'automatic tendancy' is present.

The next point adds: "Government policies to increase demand, by contrast, can reduce unemployment quickly". If the government increase the demand for something, the workforce related to this 'something' will need to be expanded to cope with supply and demand. Increasing the workforce will therefore create more Jobs and thus reduce unemployment.


Unemployment and the idea of 'demand' are closely linked

The final point says: "Sometimes increasing the money supply wont be enough to persuade the private sector to spend more, and government spending must step into the breach". Government spending has the ability to stabilise existing workforces and create new ones. These ideas link closely to John Hicks' analysis of the General Theory, where he explains his thinking behind the 'two curves'. Hick's states the General Theory can be interpreted in two curves: The IS curve (shifted by tax / spending changes) and the LM curve (shifted by changes in money supply)

Krugman also highlights issues with the General Theory. "He [Keyne] underestimated the ability of mature economics to stave off diminishing returns", he writes. He also describes how the economist failed to predict a future of constant inflation. This ultimately meant that Keynes was pessimistic about the future of monetary policy, which would have helped shape a number of his views.

Although some economists feels we've lost sight of the 'true Keynesian path', Krugman suggests otherwise. "The bottom line is that really we are all Keynesian now", he argues. A large part of what modern macro economists do derives from the The General Theory of Employment, Interest and Money by Keynes. This is a clear sign of the impact the British philosopher had on the world of economics. Even now his views towards finance and government control shape the thinking of experts today.

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