The Economics of John Maynard Keynes

The Theory of a Monetary Economy

Dudley Dillard

• Publisher: Papamoa Press
• Year: 2018
• ISBN:
  9781789122299
• Topic: Economics
• Subtopic: Banks & Banking
• Index: Economics

The Economics of John Maynard Keynes: The Theory of Monetary Economy by Dudley Dillard seeks to make The General Theory of Employment, Interest and Money by John Maynard Keynes understandable to both the economist and to the non-economist. First published in 1948 and since translated into over 10 languages, Dr. Dillard's book has been widely regarded as the seminal scholarship on the monetary aspects of Keynesian economics.In addition to explaining the economic theories of Keynes, Dillard also includes a chapter on Keynes's philosophical development and the "social philosophy toward which it leads." Throughout the book, Dillard provides summaries and examines Keynes' concepts on employment, income, saving, marginal propensity to consume, the investment multiplier, fiscal policy, post-war inflation, interest, and wages.

THE ECONOMICS OF JOHN MAYNARD KEYNES

The Theory of a Monetary Economy

CHAPTER 1 — INTRODUCTION AND FUNDAMENTAL IDEAS

I am more attached to the comparatively simple fundamental ideas which underlie my theory than to the particular forms in which I have embodied them….

J. M. Keynes, The Quarterly Journal of Economics, February, 1937, page 211.

WITHIN the first dozen years following its publication, John Maynard Keynes’ The General Theory of Employment, Interest and Money (1936) has had more influence upon the thinking of professional economists and public policy makers than any other book in the whole history of economic thought in a comparable number of years. Like Adam Smith’s Wealth of Nations in the eighteenth century and Karl Marx’s Capital in the nineteenth century, Keynes’ General Theory has been the center of controversy among both professional and non-professional writers. Smith’s book is a ringing challenge to mercantilism, Marx’s book is a searching criticism of capitalism, and Keynes’ book is a repudiation of the foundations of laissez-faire. Many economists who were at first highly critical of Keynes have deserted their old position for the Keynesian camp. In book after book, leading economists acknowledge a heavy debt to the stimulating thought of Lord Keynes.

If the influence of Lord Keynes were limited to the field of technical economic doctrine, it would be of little interest to the world at large. However practical economic policy bears even more deeply than economic theory the imprint of Keynes’ thought. A few examples of the wide and growing acceptance of Keynes’ philosophy of governmental intervention, public investment, and other forms of economic policy designed to fill the gaps in the private enterprise economy are: the economic policies of the New Deal, the special economic message of President Truman to Congress at the close of the second world war, the English, Canadian, and Australian “White Papers” on unemployment policy, the Murray Full Employment Bill of 1945 and the Employment Act of 1946 in the United States, the provision in the new French Constitution which requires an annual employment budget, the newer thinking in the field of fiscal policy, the International Monetary Fund, and the International Bank for Reconstruction and Development. It appears that the trend in economic policy in those countries where private enterprise is still vigorous will be in the direction which Lord Keynes charted. Many of his ideas and most of his theoretical apparatus can be useful in socialist economies even though his fundamental social philosophy is anti-Marxian.

During his lifetime Keynes wrote numerous books, many of which are outstanding contributions to special fields of economics. Clearly, however, The General Theory of Employment, Interest and Money contains the essence of his contribution to general economic theory. This work, published when he was fifty-two years of age (he lived to be sixty-two), is a product of his mature thought. It seems appropriate that a book on the economics of Keynes should begin with a discussion of the fundamentals of his thinking as outlined in the General Theory. The fundamental ideas are to be distinguished from the form in which these ideas are expressed. In the first restatement of his position after publication of the General Theory, Keynes wrote: “I am more attached to the comparatively simple fundamental ideas which underlie my theory than to the particular forms in which I have embodied them…”{1} The theory stands or falls on these basic ideas. The forms in which the ideas are presented, on the other hand, allow for compromise. It is mainly these forms which have been the subject of debate subsequent to the publication of the General Theory. Once the fundamental ideas are clear, the rest falls easily into place. A full statement of the underlying ideas involves, of course, an explanation of the framework upon which they are built, but for the purpose of a general introduction the framework can be temporarily neglected. These fundamental ideas center around the following: (1) the general nature of Keynes’ theory, (2) the role of money, (3) the relation of interest to money, (4) investment, and (5) uncertainty about the future.

(1) A General Theory: In the title of his book The General Theory of Employment, Interest and Money,{2} Keynes’ emphasis is on the word general. His theory deals with all levels of employment in contrast with what he calls “classical” economics, which is concerned with the special case of full employment. The purpose of Keynes’ general theory is to explain what determines the volume of employment at any given time, whether it happens to be full employment, widespread unemployment, or some intermediate level. For reasons to be explained in the following chapter, the classical school assumes there is a tendency for the economic system based on private property in the means of production to be self-adjusting at full employment. Keynes challenges this assumption and calls the classical theory which is based on it a special theory, applicable only to one of the limiting cases of his general theory. Keynes attempts to show that the normal situation under laissez-faire capitalism in its present stage of development is a fluctuating state of economic activity which may range all the way from full employment to widespread unemployment, with the characteristic level far short of full employment. Although unemployment is characteristic, it is by no means inevitable. Another “general” aspect of the general theory is that it explains inflation as readily as it does unemployment since both are primarily a matter of the volume of effective demand. When demand is deficient, unemployment results, and when demand is excessive, inflation results. If Keynes’ more general theory is correct, then the special theory is at fault not only in being the theory of a limiting case, but also in being largely irrelevant to the actual world in which unemployment is obviously one of the gravest problems. Most of the significant differences between the classical theory and Keynes’ theory stem from the difference between the assumption that full employment is normal and the assumption that less than full employment is normal. The one is a theory of a stationary equilibrium and the other a theory of a shifting equilibrium.

There is another equally important meaning associated with the term “general” as it appears in the title of Keynes’ book. His theory relates to changes in employment and output in the economic system as a whole in contrast with traditional theory which relates primarily, But not entirely, to the economics of the individual business firm and the individual industry. The basic concepts of Keynes’ overall theory are the aggregates of employment, national income, national output, aggregate supply, aggregate demand, total social consumption, total social investment, and total social savings. The relationships between individual commodities expressed in terms of individual prices and values, which constitute the chief subject matter of traditional economics, are important in Keynes’ general theory, but they are subsidiary to the aggregate or overall concepts of employment, income, et cetera. A little reflection will reveal that conclusions which are valid for the individual unit may not be valid when applied to the economic system as a whole. For example, some people may get rich by stealing from others, but obviously a whole community cannot enrich itself merely by its members plundering each other.

(2) The Theory of a Monetary Economy: During his early career, Keynes was primarily a specialist in monetary theory and monetary policy. His greatest work prior to his General Theory was a two volume Treatise on Money. When he moved from the narrower field of monetary theory to the broader field of general economic theory, Keynes took money along with him and gave it a place of tremendous importance in the determination of employment and production in the economic system as a whole. He refers to his analysis as “the theory of a monetary economy.” (pp. vii, 239, 293) Money serves three functions: as a medium of exchange, as a unit of account, and as a store of value. Of these three, the store of value function is most important in defining Keynes’ “monetary economy.” People with more income and wealth than they currently consume may store the surplus in several forms, including hoarding money, lending money, and investing in some type of capital asset. If they choose to store their wealth in the form of money, they receive no income; if they lend their money, they receive interest; and if they purchase an investment asset, they expect to receive profits. Since money as a store of wealth is barren and other forms of wealth yield returns in the form of interest or profit, there must be a special explanation why people sometimes prefer to store wealth in the barren money form. Keynes gives as an answer the fact that money may be the safest form in which to store wealth. In lending money and in buying income property, there are uncertainties which do not exist as long as one’s wealth is kept in the money form. Owners of money have a type of security which owners of other kinds of wealth do not enjoy.

When wealth-holders generally express a preference for hoarding money rather than lending or investing it, the production of real social wealth is handicapped. This preference for owning money rather than owning income-yielding wealth exists to a significant degree only in a world in which the economic future is uncertain. If the world were one in which the economic future could be predicted with mathematical certainty, there would be no sense in storing wealth in the barren money form. Only the highly uncertain nature of the economic future explains why there is a preference for storing wealth in the form of non-income-yielding money. As Keynes says, the desire to store wealth in the form of money is “a barometer of the degree of our distrust of our own calculations and conventions concerning the future….The possession of actual money lulls our disquietude; and the premium which we require to make us part with money is the measure of the degree of our disquietude.”{3}

(3) Interest a Premium for Not-hoarding Money: The desire of wealth-holders to store wealth in the form of money against the risks of lending is not an absolute desire. It may be overcome by paying a premium in the form of interest. Interest is the reward for parting with control over wealth in its liquid form. The rate of interest depends on the intensity of the desire to hoard, or on what Keynes calls “liquidity preference,” for speculative purposes. The stronger the liquidity preference, the higher the rate of interest which must be paid. An increase in the desire of the public to hold money increases the rate of interest, although it is possible for the banking and monetary authorities to meet this increased desire by increasing the quantity of money. Keynes’ emphasis is not on the actual hoarding of money but on the desire to hoard. “Hoarding” is one of those phenomena which appear quite different when looked at from the individual, as compared with the economy-wide, point of view. An individual wealth-holder can increase the amount of money he holds only at the expense of someone else as long as the total supply of money does not increase. Therefore when the public as a whole wants more money, it cannot get it, and the increased desire for money results in the necessity of paying a higher premium to those who do part with their money. But when the price that must be paid for money increases, many types of new business activity that might be carried out at lower rates of interest will not be carried out at all. Therefore, an increase in interest rates tends to reduce effective demand and, in normal times, to cause unemployment.

Although the notion that interest is a reward for not-hoarding money may seem very ordinary from the layman’s point of view, it is most unusual from the point of view of traditional economic theory. Interest has been looked upon by economists as a reward for saving, that is, a reward for postponing consumption rather than as a premium for surrendering liquidity. The importance of interest and money in Keynes’ theory is indicated by their inclusion in the title The General Theory of Employment, Interest and Money. As further discussion will indicate, the ultimate theoretical explanation of unemployment in Keynes’ theory is found in the peculiar properties of money and interest. In the absence of money or of any form of wealth with the properties of conventional money, Keynes contends the economic system would tend to be self-adjusting at the point of full employment (p. 235). Although the title indicates a theoretical emphasis on money and interest as the basis of the ultimate explanation of unemployment, from the point of view of practical policy Keynes places even greater stress on the instability of demand for capital assets arising from the irrationality of the private investment market.

(4) Investment the Important Determinant of Employment: In a society characterized by great inequality of wealth and income, the economic ability of the community to consume is limited. The rich have more income than they wish to consume currently and the poor have so little income that their ability to consume is narrowly restricted. As a consequence, there is a sizable potential surplus of resources in excess of what is needed to produce consumers goods. This surplus, if it is to be used at all, must be devoted to producing things that are not to be currently consumed. This production in excess of what is currently consumed is called investment. Investment includes such activity as building new factories, new houses, new railroads, and all other types of goods which are not to be consumed as fast as they are produced. The distinction between consumption and investment is fundamental to Keynes’ entire analysis. His theory reduced to its simplest terms states that employment depends upon the amount of investment, or that unemployment is caused by an insufficiency of investment. This, of course, is a great simplification. Nevertheless, it indicates the emphasis on investment. Not only do some workers receive employment directly in building new factories, houses, railroads, et cetera, but the workers so employed spend their money for the products of factories already built, pay rent on houses already built, ride railroads already built, et cetera. In brief, employment in investment activity helps to maintain demand for the consumption output of existing facilities. In order to make full use of the factories already in existence, we must always be building new factories. Otherwise, in our society with its characteristic widespread inequality of income, there will not be enough money spent to keep the old factories going. If investment falls off, unemployment results. Clearly, it is very important to understand what determines the amount of investment that actually takes place. The most important section of Keynes’ General Theory is Book IV entitled, “The Inducement to Invest.” If we mean by a “cause” that factor in a complex combination of factors which fluctuates most widely and suddenly, we may say that investment is the determinant of employment. Employment fluctuates primarily because investment fluctuates. Unemployment results primarily from an inadequacy of investment. If investment can be controlled, total employment can be controlled. A high level of employment depends upon a high level of investment. The clue to understanding the general theory of employment is found in the answer to the question: What causes investment to fluctuate and characteristically to be less than the amount required for full employment?

(5) Psychological Irrationality a Cause of Instability: Investment fluctuates because present knowledge about the future rests on a precarious basis and therefore decisions which relate to the uncertain future also are precarious and subject to sudden and sweeping revision. Since investment is production other than for present consumption, it is connected with the future in a direct manner. Although investment may take the form of producing more consumers goods than are currently consumed, the more important form is investment in durable producers goods, like factories, houses, railroads, apartment houses, et cetera.{4} A decision to build a factory depends on what is expected to happen in the future. However, the outstanding fact about the future, so far as economic life is concerned at least, is that we know very little about it. The potential investor must be guided by his expectations in reaching his decision to build or not to build a new factory. The vague and uncertain state of our knowledge rules out the possibility that these expectations can be reduced to a rational, scientific basis. Yet as practical people living in a society whose productivity depends upon large-scale investment in durable assets, we must make and do make decisions concerning the long-term future, even though they rest on a foundation of shifting sand. Since those who make these dollars-and-cents decisions have very little confidence in the correctne...

Table of contents

• Title page
• TABLE OF CONTENTS
• DEDICATION
• PREFACE
• LIST OF FIGURES
• LIST OF TABLES
• CHAPTER 1 - INTRODUCTION AND FUNDAMENTAL IDEAS
• CHAPTER 2 - THE CLASSICAL BACKGROUND
• CHAPTER 3 - A PRELIMINARY SUMMARY OF THE GENERAL THEORY OF EMPLOYMENT
• CHAPTER 4 - INVESTMENT, SAVING, INCOME, AND THE WAGE-UNIT
• CHAPTER 5 - THE PROPENSITY TO CONSUME AND THE INVESTMENT MULTIPLIER
• CHAPTER 6 - FISCAL POLICY IN DEPRESSION
• CHAPTER 7 - THE MARGINAL EFFICIENCY OF CAPITAL
• CHAPTER 8 - INTEREST AND MONEY
• CHAPTER 9 - MONEY WAGES AND PRICES
• CHAPTER 10 - WAR AND POSTWAR INFLATION
• CHAPTER 11 - FURTHER APPLICATIONS OF KEYNES’ GENERAL THEORY OF EMPLOYMENT
• CHAPTER 12 - THE DEVELOPMENT OF KEYNES’ THOUGHT AND THE SOCIAL PHILOSOPHY TOWARD WHICH IT LEADS
• BIBLIOGRAPHY OF JOHN MAYNARD KEYNES’ WRITINGS
• REQUEST FROM THE PUBLISHER