“The General Theory of Employment, Interest and Money,” J.M. Keynes (1936)

Keynes has returned, haven’t you heard? Or, at least, pieces of Keynesian analysis have returned, and many economists have gone back to their copies of the General Theory hoping to glean some insight. The problem is that the General Theory is not terribly well-written, unlike Keynes’ biography of Marshall, his Economic Possibilities for our Grandchildren, or his Economic Consequences of the Peace. Samuelson, in a memoriam (gated JSTOR copy, I’m afraid) where he calls Keynes’ book a work of genius accepted by every young economist of the day, also complains that it is a poorly written book, unsuitable for classroom use, resembling the confused notes of an author whose fame allowed him to bulldoze any potential editor; you simply must read this essay by Samuelson, both for the wonderful erudition and alacrity which appears in much of his writing, as well as for his frequent riffs, self-evident to me as well, on how much of a selfish jackass Keynes often appears to be!

Nonetheless, the General Theory is one of the most important pieces of economic writing ever put to paper, so let me give a few confused notes of my own on the subject. In particular, I’ll try to be true to what’s actually in Keynes, and not the intermediated version of “Keynesianism” which flowed from the pens of men like Hicks (who formalized some of the GT into the IS-LM model in this 1937 article, on the whole far more coherent than the GT itself). I’ll also try to discuss the less-often-quoted portions of the book – the Chapter 12 Keynesians are the Christmas-and-Easter-Catholics of the economics world, are they not? I’ve even got some red meat for the microeconomics-inclined reader, if you’ll bear with me.

1) This is a book filled with ideas: the importance of capital overhang, mass unemployment as an equilibrium outcome, liquidity traps, sticky wages, and the paradox of thrift all appear here. Not all are original to the GT, of course, but all of those were certainly outside the mainstream when Keynes wrote.

2) Keynes also recommends a number of policies that seem a bit ridiculous in retrospect. He supports “stamping” currency so that the government can force holders of currency to bear a negative nominal interest rate. He supports massive government involvement in investment markets. Most importantly, he places a huge importance on interest rates for long-term growth. Let’s discuss that more.

3) Perhaps Keynes is right on this point: if we are in a world where capital deepening is the primary reason for economic growth, then we can’t castigate Keynes for focusing on it any more than we can insult Malthus now for pointing out the importance of land constraints in an era when the Malthusian mechanism basically was in effect. But my reading of growth accounting is that even by the 1930s, innovation was more important than capital deepening for growth. It’s not often understood that, though the particular aspects of Keynesian theory apply only when we are below full employment, the text treats those periods as normal and periods of full employment as special, e.g., “the evidence indicates that full, or even approximately full, employment is of rare and short-lived occurrence.” That is, this is a book about growth and not a book of “depression economics,” as Hicks called it. The main point is not about monetary and fiscal policy in depressions, but about the use of those policies in normal times to ensure full employment in a non-inflationary way.

4) Keynes really hates on mathematical economics: perhaps this is the influence of Marshall at Cambridge. He claims at one point that he finds the math elides over qualifications that everyday language can keep “in the back of the mind.” This is a bit odd considering how difficult it is to understand many of the statements Keynes makes; even worse, we know in hindsight that those who “translated” Keynes to a formal language found many mistakes in the text. I wonder if his antipathy results from simply being unable to follow cutting edge mathematical economics as he got older. The Samuelson biography of Keynes I linked to above mentions some examples of utterly trivial mathematical errors Keynes made late in his career.

5) I find it entertaining that, at the end of Chapter 20, you find precisely the neoclassical point that confusion about whether price changes are relative or absolute can have major effects.

6) Liquidity definitely mattered in the recent financial crises, but I don’t think it mattered in the way Keynes uses the term. For Keynes, liquidity preference results, in general, from Knightian uncertainty about the future. I use liquid assets to deal with such uncertainty. But the precise financial market issue where liquidity seems most important today – collateral – is hardly discussed at all. That said, the discussion of liquidity, Chapter 17, is the best part of the General Theory. Keynes is a good marginalist, pointing out, among other things, that greater demand for liquidity will not lead to greater hoarding of money as the money supply is set by the government and not the potential hoarders. Rather, greater demand for liquidity simply leads to higher interest rates for potential borrowers.

So what of the legacy? For the standard counterpoint, see the wonderful 1977 essay “Is Keynesian Economics a Dead End?” by Tom Sargent, this year’s Nobel winner. What is great is that this essay very succinctly covers both what is wrong with large-scale Keynesian models of the economy, as well as an early response to the “counter-counter-revolutionaries” who defended themselves against Lucas, Sims, Sargent and the rest of the Young Turks. The basics of neoclassicism you surely know: expectations enter economics through a complicated feedback loop which was not captured by the identification restrictions of large macro models in the 1970s, a reasonable way to handle expectations is “rationally” where agents optimize conditional on not having perfect information, and simple thought experiments incorporating that idea show that within the range of policy options available, such expectations can give massively different predictions from orthodox Keynesianism, particularly that high inflation and high unemployment are possible. Further, though the driver in such models is agents’ misunderstanding about whether price changes are relative or absolute in the short term, such minor impulses can lead to large effects in a more interesting way that just that “the Great Depression was a period of contagious laziness,” as critics were putting it even back in the 1970s. This all seems totally reasonable to me. The New Keynesians (see, for instance, this nice 1990 review by Bob Gordon) restored Keynes a bit by focusing on non-informational reasons why prices might be sticky.

Of course, most modern macroeconomists believe both that the expectations process used to identify macro models must be well-founded and that price or wage stickiness plays an important role. More importantly, both schools more or less accept the nonneutrality of money in the short run, the neutrality of money in the long run, and the basic tenet of optimizing agents subject to constraints, of which only the first appears in Keynes (or, at least, the Keynes of the General Theory, since something like rational expectations appears in his earlier Treatise on Money); further, that first item is relatively unimportant to the General Theory, as noted in the earlier discussion. Keynes may be important to read, but he is certainly not “back,” financial crisis or not.

Full version online at http://www.marxists.org/reference/subject/economics/keynes/general-theory/, though the nice Harcourt edition is cheap enough to buy in print. Marxists.org actually has a great online library of economics classics, from Petty and Locke through to Taylorism and Keynes. Also see Keynes’ famous followup article in a 1937 QJE, though I would argue that this article has a totally different emphasis from the book.


2 thoughts on ““The General Theory of Employment, Interest and Money,” J.M. Keynes (1936)

  1. I found it quite amazing that you didn’t mentioned the principle of effective demand, nor the idea of own interest rates.

    And regarding the idea that the GT is a book about growth, I disagree with you. I think is a book about the short run. The point of Keynes, I think, is that the long run is the sum of several short runs, and not (as is nowadays) an intertemporal equilibrium.

    • afinetheorem says:

      Effective demand is clearly an important idea in Keynes, though I hope economists already know about it! As I wrote, I just wanted to put a few notes on things that struck me as less appreciated in the GT, rather than write a summary.

      As for being about growth, I would only say that you should read the book again in that perspective. Dozens of times, Keynes argues that 1) high interest rates retard capital accumulation when we are not at full employment, and that 2) we are basically never at full employment. I believe he said in a later commentary that his book is not a book only about depressions. He even has an explicit passage arguing that the reason nations are still so poor after centuries of saving is a liquidity preference/interest rate story.

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