The Attempt of John Maynard Keynes General Theory - Case Study Example

Was Keynes’s General Theory actually a general theory of capitalist production or merely a of the circumstances surrounding the Great Depression? Introduction John Maynard Keynes’ General Theory attempts to explain the causes of the Great Depression. This theoretical perspective has contributed to Keynes becoming one of the most prominent 20th century economic thinkers. When Keynes’ text ‘General Theory of Employment, Interest and Money’ was published, it instantly had an enormous influence on economists, giving rise to a variety of Keynesian research programmes. Keynes’ theory was based on circulation; namely that money operated within a top-down structure and a firmness of wages and prices. Still, his text has garnered significant criticism from scholars that contend his perspectives are short sighted. In particular, his argument that strong government interventionist economic policies are necessary as a means of stimulating an economy out of recession have garnered significant criticism from individuals would argue that it’s impossible to spend one’s way out of a recession. This essay considers the extent Keynes’ theory is a general theory of capitalist production or merely a description of the circumstances surrounding the Great Depression. It also considers the main weaknesses of the theory. Analysis Background on Keynesian Economics One of the overarching aspects of Keynesian economic theory is the contention that one person’s spending becomes another person’s earning. This notion is extended to the logical conclusion that one person’s spending helps another person’s subsistence and earning.1 When the Great Depression occurred in 1929, it triggered a natural trend of saving as a means of hedging against the recession economy; this subsequently contributed to further depression conditions. Under Keynes’ theory, when the money circulation stopped, the economy went to a standstill. Keynes’ argued that the Federal Reserve did not go far enough in encouraging spending. Instead he believed the government and Fed should have lowered interests rates and engaged in increased public spending projects as a means of stimulating the economy. While his solution gained considerable criticism, one considers that Franklin Roosevelt’s New Deal massive spending policies, coupled with post-war consumer spending, greatly helped bring the United States out of the depression. To an extent Keynesian economics places the emphasis on the public sector to help economic recovery. While this seems a simply idea, such notions are opposed to Adam Smith’s neo-classical approach. In this largely laissez-fair approach to capitalism the invisible hand of the market will regulate and control market conditions; essentially this understanding exists in contemporary approaches of free-market capitalism. Hayek is one such free-market capitalist and prominent Keynesian opponent. Hayek believed that the market could establish balance on its own without intervention.2 Keynesian economics also holds that a level of redistribution of wealth may also be necessary for economic recovery. His pragmatic reason about such redistribution is that when the poor are given some amounts of money, they have a much higher potential of spending these funds rather than saving, effectively contributing to economic growth. Another crucial point is that Keynes’ theory is firmly rooted in macroeconomics for its wide view of economic structure. In this context of understanding, it’s arguable that Keynes’s ‘the General Theory’ is simply a description of the capitalistic process that explains condition surrounding the Great Depression, rather than being a strategic means of economic recovery. Keynes’ Response to the Great Depression Dating from 1929 to 1939, the Great Depression was the longest and most persistent economic slump in American history. This depression also affected economic sectors internationally making it perhaps the greatest recession in world history. There are a number of significant elements that triggered ‘the Great Depression’. One reason is that agriculture expanded rapidly, resulting in an unnecessary surplus. Secondly, in the industrial field machines replaced labour workers. This replacement produced an overflow of goods. Third, these surpluses resulted in an inequitable distribution of incomes.3 Moreover, in the stock market, rumours and instalment buying resulted in an overexpansion of credit resulting in harmful speculation. International trade started to decline with high tariff policies. Finally, political disorder occurred resulting in countries that could not payback foreign debts. The culmination of these reasons resulted in a decade long economic dark ages. In the height of this economic depression, Keynes proposed a solution where individuals wishing to save money would also spend more than they desired to invest. Following this idea, people would also consume less than they produced. He also claimed that the government should correct deficiencies in consumer demand by spending a proportion of income used for taxes or government services. After the war, his ideas became popular in economic circles. Economists recommended his theory to many government systems, but were greatly ignored by policy makers. Understanding the General Theory In interpreting Keynes’ theory, there have been a number of approaches to ‘the General Theory’. In understanding his treatment, it is crucial to point out that Keynes gave a point of view differing from classical economic theory. Regarding Keynes, Harris noted, (1) Actually, however, we have, as a rule, only the vaguest idea of any but the most direct consequences of our acts. . . . Thus, the fact that our knowledge of the future is fluctuating, vague, and uncertain, renders wealth a peculiarly unsuitable subject for the methods of classical economy theory. This theory might work very well in a world in which economic goods were necessarily consumed within a short interval of their being produced. (2) If, on the other hand, our knowledge of the future was calculable and not subject to sudden changes, it might be justifiable to assume that the liquidity-preference curve was both stable and very inelastic. . . . In these conditions we might reasonably suppose that the whole of the available resources would normally be employed; and the conditions required by the orthodox theory would be satisfied. The basic point made in both of these passages is that the classical theory could constitute a practical economic theory.4 According to these passages, it is impossible to accurately predict future market conditions and as such it would be impossible for regulatory mechanisms to positive affect market conditions. While such an understanding appears ostensibly logical, Keynes argues that the future is not going to involve unexpected results or lack of market knowledge. Keynes stated, “It may well be that the classical theory represents the way in which we should like our Economy to behave. But, to assume that it actually does so is to assume our difficulties away.”5 Keynes believed that uncertainty is related to the decision of investors to avoid making. In this manner, his theory could explain that fluctuations are elements of a rational marketplace. It should be noted that both uncertainty and ignorance are aspects of all markets. However, in classical economic theory, theoretically if all savings were invested, there would be have any uncertainty. Heilbroner claimed that at one time during the ‘reign’ of classical economic theory all savings were generally invested.6 Unfortunately, in terms of the structure of the modern economy savings and investment are not related in this manner. In these regards, Keynes contends that his theory is more consistent with a scientific viewpoint than the classical economic approach. He contends that such economics is the scientific process of thinking in terms of models that are significantly related to the contemporary world.7 Keynes also provided a pessimistic analysis of capitalism. He argued that economic developments are involuntary and that period economic depressions could remain for the foreseeable future. Such depressions will occur, as wealth is dependent on savings. In addition, investment depends on how production expands. In other words, the entrepreneur cannot be look forward to increases or decreases of production through savings, as doing so places the capitalistic economy under threat of collapse. Structural Components of the General Theory ‘The General Theory’ has three analytical structures: the effective demand, the multiplier mechanism and the theory of monetary and financial markets. This final aspect is oftentimes distorted by interpretation. His ideas could be another articulation of capitalistic production, with effective demand described as the possibility of underemployment equilibrium. Although this is a crucial value of his theory of investments and savings, Keynes’s notion of effective demand does not play a major role in his strategic approach to economic development. The multiplier mechanism determined income both attributed active roles to investments and consumption, and to savings a passive role. It is not merely understandable to connect some amount of income to independent spending or its charges. Warming pointed out that if people save a quarter of the income, the investment rate will increase four times more than they if they did not save the income. In other words, the amounts of the multiplier were decided by the ratio of income saved.8 With this multiplier, Keynes could link between investment and the level of demand in the economy, what he referred to as ‘fundamental psychological law’.9 That is, although someone’s income rises and another’s consumption rises, expenditure is still less than full capacity. He also described the proportion of the rise in consumption to the rise in income as the ‘propensity to consume’.10 In terms of a theory of investment, Keynes approach is similar to Fisher’s argument that the level of expected return on investment is a factor of the ‘marginal efficiency of investment’ and the ratio of interest.1112 In other words, when the interest rate rises, it could produce a decrease in investment. In Keynes’ view, investment and the interest rate put together contribute to market uncertainty. Through this, he also investigated the relationship between uncertainty and investment in what he called ‘the state of long-term expectation’.13 This claim could explain all factors, including deciding the profitability of an investment, consumer demand, changes in consumers’ tastes, costs, and the category of goods’ available. Investors would evaluate all of these issues. The outstanding fact is the extreme precariousness of the basis of knowledge on which estimates of prospective yield have to be made. Knowledge of the factors that will govern the yield of an investment is usually slight and often negligible. If we speak frankly, we have to admit that our basis of knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing.14 This uncertainty made investment not overly dependent on the calculation of future returns. In particular, the conventional rules the way of practice keep for an indefinite period except for having particular reasons to look forward to any change.15 That is to say, Keynes implied that merely minor changes reacted to significant expectations that are based on conventions. Keynes on Global Economic Change Another feature of Keynes theory is that the notion of economics would change between inter-war and post-war periods. It can explain that generally both periods are so different based on monetary economics and business cycles. In these regards, macroeconomics began to clarify mathematical models, including Keynesian economics mathematical models. This economic trend influenced not only macroeconomics, but also other part of world economics. Keynesian economics leads this mathematical subject so that they provided a framework that already proved fully useful. Therefore, Laidler claimed that Keynesian model eventually resulted in the ‘IS-LM model’.16 This model has two primary aspects. The first is that, the IS-LM model incorporated the core of theoretical idea of the General Theory, and disregarded other aspects of it. However, this is an expected consequence of all theories. In the General Theory, a lot of economists claim that Keynes missed important insight. The IS-LM model illustrates a ‘bastard Keynesians’ used by Robinson.17 The reason may be that, when we compare post-war economics with economics between 1920s and 1930s, some forgotten quantities show up. In this manner, the problem is that a lot of economists accepted as facts Keynes’ macroeconomic policies as formulated through past business cycles. The second, more important aspect, regardless of Keynesianism, had success in order to the discussion of the IS-LM model. In these regards, primary types of the economical model did not entirely disappear that they just became minority elements. For instance, Hayek tried to approach political philosophy rather let it fall from core of economic understanding.18 Counter Perspectives to the Keynesian Approach to Economic Recession Hayek argues that the intervention of markets made by government is redundant, or even counter productive. He thinks that the capitalist economy has the function of stabilizing itself. He contends that the main reason of the economic recession is excessive investment that leads to the lack of money supplies. Therefore, as long as the market runs its course, the falling of price caused by recession will trend downward in the savings ratio. The situation in terms of a lack of money supply will reverse conditions and the economy will naturally move toward recovery. However, this argument proved to wrong according to the historical recession.  He claimed that the rise of the totalitarian dictator is because of excessive government intervention and control in the market, leading to the loss of civil liberties as well as politic.19 Hayek considered that Keynes’ ‘The General Theory’ is ‘a tract for the times’.20 In addition, he prepared a model with capital-theoretic foundations, such that that Keynes theory would be replaced by his model. However, although Hayek’s new model was not picked out, he did not want to weaken his influence through argument about wartime inflation.21 On the other hand, the Chicago school’s viewpoint of monetary policy, with Friedman, has been firmly related to inflation as increasing because the supply of money. In particular, money supply actively responds to achievement in the economy, such that the money supply has a strong effect on the economy.22 Apart from other arguments, Fisher’s analysis of the rate of interest looks -- with the price being associated with the present and future – highly influential and persuasive.23 One of the main considerations in terms of the efficacy of the Keynesian approach can be considered in terms of the 2008 economic recession. During this period the United States government, under both the Bush and Obama administrations, administered significant funding as a means of economic stimulus. The ultimate benefits of this program have been greatly debated by opposing political parties as such that gaining a strong understanding of the effectiveness remains vague. Still, the United States unemployment levels still reside relatively high at 9%.24 One considers that rather than large-scale government spending, approaches to economic recession are more functional when driven by entrepreneurial innovation and decreased tax rates. Such innovation has been argued by theorists such as Schumpeter to cause a process of ‘creative destruction’ that results in economic expansion.25 Conclusion In conclusion, Keynes’ theoretical model was both a theory of capitalistic, as well as a description of the events surrounding the Great Depression. Indeed, The Great Depression was the perfect opportunity to test Keynes’ theory. Although his theory had little attention at that moment amongst policy makers, Keynesianism economics was successful for the economic era. No one can deny this in terms of post-war economic prosperity. In particular, his ideas would come to lead world economic thought, including anti-classical economics, government-led deficit spending, full employment and remarkable economic growth within the welfare state. In understanding his theory as a point of fact, it is general theory of capitalist production. Keynes’s theory was based on the circulation of money flows from a top down structure, with a firmness of wages and prices. Under his theory, when money circulation stopped, the economy keeps at a standstill and becomes congested. Basically, Keynesian economics simply encourages the public sector to spend to help the economy. In his treatment, it is crucial to point out that Keynes gave different points of view from classical economic theory. The basic aspect made in both passages is that the classical theory could play a role as a practical economic theory. According to these passages, classical theory operates as a functional static model, but is ineffective in the current economy because of a relative lack of spending compared to past decades. In addition, Keynes theory is not going to be from unexpected results or lack of knowledge, as the theory operates under the assumption of actual knowledge. That is to say, Keynes offered a criticism of the classical theory. If people save a quarter of their income, the investment rate will increase four times more than they if did not save this income. In terms of a theory of investment, Keynes approach is similar to Fisher’s argument that the level of expected return on investment is stated by the ‘marginal efficiency of investment’ coupled with the ratio of interest. The main reason is that macroeconomics began to clarify mathematical models that included Keynesian economics. Ultimately, Keynes economic trend influenced not only macroeconomics, but also other part of world economics. For instance, the IS-LM model implemented the core theoretical ideas of the General Theory. In the General Theory, many economists claimed that Keynes missed important insights. The main reason of economic recession is excessive investment that leads to the lack of money supplies. In particular, money supply actively responds to achievement in the economy and that the money supply had a strong effect on the economy. Read More