{"id":7348,"date":"2020-01-20T14:41:19","date_gmt":"2020-01-20T14:41:19","guid":{"rendered":"https:\/\/progressiveeconomyforum.com\/development\/?p=7348"},"modified":"2020-01-20T14:48:10","modified_gmt":"2020-01-20T14:48:10","slug":"principals-of-macroeconomics-4-the-keynesian-revolution","status":"publish","type":"post","link":"https:\/\/progressiveeconomyforum.com\/development\/blog\/principals-of-macroeconomics-4-the-keynesian-revolution\/","title":{"rendered":"Principals of Macroeconomics 4: The Keynesian Revolution"},"content":{"rendered":"\n

Background to Keynes<\/strong><\/h3>\n\n\n\n

<\/p>\n\n\n\n

Businesses produce things in\norder to sell them. The implied causality that spending (demand) determines how\nmuch is produced (supply) seems so obvious today after 150 years of\nboom-and-bust that it is strange that mainstream economics largely ignored it\nfrom the 1860s into the 1920s. <\/p>\n\n\n\n

Ideological bias offers the most plausible\nexplanation of this avoidance of the demand problem endemic to market societies.\nBefore the 1860s the major thinkers from Ricardo<\/a>\nto Marx<\/a>\nsought to explain the operation of the emerging market system. Whatever their\npolitical predilection, they could not ignore the weaknesses of the\nincreasingly dominant capitalist system if they took the task of explanation\nseriously.<\/p>\n\n\n\n

By the 1860s capitalism clearly\nachieved its dominance, especially in the United Kingdom. The mainstream of the\nprofession adopted as its task justification and defence not explanation. William\nStanley Jevons (1835-1882) took the lead in the canonising of capitalism and\nits value system, an approach challenged only by a few radicals such\nas John A. Hobson<\/a>.<\/p>\n\n\n\n

For\nseventy years after Jevons’ seminal work, A\nGeneral Mathematical Theory of Political Economy<\/em> (1862), a highly ideological model of the market\nsystem, prevailed in the profession. That model treated market economies as self-adjusting\nto full utilization of resources if governments did not interfere with its automatic\noperation. Competition in unregulated markets would eliminate unemployment and\ngenerate the most efficient allocation of society’s resources. The great ills\nof capitalism, unemployment and inflation, resulted from public intervention\nand trade unions.<\/p>\n\n\n\n

John Maynard Keynes (1883-1946) referred to this ideology as\nclassical [economic] theory and to its advocates simply as “the\nClassics” (The General Theory of\nEmployment, Interest and Money,<\/em> Preface]. While this creates a potential\nsource of confusion (Adam Smith through John Stuart Mill are usually called\n“classical\u201d economists), in the late 1930s with an article by Sir John\nHicks titled “Mr Keynes and the Classics” (1937 established it as\nstandard terminology.<\/p>\n\n\n\n

Effective Demand & its Implications<\/strong><\/h3>\n\n\n\n

<\/p>\n\n\n\n

The presumption of automatic adjustment to full employment,\ncontinuous full employment, meant that the Classical analysis did not consider\nchanges in the level of output. The economy was always at full employment\nmaking it unnecessary to analyze or devote concern to idle labour or machinery.\n<\/p>\n\n\n\n

In his Preface to The General Theory<\/em>, Keynes makes a criticism of his own work based on this analytical limitation:<\/p>\n\n\n\n

“But my lack of emancipation [in the Treatise on Money<\/a> <\/em>1930] from preconceived ideas showed itself in what now seems to me to be the outstanding fault of the theoretical parts of that work…that I failed to deal thoroughly with the effects of changes in the level of output… This book [The General Theory<\/em>], on the other hand, has evolved into what is primarily a study of the forces which determine changes in the scale of output and employment as a whole; and, whilst it is found that money enters into the economic scheme in an essential and peculiar manner, technical monetary detail falls into the background.” (The General Theory. Preface).<\/p><\/blockquote>\n\n\n\n

A few sentences later Keynes uses\nthe phrase “a struggle of escape” to describe his intellectual\nchange, “The composition of this book has been for the author a long\nstruggle of escape…a struggle of escape from habitual modes of thought and\nexpression”. It is one thing to recognize that full employment represents\na special case, but much more difficult to specify how to explain why employment\ngoes up and down. <\/p>\n\n\n\n

After defining his concepts,\nKeynes provides the insight to understanding levels of output and employment in\nBook III of The General Theory<\/em>,\n“The Propensity to Consume” (Chapters 8-10). In these chapters Keynes\nverifies the famous quotation by Albert Einstein, “genius is taking the\ncomplex and making it simple”, in this case variations in output is the\ncomplex and the \u201cconsumption function\u201d provides the key to explaining it\nsimply.<\/p>\n\n\n\n

We can understand the basic\nargument without delving into the technical detail of Keynes\u2019 theory of\nconsumption. A market economy has four types of expenditure on domestic\nproducts, household spending (consumption), business spending (investment),\ngovernment outlays and exports. These are obvious and listing them involves no\ninsight.  Keynes provided insight by focusing\non the two major sources of private domestic spending, consumption and\ninvestment.<\/p>\n\n\n\n

In this simple case of a purely private\neconomy what households and businesses spend determines what business produce. Business\ninvestment creates new production facilities and machinery that may last for years.\nTherefore, businesses do not make the decision to invest on the current health\nof the economy, but on their expectations for an extended future (discussed in\nChapter 12 of The General Theory<\/em>). While\nrecessions and depressions discourage investment, as during 2008-2010,\ninvestment increases because of optimism about conditions well into the future\nnot just this year. Private investment tends to be volatile and unstable like\nthe expectations that so strongly influence it.<\/p>\n\n\n\n

We now come to Keynes’ first major conclusion<\/strong>, that changes in employment and production result from the instability of private investment. When expectations by businesses are robust, the economy expands, driving household spending and raising employment and vice-versa. Household consumption, much of it based on immediate need, tends to be stable compared to investment.<\/p>\n\n\n\n

The second major insight<\/strong> follows directly from the first. The amount of private investment determines our economy\u2019s production and employment. While investment and the expenditure it generates stabilize the economy, this can occur at less than full employment. A fully employed economy is the special case, and less than full employment the general case (thus, the title of Keynes\u2019 book, The General<\/em> Theory)).<\/p>\n\n\n\n

Economic Policy Revolutionised<\/strong><\/h3>\n\n\n\n

<\/p>\n\n\n\n

Keynes\u2019 basic insights, that private\ninvestment stabilizes output and that stabilization typically occurs with idle\nlabour, constitute the core of the \u201cKeynesian Revolution\u201d. The conclusion that\nidle labour is the usual state of a market economy has profound implications\nfor mainstream theory and policy.<\/p>\n\n\n\n

The insights imply that left to\nits normal operation, the private sector results in an economy characterized by\npersistent under-utilization of human and material resource. This leads to the\nobvious economic policy guideline that public sector intervention is necessary\nin order for the national economy to maintain and prosper at full utilization\nof its human resources.<\/p>\n\n\n\n

The necessity for policy action\nto achieve and maintain full capacity forms part of a more general and quite far-reaching\nconclusion. Mainstream economics is the analysis of, science of some would say,\nthe allocation of scarce resources among unlimited desires. Resources are\nlimited and people\u2019s wants are unlimited. This putative tension between the reality\nof scarcity and subjective desire for abundance is allegedly resolved through\nthe price system. On the basis of market prices people allocate their limited\nincomes to best satisfy their wants.<\/p>\n\n\n\n

If the normal operation of the\neconomy results in idle labour, then resources are not scarce. Idle labour\nimplies for the economy as a whole more can be produced of everything. To the\nindividual resources appear scarce \u2013 household income cannot cover the needs of\nmost families. For the economy in its entirety that opposite is the case,\nchronic unemployment leaves productive resources wasted. Government spending\nmanagement converts aggregate idleness into full employment, increasing\nhousehold incomes and reducing household \u201cscarcity\u201d.<\/p>\n\n\n\n

Further reading from PEF economists:<\/strong> <\/h3>\n\n\n\n

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