Editing Keynesian economics (section)

==Historical context==
===<span id="prekeynesian"></span>Pre-Keynesian macroeconomics ===
[[Macroeconomics]] is the study of the factors applying to an economy as a whole. Important macroeconomic variables include the overall price level, the [[interest rate]], the level of employment, and income (or equivalently output) measured in [[real versus nominal value (economics)|real terms]].

The classical tradition of [[partial equilibrium|partial equilibrium theory]] had been to split the economy into separate markets, each of whose equilibrium conditions could be stated as a single equation determining a single variable. The theoretical apparatus of [[supply (economics)#Supply curve|supply]] and [[demand curve]]s developed by [[Fleeming Jenkin]] and [[Alfred Marshall]] provided a unified mathematical basis for this approach, which the [[Lausanne School]] generalized to general equilibrium theory.

For macroeconomics, relevant partial theories included the [[Quantity theory of money]] determining the price level and the [[interest#classicalinterest|classical theory of the interest rate]]. In regards to employment, the condition referred to by Keynes as the "first postulate of classical economics" stated that the wage is equal to the marginal product, which is a direct application of the [[marginalism|marginalist]] principles developed during the nineteenth century (see [[The General Theory of Employment, Interest and Money#stickiness|''The General Theory'']]). Keynes sought to supplant all three aspects of the classical theory.

=== Precursors of Keynesianism ===
{{See also|Underconsumption|Birmingham School (economics)|Stockholm school (economics)}}
Although Keynes's work was crystallized and given impetus by the advent of the [[Great Depression]], it was part of a long-running debate within economics over the existence and nature of [[general glut]]s. A number of the policies Keynes advocated to address the Great Depression (notably government deficit spending at times of low private investment or consumption), and many of the theoretical ideas he proposed (effective demand, the multiplier, the [[paradox of thrift]]), had been advanced by authors in the 19th and early 20th centuries. (E.g. [[J. M. Robertson]] raised the paradox of thrift [[J. M. Robertson#Political views|in 1892]].<ref name="neglect">{{cite journal|last1=Nash|first1=Robert T.|last2=Gramm|first2=William P.|year=1969|title=A Neglected Early Statement the Paradox of Thrift|journal=History of Political Economy|volume=1|issue=2|pages=395–400|doi=10.1215/00182702-1-2-395}}</ref><ref>{{cite book|url=https://archive.org/stream/fallacyofsavings00robe/fallacyofsavings00robe_djvu.txt|title=The Fallacy of Saving|last=Robertson|first=John M.|year=1892|author-link=J. M. Robertson}}</ref>) Keynes's unique contribution was to provide a ''general theory'' of these, which proved acceptable to the economic establishment.

An intellectual precursor of Keynesian economics was [[underconsumption]] theories associated with [[John Law (economist)|John Law]], [[Thomas Malthus]], the [[Birmingham School (economics)|Birmingham School]] of [[Thomas Attwood (economist)|Thomas Attwood]],<ref>{{Cite book|url=https://books.google.com/books?id=e1ZEPd_pQnoC|title=Business Cycles and Depressions: An Encyclopedia|last=Glasner|first=David|publisher=Taylor & Francis|year=1997|isbn=978-0-8240-0944-1|editor-last=Glasner|editor-first=David|page=22|contribution=Attwood, Thomas (1783–1856)|access-date=15 June 2009|contribution-url=https://books.google.com/books?id=e1ZEPd_pQnoC&pg=PA22|archive-date=9 July 2017|archive-url=https://web.archive.org/web/20170709015906/https://books.google.com/books?id=e1ZEPd_pQnoC|url-status=live}}</ref> and the American economists [[William Trufant Foster]] and [[Waddill Catchings]], who were influential in the 1920s and 1930s. Underconsumptionists were, like Keynes after them, concerned with failure of [[aggregate demand]] to attain potential output, calling this "underconsumption" (focusing on the demand side), rather than "[[overproduction]]" (which would focus on the supply side), and advocating [[economic interventionism]]. Keynes specifically discussed underconsumption (which he wrote "under-consumption") in the ''General Theory,'' in [http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch22.htm#iv Chapter 22, Section IV] and [http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch23.htm#vii Chapter 23, Section VII].

Numerous concepts were developed earlier and independently of Keynes by the [[Stockholm school (economics)|Stockholm school]] during the 1930s; these accomplishments were described in a 1937 article, published in response to the 1936 ''General Theory,'' sharing the Swedish discoveries.<ref>{{Cite journal|last=Ohlin|first=Bertil|author-link=Bertil Ohlin|year=1937|title=Some Notes on the Stockholm Theory of Savings and Investment|journal=Economic Journal}}</ref>

===<span id="earlykeynes">Keynes's early writings</span>===
In 1923, Keynes published his first contribution to economic theory, ''[[A Tract on Monetary Reform]]'', whose point of view is classical but incorporates ideas that later played a part in the ''General Theory''. In particular, looking at the hyperinflation in European economies, he drew attention to the [[opportunity cost]] of holding money (identified with inflation rather than interest) and its influence on the [[Velocity of money|velocity of circulation]].<ref>Robert Dimand, ''The origins of the Keynesian revolution'', p. 7.</ref>

In 1930, he published ''[[A Treatise on Money]]'', intended as a broad treatment of its subject "which would confirm his stature as a serious academic scholar, rather than just as the author of stinging polemics",<ref>Dimand, ''op. cit''., p. 23.</ref> and marks a large step in the direction of his later views. In it, he attributes unemployment to wage stickiness<ref>Dimand, ''op. cit''., p31.</ref> and treats saving and investment as governed by independent decisions: the former varying positively with the interest rate,<ref>Dimand, ''op. cit''., p. 36.</ref> the latter negatively.<ref>Dimand, ''op. cit''., p35.</ref> The velocity of circulation is expressed as a function of the rate of interest.<ref>Dimand, ''op. cit''., p. 38.</ref> He interpreted his treatment of liquidity as implying a purely monetary theory of interest.<ref>Dimand, ''op. cit''., p133.</ref>

Keynes's younger colleagues of the [[Cambridge Circus (economics)|Cambridge Circus]] and [[Ralph Hawtrey]] believed that his arguments implicitly assumed [[full employment]], and this influenced the direction of his subsequent work.<ref>Dimand, ''op. cit''., pp. 136–141.</ref> During 1933, he wrote essays on various economic topics "all of which are cast in terms of movement of output as a whole".<ref>Editorial introduction to the ''General Theory''  in Keynes's Collected Writings.</ref>

===Development of ''The General Theory''===
At the time that Keynes wrote the [[The General Theory of Employment, Interest and Money|General Theory]], it had been a tenet of mainstream economic thought that the economy would automatically revert to a state of general equilibrium: it had been assumed that, because the needs of consumers are always greater than the capacity of the producers to satisfy those needs, everything that is produced would eventually be consumed once the appropriate price was found for it. This perception is reflected in [[Say's law]]<ref>{{cite book|title=A Treatise on Political Economy; or the Production Distribution and Consumption of Wealth|last=Say|first=Jean-Baptiste|publisher=Batoche Books|year=2001|location=Kitchener}}</ref> and in the writing of [[David Ricardo]],<ref>{{cite book|title=On The Principles of Political Economy and Taxation|last=Ricardo|first=David|year=1871}}</ref> which states that individuals produce so that they can either consume what they have manufactured or sell their output so that they can buy someone else's output. This argument rests upon the assumption that if a surplus of goods or services exists, they would naturally drop in price to the point where they would be consumed.

Given the backdrop of high and persistent unemployment during the Great Depression, Keynes argued that there was no guarantee that the goods that individuals produce would be met with adequate effective demand, and periods of high unemployment could be expected, especially when the economy was contracting in size. He saw the economy as unable to maintain itself at full employment automatically, and believed that it was necessary for the government to step in and put purchasing power into the hands of the working population through government spending. Thus, according to Keynesian theory, some individually rational [[microeconomics|microeconomic-level]] actions such as not investing savings in the goods and services produced by the economy, if taken collectively by a large proportion of individuals and firms, can lead to outcomes wherein the economy operates below its potential output and growth rate.

Prior to Keynes, a situation in which [[aggregate demand]] for [[good (economics)|goods]] and services did not meet supply was referred to by [[classical economics|classical economists]] as a ''[[general glut]]'', although there was disagreement among them as to whether a general glut was possible. Keynes argued that when a glut occurred, it was the over-reaction of producers and the laying off of workers that led to a fall in demand and perpetuated the problem. Keynesians therefore advocate an active stabilization policy to reduce the amplitude of the business cycle, which they rank among the most serious of economic problems. According to the theory, government spending can be used to increase aggregate demand, thus increasing economic activity, reducing unemployment and [[deflation (economics)|deflation]].

===<span id="multorigins">Origins of the multiplier</span>===
The [[Liberal Party (UK)|Liberal Party]] fought the 1929 General Election on a promise to "reduce levels of unemployment to normal within one year by utilising the stagnant labour force in vast schemes of national development".<ref>[http://www.liberalhistory.org.uk/history/the-1929-general-election/The 1929 general election] {{Webarchive|url=https://web.archive.org/web/20220717055645/https://liberalhistory.org.uk/journal-articles/the-1906-landslide-the-legacy/ |date=17 July 2022 }}, Liberal Democrat History Group.</ref> [[David Lloyd George]] launched his campaign in March with a policy document, ''We can cure unemployment,'' which tentatively claimed that, "Public works would lead to a second round of spending as the workers spent their wages."<ref>Dimand, ''op. cit.'', pp102f.</ref> Two months later Keynes, then nearing completion of his ''Treatise on money'',<ref>He had been working on the book since 1923, and finally signed the preface on 14 September 1930. Dimand, ''op. cit.'', p. 119.</ref> and [[Hubert Henderson]] collaborated on a political pamphlet seeking to "provide academically respectable economic arguments" for Lloyd George's policies.<ref>Dimand, ''op. cit.'', pp92f.</ref> It was titled ''Can Lloyd George do it?'' and endorsed the claim that "greater trade activity would make for greater trade activity ... with a cumulative effect".<ref>Kahn, ''The making of the ''General Theory'' '', p92.</ref> This became the mechanism of the "ratio" published by [[Richard Kahn, Baron Kahn|Richard Kahn]] in his 1931 paper "The relation of home investment to unemployment",<ref>Published in ''The Economic Journal''.</ref> described by [[Alvin Hansen]] as "one of the great landmarks of economic analysis".<ref>''Guide to Keynes'' (1953), p. 88.</ref> The "ratio" was soon rechristened the "multiplier" at Keynes's suggestion.<ref>Kahn, ''The making of the ''General Theory, p. 95.</ref>

The [[Fiscal multiplier|multiplier]] of Kahn's paper is based on a respending mechanism familiar nowadays from textbooks. Samuelson puts it as follows:
<blockquote>Let's suppose that I hire unemployed resources to build a $1000 woodshed. My carpenters and lumber producers will get an extra $1000 of income... If they all have a marginal propensity to consume of 2/3, they will now spend $666.67 on new consumption goods. The producers of these goods will now have extra incomes... they in turn will spend $444.44 ... Thus an endless chain of ''secondary consumption respending'' is set in motion by my ''primary'' investment of $1000.<ref>P. A. Samuelson, ''Economics: an introductory analysis'', 1948 and many subsequent editions. 16th edition consulted.</ref></blockquote>
Samuelson's treatment closely follows [[Joan Robinson]]'s account of 1937<ref>''Introduction to the Theory of Employment'', which she described as a "told-to-the-children" account (letter to Keynes included in his Collected Writings vol XXIX, p185), referring to a series of retellings of classic stories.</ref> and is the main channel by which the multiplier has influenced Keynesian theory. It differs significantly from Kahn's paper and even more from Keynes's book.

The designation of the initial spending as "investment" and the employment-creating respending as "consumption" echoes Kahn faithfully, though he gives no reason why initial consumption or subsequent investment respending should not have exactly the same effects. [[Henry Hazlitt]], who considered Keynes as much a culprit as Kahn and Samuelson, wrote that ...
<blockquote>... in connection with the multiplier (and indeed most of the time) what Keynes is referring to as "investment" really means ''any addition to spending for any purpose''... The word "investment" is being used in a Pickwickian, or Keynesian, sense.<ref>''The failure of the new economics'', 1959, pp148f.</ref></blockquote>

Kahn envisaged money as being passed from hand to hand, creating employment at each step, until it came to rest in a ''cul-de-sac'' (Hansen's term was "leakage"); the only ''culs-de-sac'' he acknowledged were imports and hoarding, although he also said that a rise in prices might dilute the multiplier effect. Jens Warming recognised that personal saving had to be considered,<ref>"International difficulties arising out of the financing of public works during depressions," ''Economic Journal'', 1932.</ref> treating it as a "leakage" (p.&nbsp;214) while recognising on p.&nbsp;217 that it might in fact be invested.

The textbook multiplier gives the impression that making society richer is the easiest thing in the world: the government just needs to spend more. In Kahn's paper, it is harder. For him, the initial expenditure must not be a diversion of funds from other uses, but an increase in the total expenditure: something impossible – if understood in real terms – under the classical theory that the level of expenditure is limited by the economy's income/output. On page 174, Kahn rejects the claim that the effect of public works is at the expense of expenditure elsewhere, admitting that this might arise if the revenue is raised by taxation, but says that other available means have no such consequences. As an example, he suggests that the money may be raised by borrowing from banks, since ...
<blockquote>... it is always within the power of the banking system to advance to the Government the cost of the roads without in any way affecting the flow of investment along the normal channels.</blockquote>
This assumes that banks are free to create resources to answer any demand. But Kahn adds that ...
<blockquote>... no such hypothesis is really necessary. For it will be demonstrated later on that, ''pari passu'' with the building of roads, funds are released from various sources at precisely the rate that is required to pay the cost of the roads.</blockquote>

The demonstration relies on "Mr Meade's relation" (due to [[James Meade]]) asserting that the total amount of money that disappears into ''culs-de-sac'' is equal to the original outlay,<ref>See Dimand, ''op. cit.'', p. 114. Kahn's presentation is more complicated owing to the inclusion of dole and other factors.</ref> which in Kahn's words "should bring relief and consolation to those who are worried about the monetary sources" (p.&nbsp;189).

A respending multiplier had been proposed earlier by Hawtrey in a 1928 Treasury memorandum ("with imports as the only leakage"), but the idea was discarded in his own subsequent writings.<ref>Dimand, ''op. cit.'', pp. 107–110.</ref> Soon afterwards the Australian economist [[Lyndhurst Giblin]] published a multiplier analysis in a 1930 lecture (again with imports as the only leakage).<ref>Dimand, ''op. cit.'', pp105-107.</ref> The idea itself was much older. Some Dutch [[mercantilism|mercantilists]] had believed in an infinite multiplier for military expenditure (assuming no import "leakage"), since ...
<blockquote>... a war could support itself for an unlimited period if only money remained in the country ... For if money itself is "consumed", this simply means that it passes into someone else's possession, and this process may continue indefinitely.<ref>Eli Heckscher, ''Mercantilism'' (1931, English tr. 1935), vol II, p. 202.</ref></blockquote> Multiplier doctrines had subsequently been expressed in more theoretical terms by the Dane [[Julius Wulff]] (1896), the Australian [[Alfred de Lissa]] (late 1890s), the German/American [[Nicholas Johannsen]] (same period), and the Dane Fr. Johannsen (1925/1927).<ref>Dimand, ''op. cit.'', pp117f.</ref> Kahn himself said that the idea was given to him as a child by his father.<ref>Kahn, ''The making of the ''General Theory'' '', p. 101.</ref>

===<span id="policydebates">Public policy debates</span>===
As the 1929 election approached "Keynes was becoming a strong public advocate of capital development" as a public measure to alleviate unemployment.<ref>Kahn, ''op. cit.'', p78.</ref> Winston Churchill, the Conservative Chancellor, took the opposite view:
<blockquote>It is the orthodox Treasury dogma, steadfastly held ... [that] very little additional employment and no permanent additional employment can, in fact, be created by State borrowing and State expenditure.<ref>Kahn, ''op. cit.'', p. 79, quoting from Keynes's collected writings.</ref></blockquote>
Keynes pounced on a flaw in the [[Treasury view]]. Cross-examining [[Richard Hopkins (civil servant)|Sir Richard Hopkins]], a Second Secretary in the Treasury, before the [[Macmillan Committee]] on Finance and Industry in 1930 he referred to the "first proposition" that "schemes of capital development are of no use for reducing unemployment" and asked whether "it would be a misunderstanding of the Treasury view to say that they hold to the first proposition". Hopkins responded that "The first proposition goes much too far. The first proposition would ascribe to us an absolute and rigid dogma, would it not?"<ref>Kahn, ''op. cit.'', pp83f, quoting the Committee minutes.</ref>

Later the same year, speaking in a newly created Committee of Economists, Keynes tried to use Kahn's emerging multiplier theory to argue for public works, "but Pigou's and Henderson's objections ensured that there was no sign of this in the final product".<ref>Kahn, ''op. cit.'', p. 96, quoting a study by Susan Howson and Donald Winch.</ref> In 1933 he gave wider publicity to his support for Kahn's multiplier in a series of articles titled "The road to prosperity" in ''The Times'' newspaper.<ref>Dimand, ''op. cit.'', p158.</ref>

[[Arthur Cecil Pigou|A. C. Pigou]] was at the time the sole economics professor at Cambridge. He had a continuing interest in the subject of unemployment, having expressed the view in his popular ''Unemployment'' (1913) that it was caused by "maladjustment between wage-rates and demand"<ref>Cited by Kahn, ''op. cit.'', p. 193.</ref> – a view Keynes may have shared prior to the years of the ''General Theory''. Nor were his practical recommendations very different: "on many occasions in the thirties" Pigou "gave public support [...] to State action designed to stimulate employment".<ref>Kahn, ''op. cit.'', p. 193.</ref> Where the two men differed is in the link between theory and practice. Keynes was seeking to build theoretical foundations to support his recommendations for public works while Pigou showed no disposition to move away from classical doctrine. Referring to him and [[Dennis Robertson (economist)|Dennis Robertson]], Keynes asked rhetorically: "Why do they insist on maintaining theories from which their own practical conclusions cannot possibly follow?"<ref>Dimand, ''op. cit.'', p. 76.</ref>