Keynes's Theory

Keynes’s Theory by Mark Lindley To explain briefly the ma in thing tha t John M ayna rd Keyn es achieved as an eco nom ic theorist in his famou s Gen eral Th eory of Employment, Interest and Money (1936), let me describe the traditional concept of market “equilibrium,” starting with the everyday notion of the difference between a “buyer’s market” and a “seller’s market.” Bargains – the chance to buy things for less than you think they are worth – make a buyer’s market. Suckers (including “muppets,” i.e. investors ignorantly optimistic about what they are bu ying) an d other people willing to pay m ore for th ings than th e sellers think they are worth, m ake a seller’s market. “E quilibrium” would occur when there is neither a buyers’ nor a sellers’ market, i.e. when (a) the prices that sellers would like to get and (b) those which buyers wo uld like to pay are the same (and so no ha ggling is needed). You m ight imagine that each day in the stock mark et (back in the old days when it was realistic to conside r the stock m arket as a m erely nation al thing that closed down o vernight), a certain equilibrium is reflected in the prices posted at the end of the day. (And indeed the concept of general equilibrium in the market was invented, in the 1870s, by an economist alert to that phenomenon.) But if you imagine that during the night some potential sellers and/or buyers must be eagerly awaiting the next morning because they think the closing prices show how they can profit by further dealing and wheeling, you can see that it’s not really an equilibrium but only a pause in a market that still has some disequilibrium. Market equilibrium – which would be attained if and when supply and demand were exactly the same – is a little like a mathematical limit that can be approached but never quite reached. But somewhat as it’s useful in calculus to imagine a mathematical limit attained, so also the theoretical concept of market equilibrium might p erhap s be useful in m arket econom ics. A belief universally accep ted in “neoclassical” econo mic theo ry before Keynes (“n eoclassical” theory goes ba ck to the 1860s; the difference betw een it and th e “cla ssical,” Ad am -Sm ith-type theory need n’t concern us here) was tha t in a state of general eq uilibrium in regard to prices, there would be no unemployment: everybody who wanted a paying job would have one. Keynes’s great achievement as an economic theorist was to show that general equilibrium in regard to prices could co-exist with massive unemployme nt – som ething so bad that “depressio n” is clearly a mo re pertin ent term for it th an “equilibrium .” His pro posed rem edy would be to lapse from laissez-faire and interfere with the workings of the market by G IV IN G some money to people who need things. They would use it to increase demand in the market; the resulting disequilibrium (a sellers’ market, and hence with an inflationary tendency) wou ld stimulate produ cers to prod uce m ore and therefore to hire more wo rkers; and th is would set th e market off in a better direction. And who might give money to the needy (and thus interfere creatively with the workings of the free market)? The two possibilities are charity and governm ent. If governm ent wo uld do it and m eanw hile print mo re mo ney, the overall effect could be to make the economy bigger and thus increase per-cap ita wealth if the population is stable. The government might oblige some of the recipients of the mon ey to do som ething for it – to plant trees or build schools and po st offices and decorate them with murals, etc. – but all that would be merely a set of additional benefits to the nation; the essential thing would be the “demand-side” stimulating effect of providing poor folks with money to spend for goods and services they need. Critics of the Keynesian prescription for getting out of a depression would argue that while mass unemployment is an unfortunate thing, the re is sometim es a solid reason for it – an und erlying disease in the econo my – and th at the Keynesian p rescription interferes with the proper cure for that kind of disease. That disease would always be: outmoded and/or otherwise inefficient kinds of production. The “natural” cure (i.e. within the unhampered free market) would be “creative destruction,” a weeding out of the inefficient firms and outmoded methods of production; but in a “sellers’ market” the bad old firms would be able to hang on, and thus the underlying disease, uncured, would inevitably recur in the long run – and worse than before, since the outmoded methods would n ow be eve n m ore outm ode d an d the mana gers of the inefficient firms wouldn ’t have learne d the right lesson. It was not in response to such a critique that Keynes wrote his most famous sentence, “In the long run we are all dead.” (On the contrary, he made that remark in the context of arguing for government intervention to prevent excessive inflation.) Yet it can be adap ted to m ean that in the long run after a p eriod of artificial, deman d-side stimulation , new generation s of geeks and man agers would have a sporting chance of seeing where the old ways had become outmoded or had gone awry, and hence of inventing and adopting better methods of production. Keynes’s theoretical model of 1936 did not include, however, a time-dimension; the thing about it was that it showed that a theoretical equilibrium in regard to p rices would not en tail full emp loyment. Keynes was optimistic about future generations. He had no inkling of potential ecological problems. However, his teacher, Alfred Marsh all, the preëm inen t English-speakin g eco nomist of th e previous generation , had rema rked th at “e very cha nge in so cial co nditions is likely to require a new development of economic doctrines,” and Keynes incorporated this insight in the following definition: “Econom ics is a science of thinking in te rms of m odels [, ] joined to the art of choosing models which are relevant to the contemp orary w orld. It is compelled to do this because [,] unlike the typ ical natural science, the material to which it is applied is, in too many respects not hom ogeneo us through tim e.”