SOP (D) Economics Keynes Amogha

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John Maynard Keynes(5th June 1883 ± 21st April 1946)

S.O.P. (C)

Economics

January 30

2012Was Keynes right after all? Justify

your view. 1103521B



(Krugman, 2011)³The good news, such as it is, is that President Obamahas finally gone back to fighting against premature austerity ² and heseems to be winning the political battle. And one of these years we might actually end up taking Keynes¶s advice, which is every bit as valid now asit was 75 years ago AFTER ALL.´ The U.S., now the world's largestdebtor, embraces the great British economist's 75-year-old argument

(Skidelsky, 1996)Born in a total diff erent world of µCapitalisticIndividualism¶ was John Maynard Keynes on the 05th of June 1883, tosave the µCapitalistic Individualism¶ . Which if left unchecked would make a

µauthoritarian state system¶. At age of 31, during the First World WarKeynes played an important role in averting gold standard collapse inbanking crisis. (Rowse, 1996) Undoubtedly he was a genius person and a

devoted state servant. (Keynes, 1920) His best-selling book making himworld famous for his prediction that levying Germany on the post warreparation cost would pave way for hyperinflation in Germany and bearinga negative consequence over Europe & foster a desire for revenge amongGermans. Followed by this was the prediction of the slowdown in

economic growth and reduction in real wages due to return to a pre-warexchange rate yielded him name and fame. In the era where people were deciding between communism and capitalism, it was Keynes who showedthem a third way which over turned the world of economics. A geniusperson like others of his era, Keynes was full of ideas, often innovative and heterodox. Even to this day many people refuse to accept that

analysis of Keynes was correct; on the other hand none have questionedthat what topic he dealt with was at the heart of economic theory andpolicy. Yet where did he go wrong for people to debate ³W AS HE RIGHT

± AFTER ALL´ . Do not forget one thing: ³if Adam smith was the father of economics, J M Keynes was the rock star of economics´

Introduction

(Stewart, 1972) Between the two world wars there existed a huge unemployment f eature.

Keynes had an explanation to this. µThe ideas of economists and political philosophers,¶ he wrote in the General Theory are more powerful thancommonly understood. (Harrod, 1951) It is precisely due to those defunct

economists¶ salves of the 1920s and 30s who call them as practice men,things went badly wrong. This is because the world had changeddrastically since their time and following those invalid assumptions was

defunct. In order to understand Keynes theory better and to justify hisviews we need to begin by looking back at what the pre-Keynesian

economists had to say on sub ject of employment.(Robinson, 1947) Economics is not an exact science: controlledexperiments cannot be conducted on its sub ject matter. (Stewart, 1972)Say¶s Law stated that supply created its own demand. Ricardo laterargued that some shift in demand could result in sudden fall of demand.With the emergence of the 19th century trade and attempts made to



account for it, resulted in qualification of say¶s law. Nevertheless say¶s lawwas valid among small periodic appearance of unemployment in capitalgood industries in large numbers. (Heilbroner, 1969)The unemploymentwas result of unbalanced production caused by rapid expansion. Inprinciple, the economy would absorb the entire commodity it produced.So an economist then thought that all one could do was to stand back

wait and watch. What if the economy never regained was the question.The only solution was to reduce wages in order to get back to fullemployment. (Hazlitt 1995:21), nevertheless, this theory made many

economists including Keynes f eel uneasy and refused to advocate the policy measures. (Hazlitt, 1995) Keynes was against this theory andproves it wrong through his work µThe General Theory¶ argues Hazlitt.

(Kregel, 1983) The missing piece of theory ³demand for the output as awhole´ which was explained by Keynes in his theory was his greatestcontribution.

The Issues between Keynes and Classics:

(Keynes, 1935) The simple classical theory concentrates only on two basichypothesises. First being ³the wage is equal to the marginal product of

labour´ and secondly ³the utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of

employmen´. (Keynes, 1937) argued that many concepts were failed tobe explained in the Classical Theory. Keynes decribes money as ´ store of wealth´, unlike classical econimists who do term it unproductive.³The boom, not the slump, is the right time for austerity at the Treasury´ So declared J M Keynes in the year 1937, even as president Franklin DRoosevelt, was about to prove Keynes right by attempting a pre-mature

balanced budget trial, sending the United States economy ² which hadbeen steadily recovering up to that point ² into a severe recession. The economy further weakens when government spending is slashed pre-

maturely in a weak economy; austerity should wait until a strongrecovery is well under way. (Budd, 2011) Keynes was argued thatgovernments must never balance their budgets but run a deficit orsurplus in order to aff ect economic lif e generally.

The General Theory & Monetarism

(Viner, 1937) ³frictional´ and ³voluntary´ were the only two types of unemployment that Classical Theory was aware off. But what about the ³invoulantary´ type? (Mantoux, 1946) (Viner, 1937) Keynes disagreed onthe Classical Theory concept of Decrease in Wages would increase

employment but instead states that the absence of ³invoulantary´ unemployment triggers ³full employment´ . (Skidelsky, 1996) Keynes was

mainly concerned about why unemployment appears in certain induatriessometimes.



(Skidelsky, 1996) (Keynes, 1935) Output is always determined by aconcept called as ³effective demand´ that was neglected by classicaleconomists. ³Effective demand´ is determined why what factor? Keynesher argues that ³effective demand´ must be broken into two components,consumption and demand and then study them each in turn. (Earl & Wakeley:425, 2005) (Keynes, 1935) There is a fairly clear distinction

between each other. If an individual spends money on any item then itsexpenditure on the same hand if a company or firm spends the same thenits investment.

(Stewart,1967:84)Consumption of an individual is based on his income.Consumption is normally rather less than his income, but in rare cases itis equal to his income but never excess. (Keynes J. M., 1935:39)

Propensity to consume as christened by Keynes is described as arelationship between consumption in terms of wage-units (Cw) to the income in terms of wage-units (Yw) equivalent to a level of employment N.Generally, regarding Yw as uniquely determined by N is a goodapproximation. Due to incapability of precise numerical measurement of

real income in terms of product, Keynes conveniently regards income interms of wage-units, which is assumed by Keynes and Argued by (Knight,1937) that¶s this is due simplicity and not the fact. Keynes defines what¶scalled propensity to consume as the functional relationship c between Yw a given level of income in terms of wage-units, and Cw the expenditureon consumption out of that level of income, so that Cw = c(Yw) or

c=Cw/Yw.As stated earlier the value of consumption is always less than income.(Keynes, 1935:41)Hence the change in Income and consumption is

always a positive fractional value less than unity. (Mantoux, 1946) Alsoadds to this by saying that eff ective demand increases directly with more

savings. What happens if at any point Cw exceeds Yw asks (Viner,1937:51-52). Also Jacob Viner comments that at the time of war orrecession, expenditure exceeds income. Hence he says that Keynes

theory is valid for a given time, hence incomplete and needs modificationas time progresses.Also (Keynes, 1935) The Keynesian Cross is a simple closed economy

model in which income is determined by expenditure. The GDP can be calculated by using the terms propensity to consume and effective

demand. The Figure beside showsthe Keynesian Cross Model, which isnothing but a relationship of Income

(Y) on X-axis and Aggregate Demand/Expenditure (AD) on the Y-axis. When Expenditure equalsincome we get a 45° Line (Ideal

Condition). When a desiredexpenditure value (C+I+G) is plottedagainst the ideal line (blue line in the fig) the intersection point gives us



the equivalent value of Y which is nothing but real GDP. Also GDP isdependent on the C,I,G factor. Assuming a change in Government PolicyG, then AE varies, like an increase in Tax with reduce Expenditure andvice versa causing GDP to fluctuate. The below illustration shows the GDPchange with change in G. Also the illustration shows what is called as the Multiplier eff ect, where in Keynes showed that marginal propensity to

consume could in fact induce a drastic change in the GDP equilibrium andis supported by (Earl & Wakeley, 2005) & (Tily, 2010)



Figure 2: Keynesian Cross & Multiplier

The Keynesian Cross had its own assumptions and limitations. (Suranovic,

2010) & (Mankiw, 2002) Firstly being the AD/AE (Aggregate Demand /Aggregate Expenditure) curve is always assumed to be positive. This isbecause of an output increase, leading to an income increase and thus

increasing consumption. This in turn increases AE. The model uses fixed

prices and hence does not account for inflation or deflation analysis. Alsoprice changes eff ect the inflation. This is followed by the assumption of AE/AD curve being positive. This is in order for the AD curve to cut the Equilibrium for an output. (Earl & Wakeley, 2005) Finally Only basicknowledge of the supply side is provided. (Hale, 1976) Also argues that

the thinking of Keynesians was based on huge assumptions and they were really not supported by evidence from the real world. As in the multipliercase above Keynes has neglected to add the same for private saving.

Keynes Monetary Theory:

(Stewart, 1972:88-90) Keynes argues that rate of interest (ROI) is the price at which money is borrowed and is determined by demand & supply.

People like to hold money in liquid cash (liquidity) for reasons viz.Transaction motive, precautionary motive & speculative motive. The firsttwo are not aff ected by ROI, whereas the speculative motive is, so people may take advantage of the situation. Demand for money to satisfyspeculative motive is high at low ROI and vice versa. (Friedman, 1970)

Argues about the direct impact the supply of money may have on the total expenditure and hence on the behaviour of the economy.Investement as per The Classcial Theory is described as saving at a fixed

ROI. Whereas Keynes describes saving as diff erence in income and

consumption & is heavily dependent on this parameter. (Kregel, 1983) Arestriction on income is caused if savings and investment expenditure are related. (Stewart, 1972:90-91&142) ROI is determined by the amount of money created by central bank v/s people¶s demand for money (or, askeynes put it, their liquidity pref erence). (Mantoux, 1946:117) This is in

contradiction to the classical economist who believe ROI is dependant on³supply of and demand for saving´.The Keynesian Monetary Hypothesis is that deamnd for money is interest

elastic i.e. interest rates can cause huge change in demand for money



and hence investment. Aggregate demand rises with a rise in investmentthrough a chain process. (Scott, 1963) Argues that in many casesdemand for investment may not be receptive at low interest reates.(Friedman, 1968) concludes by saying that By adpoting the keynesianmonetary policy and following a steady course, we could achieve inpromoting economic stability.

Keynes Betrayed and Macroeconomics after 70 Years:

(Howard, 2010)Governments were successful, as they had not been in the

1930¶s, in using fiscal policy to prevent the world from sliding into a fullscale depression. (Tily, 2010) These initiatives were eff ective up to acertain point and finally we had the re-birth of Keynes hypothesis, duringthe recent financial crisis. (Worswick & Trevithick, 1983) Its only duringthe 2008 crisis did the governments (especially USA) adopted Keynes

policies to control the crisis, rather if the same had been done during the

1970¶s inflationary period we could have controlled at lot. (Arestis & Sawyer, 2010:73-74) Keynesian growth theory seems to have a

promising future analysing the dynamics of national and global economics.Along with its increasing relevance, orthodox and heterodox growth economies experiencing theoretical changes are making it more easier forKeynesian theories of economic growth to be more acceptable. Keynesiantheory can monitor long run role of government fiscal policy & examine interaction between expectational & financial factors, showing the

occurrence of cyclic growth.

Conclusion

Though it no longer holds the same esteem as it once did, far from deadis Keynesian economics. An outgrowth of Keynesian economics is seen

when we see people spend or a increasing figure in economy. Even the 2008 US Govt. stimulus checks of consumers to spend and get the economy out of trouble. (Tily, 2010) ³Keynesian thinking will never

completely leave the media or the government´. I argue that the economics prof ession has distorted and betrayed Keyneslegacy. In virtually all interpretations ± especially those taught to student

± Keynes is portrayed as concerned only with government expenditure asa means to cure economic crises. Yet Keynes¶s central aim was to prevent

economic crises, for which he prescribed monetary not fiscal policies. The present crisis has its origin in the loss of these policies. All Keynesconcern was management of money on a low long term rate on interest.

While his initiatives to a large extent influenced the financial architecture of the world in the wake of the great depression, they were never fullyembraced. As was the case in 1930¶s, the theory and associated practical

conclusions off er a means to the resolution of the µgreat recession¶ and tothe possibility of a new µgolden age¶ . ARE WE ALL KEYNESIANS YET?



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SOP (D) Economics Keynes Amogha

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