John Maynard Keynes

1. John Maynard Keynes Presentation by Russell Baker, Caitlin Buckvold, Zachary Hanson, and Max Shaugnessy April 10, 2012

2. Presentation Outline • Section I • Historical context, Keynes’ early life, career path • Section II • Major Works – Economic Consequences of the Peace, Treatise on Money • General Theory of Employment, Interest and Money • Academic Influences • Section III • Critiques of Keynesianism and modern applications

3. Section I What factors influenced Keynes’ General Theory?

4. John Maynard Keynes “Ideas shape the course of history.”

5. Early Life Life: June 5, 1883 – April 21, 1946 • Born and raised in England Family: • Father – Robert Neville Keynes • Mother – Florence Ada Keynes • Brother – Geoffrey Keynes. Knighted for work on blood transfusion, married granddaughter of Charles Darwin • Sister – Margaret Keynes. Married Noble Prize winning Physiologist

6. Florence Ada Keynes • Social Reformer and Mayor of Cambridge • Ran numerous charities: • Provided pensions for elderly living in poverty • Provided services for “deserving” poor • Reintegrated inmates back into society • Loving mother, devoted to Keynes

7. John Neville Keynes • Economist and Lecturer in Moral Sciences at Cambridge University • “Positive Economy” • “Normative Economy” • “Art of Economics” • Loving father, devoted to Keynes

8. Keynes’ Life • Studied at Eton and King’s College, Cambridge • In 1904, earned B.A. in Mathematics • President of the Cambridge Liberal Club • Promoted redistribution of wealth • Favored government involvement in the economy • Member of Cambridge Apostles • Creepy, secret-society • Debating forum for members that included many prominent mathematicians and philosophers Education

9. Keynes’ Life • Clerk for India Office, 1906-1908 • Lecturer and Researcher on probability theory at Cambridge, 1909-1913 • Published a series of articles on the Indian economy • First book: Indian Currency and Finance, 1913 • Treasury, 1915 • One of the negotiators for terms of Versailles Peace Treaty 1906-1915

10. World War I • Treaty of Versailles • Britain, France, and USA responsible for negotiating terms of treaty with Germany • Keynes working behind the scenes • Terms of Treaty • Astronomical reparations • Crippled German economy • Keynes’ Beliefs • Reparations should be minimal • Need to protect German citizens from starvation

11. Unemployment in Great Britain (1900-1950) Unemployment rates had an enormous amount of influence on Keynes’ arguments

12. Keynes’ Life • Treatise on Probability, 1921 • First, large mathematical work by Keynes • Becomes an investor and currency speculator • Very wealthy by the end of the 1920s • Advocates against the Gold Standard • Believes that, to decrease unemployment, Churchill should devalue the British Sterling • Continues to work as a lecturer at Cambridge University 1920-1930

13. Great Depression • Keynes loses most of his fortune after the Great Depression • A Treatise on Money, 1930 • Describes why unemployment persists at such high levels • Critical of British austerity measures during Depression, advocates for increased government spending

14. Keynes’ Life • Britain abandons Gold Standard, 1931 • Keynes re-earns fortune through sales of the General Theory and currency speculation • Keynes’ health begins to fail • Economic Adviser to the British Government 1930s

15. The General Theory of Employment, Interest and Money Keynes’ Masterpiece Hugely influential across the world Foundation of Keynesianism

16. Keynes’ Life • Keynes negotiates with USA to secure loans to Britain during wartime • Argues that the taxes should be increased and a mandatory savings rate established to pay for the War • Avoid inflation after War’s end • Keynes, now a Baron, takes a seat in the House of Lords among the Liberal Party • Advocates new monetary system after the War 1940s, World War II

17. Bretton Woods • Established IMF and pre-cursor to the World Bank (International Bank for Reconstruction and Development) • Establishes a world monetary system of fixed exchange rates tied to the US dollar

18. What factors influenced Keynes’ General Theory? • Family • Education at Cambridge • Government Service • World War I • Great Depression “[With Bretton Woods]… we have shown that a concourse of forty-four nations are actually able to work together at a constructive task in amity and unbroken concord. Few believed it possible. If we can continue in a larger task as we have begun in this limited task, there is hope for the world.” - John Maynard Keynes

19. Section II Keynes’ Major Works

20. The Economic Consequences of the Peace “If we aim deliberately at the impoverishment… nothing can then delay for very long that final war between the forces of Reaction and the despairing convulsions of Revolution, before which the horrors of the late German war will fade into nothing.” John Maynard Keynes

21. The Economic Consequences of the Peace • France • Wanted to set back German progress 50 years • United States • Woodrow Wilson left Washington “enjoying a prestige and moral influence unequalled in history” • In fact, weak-minded and not knowledgeable of European conditions • The French succeeded in achieving many of their demands Versailles Conference Overview

22. The Economic Consequences of the Peace • Treaty of Versailles, 1919, crippled German economy • Keynes’ proposals overlooked, considered controversial • Wrote The Economic Consequences of Peace in two months the following Summer of 1919 • The Economic Consequences of Peace was largely a critique of the Treaty of Versailles The Treaty of Versailles Overview

23. The Economic Consequences of the Peace • Europe cannot prosper without an equitable, integrated economic system • The Allies violated the Fourteen Points: a commitment fairness regarding reparations, territorial adjustments, and economic matters The Treaty of Versailles Criticism

24. The Economic Consequences of the Peace • Reparations were severe, exaggerated, and questionable • Inflation hit Europe hard, with Germany experiencing hyperinflation • Keynes attributed the hyperinflation to governments being too short-sighted to secure loans or taxes from resources they acquired, (and instead) have printed notes for the balance” The Treaty of Versailles Aftermath

25. The Economic Consequences of the Peace • Keynes claimed the Treaty did not include a rehabilitation plan to the European economy • Three key problems • Decline in Europe’s internal productivity • Breakdown of transportation and infrastructure • Inability to import goods and supplies from overseas Europe after the War

26. The Economic Consequences of the Peace • Keynes suggested a plan to help remedy the situation: • Revising the treaty and reparations • Abandonment of inter-ally Indebtedness • An international loan • European relations with Russia Solving Europe’s Problems

27. The Economic Consequences of the Peace • The Economic Consequences of Peace became an immediate bestseller on both sides of the Atlantic • Solidified Keynes’ reputation as a leading economist • Public perceived Germany was being treated unfairly, resulting in public support for appeasement • Keynes predicted the next war would begin twenty years from 1919 Success and Influence

28. A Treatise on Money

29. A Treatise on Money • Published in 1930, written during the beginning stages of the Great Depression • A Treatise on Money professed his views on money, interest, and monetary policy • Many of his views were borrowed from his mentors, Alfred Marshall and Arthur Pigou Background

30. A Treatise on Money • Keynes’ introduced his theory that where saving exceeds investment, recession will occur • Keynes suggested that in order to stabilize the economy, the price level must first be stabilized • Government Central Bank lower interest rates when prices rise, raise interest rates when prices fall • Many of his ideas are further developed in his future work, General Theory Monetary Policy

31. Classical Theory Keynes

32. A Treatise on Money • Critically acclaimed as a hard to read, and many of the concepts were a work-in-progress • Hayek wrote three reviews and critiques on A Treatise on Money • Their debates / critiques largely revolved around discrepancies in terminology, especially as it pertained to saving and investment models • Both were promising economists aspiring to develop economic models / theory Reception

33. A Treatise on Money • A Treatise on Money served as a prequel to his greatest masterpiece – The General Theory of Employment, Interest, and Money. • Many fundamental concepts within General Theory were more polished ideas from A Treatise on Money Legacy

34. The General Theory of Employment, Interest and Money “It is astonishing what foolish things one can temporarily believe if one thinks too long alone, particularly in economics” - John Maynard Keynes

35. The General Theory on Employment, Money and InterestBook I • The General Theory was written during the Great Depression, published in 1936 • Keynes introduces the book with the radical claim that The General Theory is meant to contrast his arguments with those of classical theory of economics • Keynes claims that classical economics are applicable to only special cases, which “happen not to be those of the economic society in which we actually live” Introduction

36. The General Theory on Employment, Money and InterestBook I • Classical theory of employment says the labor market is determined by supply & demand, where unemployment strictly caused by either frictional unemployment or voluntary unemployment • Doesn’t explain Great Depression • People must simply work for less? • Classical Theory – supply creates its own demand. If there are people willing to work, jobs will be created to use them • Unemployed is a result of refusal to work Introduction

37. The General Theory on Employment, Money and InterestBook I • The real wage is equal to the marginal disutility of the existing employment; • There is no such thing as involuntary unemployment in the strict sense; and • Supply creates its own demand (Say’s Law) The Classical Assumptions

38. The General Theory on Employment, Money and InterestBook I • Workers and unions will protest nominal wage reductions, but not real wage reductions under the classical school • Inflation a better solution than wage cuts? • If wages decrease, cost of production decreases, then prices decrease  real wages stay the same • Keynes uses this example to criticize fundamental assumptions of classical economics A Critique of Classical Labor Model

39. The General Theory on Employment, Money and InterestBook I • People earn money, then spend some of it – not all of it, resulting in “insufficient effective demand” • Businesses hire based off how much they expect to sell • Spending determines employment, supporting the idea of unemployment • The existence of “insufficient effective demand” will often result in less-than optimal unemployment levels, despite that marginal product of labor > marginal disutility of employment Effective Demand

40. The General Theory on Employment, Money and InterestBook I • These two fundamental concepts left Keynes baffled as to how classical Ricardian economics is considered “complete” and “victorious” • “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.” Criticism of Classical Economics

41. The General Theory on Employment, Money and InterestBook IV • Prospective yield: value of expected returns – cost of inputs and maintenance • Supply price: cost of manufacturer making new machine (replacement cost) Marginal Efficiency of Capital = prospective yield – supply price Marginal Efficiency of Capital

42. The General Theory on Employment, Money and InterestBook IV • Increasing investment in capital has two effects: • Decreases prospective yield in the long run • Increases supply price in short run • Overall diminishing the marginal efficiency • Investment-demand schedule: how much investment must increase to lower ME to a given level • Investment will be pushed until ME (general) = market interest rate Marginal Efficiency of Capital

43. The General Theory on Employment, Money and InterestBook IV • Changes in value of money affect expected yield Expect inflation  yield increases attracting more investment And vice versa • No way to predict long-term expected yields • “Beat the gun” in stock markets • Instability due to “animal spirits” Marginal Efficiency of Capital

44. The General Theory on Employment, Money and InterestBook VI • Interest rates are the price people demand for parting with their money • Depends on: • liquidity preference (desire to hold cash) • money supply • Driven by bond market speculation • expected increase in r  hold cash now, buy bonds later • People believe saving lowers interest rates when really it lowers demand and increases unemployment Interest Rates

46. The General Theory on Employment, Money and InterestBook IV • Central bank can lower short-term rates by printing money buying short-term government debt • US did this in Great Depression • To extend this to long-term rates, government should buy long-term bonds • Larger amount of cash they seek to create by purchasing bonds/debt, greater the fall of r • Monetary policy seen as experimental will not delivery long-term reduction of r • it will only increase “precautionary motive” of holding cash Controlling the Interest Rate

47. The General Theory on Employment, Money and InterestBook IV • Liquidity traps • Rates fall so low that everyone prefers holding cash and authority loses control over the rates • Hyperinflation – no one wants to hold cash • Crises – can’t get people to want to reasonably part with their cash Problems with Controlling the Interest Rate

48. The General Theory on Employment, Money and InterestBook IV • For full employment, government keeps r down by printing money • More profitable to invest in things with lower yields • ME  zero (remember: ME = yield – supply cost) • No one would invest in anything anymore • Accumulation but no growth • The rentier disappears Problems with Controlling the Interest Rate

49. The General Theory on Employment, Money and InterestBook V Changes in money-wages The employment function The theory of prices

50. The General Theory on Employment, Money and InterestBook V • Classical argument: A reduction in wages stimulates demand (due to reduced production costs) • Keynes’ rebuttal: This could only be true if aggregate demand is fixed Money-wages, Chapter 19