Finance University under the Government of the Russian

Finance University under the Government of the Russian Federation International Finance Faculty History of economic thought Lecture 5. J. M. Keynes. The Keynesian system Lecturer: Kadysheva Olga Vladimirovna Associate professor Macroeconomic regulation department Moscow 2013

John Maynard Keynes (1883 – 1946) British economist whose ideas have fundamentally affected theory and practice of modern macroeconomics. considered to be one of the founders of modern macroeconomics and the most influential economist of the 20 th century.

John Maynard Keynes

His ideas are the basis for the school of thought known as Keynesian economics , as well as its various offshoots. In many ways, subsequent developments in 20 th century economics can be viewed as either building on Keynes' ideas or reacting against them.

In the 1930 s, Keynes made a revolution in economic thinking, overturning the older ideas of neoclassical economics that believed that free markets would, in the short to medium term, automatically provide full employment. Keynes instead argued that aggregate demand determined the overall level of economic activity, and that inadequate aggregate demand could lead to prolonged periods of high unemployment. Keynes advocated the use of fiscal and monetary measures to help the economy to overcome recessions and depressions.

Keynes's ideas concerning economic policy were adopted by leading Western economies. Keynes died in 1946, but during the 1950 s and 1960 s the success of Keynesian economics resulted in almost all capitalist governments adopting Keynes’s policy recommendations.

Keynesian economics provided theoretical basis for economic policies undertaken by Presidents George W. Bush and Barack Obama of the United States, Prime Minister Gordon Brown of the United Kingdom, and other heads of governments in response to the global financial crisis that started in 2008.

In 1999, Time magazine included Keynes in their list of the 100 most important and influential people of the 20 th century, commenting that: "His radical idea that governments should spend money they don't have, may have saved capitalism. “ [in times of crisis, and to overcome recession, government spending may exceed government revenue, and there may be budged deficit, financed by government borrowing]

J. M. Keynes in his main works analyzed economic conditions in the epoch of the Great Depression The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in 1930 and lasted until the late 1930 s or middle 1940 s. It was the longest, most widespread, and deepest depression of the 20 th century.

The Great Depression The depression originated in the U. S. , after the fall in stock prices that began around September 4, 1929, and became worldwide news with the stock market crash of October 29, 1929 (known as Black Tuesday). The Great Depression had devastating effects in countries rich and poor. Personal income, tax revenue, profits and prices dropped, while international trade plunged by more than 50%. Unemployment in the U. S. rose to 25%, and in some countries rose as high as 33%. Cities all around the world were hit hard, especially those dependent on heavy industry. Farming and rural areas suffered as crop prices fell by approximately 60%. Some economies started to recover by the mid-1930 s. In many countries, the negative effects of the Great Depression lasted until the end of World War II.

John Maynard Keynes: main works and economic ideas Keynes examined the relationship between unemployment, money and prices. In his work “Treatise on Money” (1930), the central idea was that if the amount of money being saved exceeds the amount being invested – which can happen if interest rates are too high – then unemployment will rise. This is in part a result of people not wanting to spend too high a proportion of what employers pay out, making it difficult, in aggregate, for employers to make a profit.

At the height of the Great Depression, in 1933, Keynes published “The Means to Prosperity”, which contained specific policy recommendations for tackling unemployment in a global recession – counter-cyclical public spending. This work also contains one of the first mentions of the multiplier effect.

Keynes's magnum opus – “The General Theory of Employment, Interest and Money” (published in 1936) This book is often viewed as the foundation of modern macroeconomics. *Magnum opus - from the Latin, meaning "great work": refers to the largest, and perhaps the best, greatest, most popular, or most renowned achievement of a writer, scientist, researcher

“The General Theory” challenged the earlier neoclassical economic paradigm, which stated that the market would naturally establish full employment equilibrium without any government interference. Keynes was setting himself against his former teachers, neo-classical economists Alfred Marshall and Arthur Pigou. Keynes believed the classical theory was a "special case" that applied only to the particular conditions present in the 19 th century [almost perfect competition in the economy], his own theory being the general one.

Classical economists believed in Say's law (“supply creates its own demand”), and that in a free market workers would always be willing to lower their wages to a level where employers could profitably offer them jobs. An innovation from Keynes was the concept of price stickiness – the recognition that in reality workers often refuse to lower their wage demands even in cases where a classical economist might argue it is rational for them to do so. The interaction of "aggregate demand" and "aggregate supply" may lead to stable unemployment equilibrium – and in those cases, it is the state, and not the market, that can solve this problem and save the economy.

“The General Theory” argues that demand, not supply, is the key variable governing the overall level of economic activity. Aggregate demand is defined by the sum of consumption (by households) and investment (by companies). In a state of unemployment and unused production capacity, one can only enhance employment and total income by first increasing expenditures for either consumption or investment. Without government intervention to increase expenditure, an economy can remain trapped in a low employment equilibrium – the demonstration of this possibility has been described as the revolutionary formal achievement of the work.

The central argument of “The General Theory” is that the level of employment is determined, not by the price of labour as in neoclassical economics, but by the spending of money (aggregate demand). Keynes argues that it is wrong to assume that competitive markets will, in the long run, deliver full employment or that full employment is the natural, selfrighting, equilibrium state of a monetary economy. On the contrary, under-employment and under-investment are likely to be the natural state unless active measures are taken by the government.

From the end of the Great Depression to the mid 1970 s, Keynes provided the main inspiration for economic policy makers in Europe, America and much of the rest of the world. While economists and policy makers had become increasingly won over to Keynes's way of thinking in the mid and late 1930 s, it was only after the outbreak of World War II that governments started to borrow money for spending on a scale sufficient to eliminate unemployment. “…one could not have had a better demonstration of the Keynesian ideas. “ (John Kenneth Galbraith, US government official charged with controlling inflation)