|Keynes was a liberal economist whose theory revolutionized macroeconomics. As the founder of Keynesian economics, his ideas contrasted greatly with Classical economics. A main difference between Keynesian and Classical economics is their idea concerning government intervention. Keynes believed that in order to have an efficient economy, policies established by the public sector would help stabilize output. On the other hand, Classical economists were adamant that the economy would fix itself if left alone without any government intervention. Keynesian economics became prominent from 1936 onwards and quite literally brought a change in the economic system due to the quick popularity of Keynesian thought.
Early Life and Education
John Maynard Keynes was born and raised in Cambridge, England. He was born on June 5, 1883 to John (an economist and lecturer in moral sciences) and Florence Keynes (social reformer). Despite having been surrounded by economics as he grew up, Keynes originally leaned towards the field of philosophy. He was born into an academic middle class family and was considered brilliant by his teachers and peers. In 1902, Keynes attended King’s College at the University of Cambridge after leaving Eton College and graduated with a B.A. in mathematics two years later; he also later received a M.A. in economics.
In 1909, Keynes’ first professional economics article about the global economic downturn and its effect on India was published in the Economic Journal, “perhaps the world’s leading professional economics periodical at the time” (Walsh 9). Two years later, by 1911, Keynes became editor of the Economic Journal. During World War I, due to his remarkable ability to apply economic theories to realistic problems, Keynes was asked to advise the British Government regarding whether or not bank notes should be converted into gold. By 1915, Keynes was appointed a government position at the Treasury. With this job came the responsibility to devise credit terms between Britain and her allies. Besides being a phenomenal economist and brilliant in his deductions, Keynes was a prolific writer, eventually compiling his General Theory of Unemployment, Interest and Money. This series of writings formed the basis of the now common system of Keynesian Economics.
The General Theory
Published in 1936, The General Theory of Employment, Interest and Money was considered Keynes’ masterpiece. Though he was a liberal, Keynes showed interest in capitalism. In fact as noted by the Keynesian economist Galbraith, Keynes believed “’…that capitalism was worth saving, that it could be made to work’” (Wattle 4). Moreover, some of Keynes ideas coincided with those of capitalism, including the idea that an economic system that is spending money prospers. Keynes’ reputation preceded him and the people knew “Keynes stood for ‘spending one’s way out of depression’ by road building, municipal housing construction and the like” (Blaug 7). This made his ideas popular during the first U.S. depression. No doubt, Keynes wrote his ideas out broadly and without conveying a strong centralized message, but the theories he implored produced remarkable results. His incredible reasoning, though, marked a clear main message, that is that “a modern capitalist economy is constantly plagued by unemployment and that this unemployment is caused by a deficiency of … the sum total of spending by consumers and investors” (Blaug 11). He called this sum total the “aggregate demand.” Keynes predicted, after utilizing years of personal market experience, that if real aggregate demand exceeded the supply potential of the economy, inflation would occur. For the reverse – aggregate demand falling below supply potential – then unemployment would occur (Moggridge 4). A remarkable result, his prediction has held its own.
The effect of the unemployment levels that Keynes introduced is just one of the ways Keynes differed from classical doctrine on economics. Keynes believed some parts of the classical doctrine were “based on flawed assumptions and deduced outcomes clearly diverging from those in the real world,” and so he set out to overturn the fallacies in the works of his predecessors (Walsh 55). To Keynes, eliminating unemployment was a central concern for economic progress to be able to take place. For the classical theory, it was believed that there was always full employment, and in order to keep full employment, wages would be lowered; effectively, this was thought to balance and stabilize the economy. Keynes’ disagreed on this note, suggesting that unemployment levels drove the economy down. This is because the unemployment levels and aggregate demand tend to differ inversely. While his General Theory did not extend an exact solution, Keynes’ implied that the solution was to spend money! (Blaug 12). If the aggregate demand surpassed the economy’s supply potential, then employment opportunities would arise in order to balance the supply and demand, eventually reaching equilibrium when there was no unemployment. Simple and brilliant!
Interest & Money
Keynes’ economic theories branched farther than just the problems of unemployment. In fact, not many topics in macroeconomics were not covered by his General Theory. On the topic of interest and money, Keynes believed the two are closely related. He surmised that the quantity of money played a key role in determining the rate of interest in the economy (Froyen 99). For all financial assets, he believed, they can be separated into two groups: money and bonds. The demand for one asset group implies the demand of the other. Through this line of thought, Keynes rationalized equilibrium in the market: equilibrium of one side of the market would imply equilibrium in the other! Because of this, total market equilibrium would occur when supply and demand were at equilibrium. The equilibrium interest rate is the interest rate that equates money supply and money demand. In order to determine this interest rate, Keynes believed, because money supply is fixed, the demand for money would be the changing factor adjusting itself to produce equilibrium (Froyen 102). This changing demand depends on three distinct types: Transaction demand, Precautionary demand, and Speculative demand. With Transaction demand, people hold onto money to make transactions; the interest rate becomes a factor determining whether they should make transactions or not. Precautionary demand would be additional monies held by people in case of unexpected expenditures, like a cushion. Speculative demand deals with the speculation of the interest rates’ near future and the desirability for people to either buy bonds or hold their money. These three demand types were Keynes idea of why people hold on to money and how and why interest rates fluctuated. For example, an increase in money supply would lead to a decrease in interest rate, which would lead to an increase in investment, finally leading to an increase in income and, therefore, aggregate demand. This idea was unheard of before Keynes’ time, but the ramifications were incredible. Not only did it prove the relationship between money and interest rates, but also it provided economists with an applicable approach to analyzing the market.
In his more than 63 years of life, John Maynard Keynes established a legacy not soon to be followed. As a person, he exceeded without restriction; his liberal views and persona rejected the common notion of ideals present in the early 20th century. Keynes was boisterous, bisexual, and beyond genius. Within a decade of the 1929 depression, Keynes revolutionized the economic thought process and developed an economic system that sustains itself. Since his publication of his General Theory of Employment, Interest, and Money, his ideas have spread across the economic world and therefore have greatly affected the theory and practices of macroeconomics as a whole – hardly any modern theorist would overlook Keynesian theory in regards to a wide range of economics topics. Keynes’ genius was passed along due to his prolific writings and adoption of academic pursuits. It is clear that without the legacy Keynes left behind, our modern world may be quite different, and the impact he has made will be remembered forever.
Blaug, Mark. John Maynard Keynes: Life, Ideas, Legacy. New York: St. Martin's Press, 1990. Print.
Froyen, Richard T. Macroeconomics: Theories and Policies. Saddle River, N.J: Prentice Hall, 2008. Print.
Moggridge, D E. Keynes: Aspects of the Man and His Work : the First Keynes Seminar Held at the University of Kent at Canterbury, 1972. New York: St. Martin's Press, 1974. Print.
Walsh, Justyn. Keynes and the Market: How the World's Greatest Economist Overturned Conventional Wisdom and Made a Fortune on the Stock Market. Hoboken, N.J: John Wiley & Sons, 2008. Print.
Wattel, Harold L. The Policy Consequences of John Maynard Keynes. Armonk, N.Y: M.E. Sharpe, 1986. Print.