Keynes Proposes Government Management of the Economy Summary

  • Last updated on November 10, 2022

John Maynard Keynes revolutionized the field of economics when he proposed active government management of the economy through taxation, borrowing, and spending.

Summary of Event

In 1936, John Maynard Keynes of the University of Cambridge in England published The General Theory of Employment, Interest, and Money (also known simply as The General Theory). Undoubtedly the most influential book on economics written in the twentieth century, Keynes’s monograph touched off what has come to be called the Keynesian revolution. It provided a new theoretical structure for dealing with the aggregate economy, a structure that revolutionized both economic theory and policy. No other book, not even Adam Smith’s The Wealth of Nations (1776) or Karl Marx’s Das Kapital (1867, 1885-1894), had such an impact on economic theory and policy. [kw]Keynes Proposes Government Management of the Economy (Feb. 4, 1936) [kw]Government Management of the Economy, Keynes Proposes (Feb. 4, 1936) [kw]Economy, Keynes Proposes Government Management of the (Feb. 4, 1936) General Theory of Employment, Interest, and Money, The (Keynes) Economics, Keynesian revolution Keynesian revolution [g]England;Feb. 4, 1936: Keynes Proposes Government Management of the Economy[09150] [c]Government and politics;Feb. 4, 1936: Keynes Proposes Government Management of the Economy[09150] [c]Economics;Feb. 4, 1936: Keynes Proposes Government Management of the Economy[09150] [c]Publishing and journalism;Feb. 4, 1936: Keynes Proposes Government Management of the Economy[09150] Keynes, John Maynard Kahn, Richard Robinson, Joan Samuelson, Paul Harrod, Roy Hawtrey, Ralph Hansen, Alvin Tobin, James Friedman, Milton

The General Theory was published at a critical juncture in the history of Western civilization. In the early 1930’s, the world was in the midst of the Great Depression, Great Depression;economics the most sweeping economic catastrophe of modern times. As the Depression deepened, millions of people were thrown out of work. In the United States, from 1929 through 1932 more than eighty-five thousand businesses failed, more than five thousand banks suspended operations, farm income fell by more than half, manufacturing output decreased by almost half, and the unemployment rate increased to 25 percent. The Depression came at a time when natural resources were still plentiful. Thousands of factories stood idle or operated far below capacity, and workers had the same skills as they had in better times and wanted to put them to work. The U.S. economy and other economies clearly were able to produce, yet millions of people begged, borrowed, stole, and lined up for charity. The widespread social unrest caused by mass unemployment also threatened the viability of democratic institutions. The appeals of communism and fascism gained strength. A totalitarian government took power in Italy, and the National Socialist Party was on its way to taking power in Germany. Many people thought that this was the end of capitalism and that Karl Marx’s predictions regarding socialism’s inevitability were coming true.

The Depression was a mystery that posed problems that no one knew how to overcome. Conventional economics suggested that further wage cuts were necessary in order to allow more people to be hired, but this approach aggravated the malaise instead of relieving it. Even workers who had jobs barely supported themselves, and because they had low incomes they could not buy things produced by other workers. The appearance of The General Theory provided both a revolutionary explanation of the problem and theoretically supported solutions within a democratic framework, thus offering potential solutions to the burning political, economic, and social problems.

The central idea of The General Theory is that policy planners cannot rely on free markets to maintain full employment in the economy. The self-correcting features of the system are too weak to do that. Modern capitalist economies may be plagued by unemployment because of a deficiency of aggregate demand (the total of planned spending by consumers, investors, and the government). Some products may remain unsold because no one wants to buy them. Paradoxically, this problem gets worse as a society becomes affluent, because consumers have a tendency to devote an increasing percentage of their income to saving rather than to consumption. This tendency to save more will not create difficulties as long as savings are channeled, via financial markets, into an equivalent amount of investment spending on factories and equipment. There is no mechanism, however, to guarantee that every dollar saved will be converted to an equivalent amount of investment. Thus, if there is not enough investment spending to absorb the increased saving, the result will be unemployment as firms begin to produce less. An economy can get stuck in such a position, according to The General Theory.

Keynes argued that aggregate demand (especially investment) is inherently unstable and that government must pick up the slack when necessary. Thus when business activity falls and there is substantial unemployment, the government should increase its expenditures or reduce taxes (or perhaps both); during periods of prosperity it should do the opposite. Such active intervention offered the possibility of maintaining full employment.

The General Theory was the product of Keynes’s involvement in the economic problems of the Western world in the 1920’s and 1930’s. The roots of his ideas can be traced back to before the 1929 stock market crash that signaled the beginning of the Depression. Keynes’s Indian Currency and Finance (1913) Indian Currency and Finance (Keynes) was a contribution to understanding the functioning of economies with gold exchange standards, but it was his The Economic Consequences of the Peace (1919) Economic Consequences of the Peace, The (Keynes) that brought him international fame. In it, he questioned the widely accepted modes of thought about war reparations and war debt and presented a vivid examination of an extraordinary episode of laissez-faire capitalism. A later book, A Tract on Monetary Reform (1923), Tract on Monetary Reform, A (Keynes) was written in response to the monetary disorder following World War I, and it was followed by A Treatise on Money (1930), Treatise on Money, A (Keynes) which contained a comprehensive exposition of monetary theory and policy.

Keynes’s preface to the Japanese edition of A Treatise on Money, dated April 5, 1932, was possibly the first public intimation of the ideas to appear in The General Theory. Keynes’s correspondence and discussion with economists Joan Robinson, Roy Harrod, Richard Kahn, Ralph Hawtrey, and others give indications that he began writing the book in the summer of 1932. These economists also played crucial roles in the origin and development of the book, as Keynes made extensive revisions based on their feedback and circulated drafts among the group. On October 10, 1932, Keynes began the first of his eight lectures for the fall term. He changed the title of these lectures from “The Pure Theory of Money” to “The Monetary Theory of Production” and in effect announced the beginning of the Keynesian revolution.

John Maynard Keynes.

(Library of Congress)

In a letter to playwright and philosopher George Bernard Shaw in 1935, Keynes wrote that the book he was then writing on economic theory would revolutionize the way the world thinks about economic problems. His prophecy was amply fulfilled. The General Theory is a technical, theoretical book addressed to the economics profession, and economists hotly debated the merits of Keynes’s theory and policy prescriptions. Although Keynes’s ideas did not gain instantaneous acceptance, it was not long before the book became the gospel of an ardent group of followers. Within a short time, the ideas and analytic techniques of The General Theory stimulated what came to be called the Keynesian revolution.

The timing of the publication had much to do with the book’s acceptance. The protracted unemployment of the 1930’s cast doubts on the viability of laissez-faire capitalism, and The General Theory offered a theoretically justified plan to retain capitalism, although with significant active government participation. With the outbreak of World War II, unemployment problems began to melt away. Increased government expenditures during the war transformed severe unemployment to shortages of labor. The war experience suggested that Keynes’s ideas were correct: A government’s wise use of taxation, borrowing, and spending can move an economy to full employment.

The book can be credited with giving intellectual justification to the notion that an economy can be and perhaps should be managed to smooth out fluctuations in output and employment. To Keynes and his followers, a balanced economy is more important than a balanced budget. Specific recommendations to tackle an economic depression were maintenance of low interest rates through central control, redistribution of wealth through taxation, and augmentation of insufficient private investment by government spending. For these policy prescriptions, Keynes was accused of being both a left-wing ideologue as well as a defender of imperialist capitalism. Keynes always claimed that his intention was to save capitalism, not to destroy it.

The publication of The General Theory coincided with the development of quantitative economic data on employment, the gross national product and various related income categories, consumer spending, and savings and investment. These data made it possible for analysts to test macroeconomic relationships empirically. The various concepts discussed in The General Theory were widely incorporated into the economics profession and created the modern macroeconomics that still forms the basis of what is taught in undergraduate macroeconomics courses throughout the world. Policy implications were widely adopted to provide the tax, expenditure, and debt management agendas of most countries.

Keynesian economics achieved its greatest influence in the United States during the 1960’s. One of the longest unbroken economic expansions in American history occurred in the period 1961-1968, during which time the members of the Council of Economic Advisers were Keynesian almost without exception. They promoted tax cuts that coincided with increased prosperity, as expected by Keynesian logic. During the 1970’s, however, Keynesian economics failed to provide a satisfactory answer to the twin problems of high unemployment and high inflation. Keynesian economics has often been criticized for ignoring inflation. Economists such as Milton Friedman generated a counterrevolution in economics in the 1970’s, claiming that government is not wise enough to manage the economy along Keynesian lines and recommending that government’s influence in the economy should be kept to a minimum. The views of Friedman and other economists (referred to as monetarists) have also become widely accepted. Data do not yet exist to prove either Keynesian or monetarist theory correct; the principles underlying both schools of thought are widely believed and taught. However, the gradual globalization of the international economy and fluid movements of capital by private banks and corporations across national boundaries have inhibited the ability of governments to control the money supply strictly through centralized monetary policy. Supply-side economists have also pointed out that fiscal approaches that seek to control inflationary periods by raising taxes hurt business activity, leading to declining revenue. According to proponents of this school of thought, low and lower taxes are always better for economic growth and generation of government revenue.

Significance

The General Theory’s revolutionary impact on the field of economics and on the general public can be seen in the speed with which the policies advocated in it were incorporated into government planning. Many of the measures instituted during the later years of the New Deal were Keynesian in origin. Franklin D. Roosevelt, by his second presidential term (1937-1941), had come to embrace deficit spending as a necessary condition of prosperity. He recommended resumption of lending to increase aggregate demand. In 1946, the U.S. Congress passed the Employment Act, which legally (although in vague terms) obligated the government to maintain high levels of employment. The president’s Council of Economic Advisers Council of Economic Advisers and the Joint Economic Committee in Congress were created to fulfill this mandate.

In Great Britain, The General Theory’s influence was clearly demonstrated in the 1941 budget and the coalition government’s White Paper on Employment (1944), which made a strong commitment to full employment as a public policy. By the end of World War II, Canada, New Zealand, Australia, Sweden, and South Africa had accepted national responsibility for achieving high levels of employment. Similar concepts of economic management were embodied in the new French constitution of 1946, in the Charter of the United Nations, and in the Treaty of Rome.

Keynesian economics found success because it offered something to almost everyone. Labor liked the government’s support during economic depressions, businesses benefited from government contracts, banks found profitable areas for investment in government bonds, and government control gave the banking system liquidity, security, and stability. Reformers and intellectuals enjoyed increased employment in the government services and influence on government policies. General Theory of Employment, Interest, and Money, The (Keynes) Economics, Keynesian revolution Keynesian revolution

Further Reading
  • citation-type="booksimple"

    xlink:type="simple">Blaug, Mark. John Maynard Keynes: Life, Ideas, Legacy. New York: St. Martin’s Press, 1990. An excellent book for general readers and beginning students of economics.
  • citation-type="booksimple"

    xlink:type="simple">Clarke, Peter. The Keynesian Revolution in the Making, 1924-1936. New York: Oxford University Press, 2006. Provides a historical account of Keynes’s thought leading to publication of The General Theory. Good for those interested in economic history.
  • citation-type="booksimple"

    xlink:type="simple">Hamouda, Omar F., and John N. Smithin, eds. Economics and Policy. Vol. 2 in Keynes and Public Policy After Fifty Years. New York: New York University Press, 1988. Covers a wide range of topics. Part 1 concerns public policy in Great Britain and the United States, with some discussion of Keynes.
  • citation-type="booksimple"

    xlink:type="simple">Harrod, Roy F. The Life of John Maynard Keynes. New York: St. Martin’s Press, 1963. A definitive biography of Keynes. Chapter 11 provides letters written by Keynes and to Keynes on the theory and policy articulated in The General Theory.
  • citation-type="booksimple"

    xlink:type="simple">Kahn, Richard F. The Making of Keynes’ “General Theory.” New York: Cambridge University Press, 1984. Collection of lectures on the book by an economist closely associated with Keynes. Valuable insights into the making of the book are given in lectures four and five; Keynes’s relations with other economists are discussed in lecture six.
  • citation-type="booksimple"

    xlink:type="simple">Lekachman, Robert, ed. Keynes’ “General Theory”: Reports of Three Decades. New York: St. Martin’s Press, 1964. Part 1 contains Austin Robinson’s excellent discussion of Keynes’s life and ideas.
  • citation-type="booksimple"

    xlink:type="simple">Moggridge, Donald E. John Maynard Keynes. New York: Penguin Books, 1976. Suitable for both economists and noneconomists. Provides a simple exposition of Keynes’s ideas, his work, and his influence.
  • citation-type="booksimple"

    xlink:type="simple">Skidelsky, Robert. John Maynard Keynes, 1883-1946: Economist, Philosopher, Statesman. New York: Penguin Books, 2005. Abridged version of Skidelsky’s three-volume biography of Keynes. Although biased toward his subject, Skidelsky forcefully argues that Keynes was a visionary who changed the course of economic theory.

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