Critical Analysis
The Heresies of John Maynard Keynes
1. In Great Depression, we witnessed a paradox of idle machines and idle men. The earlier
understanding of business cycles considered it to be a result of mass hysteria and the idea of the
possibility of general glut wasn’t acceptable to many economists. Later, realisations came that
savings breaks the circular flow, unless invested. But businesses needed savings only during
expansion. Households may always be able to save something, but businesses might not always be
able to expand, which gives rise to a possibility of depression as we are returning to the economy
less and less.
2. Keynes in his Treatise of Money took interest rate as the lubricant for the seesaw mechanism of
business cycles, but it had seen a violation in the face of the Great Depression as the economy
remained in the trough for very long with no signs of a recovery. Then in The General Theory,
Keynes explained that the incomes were so less that there was not much savings to push the interest
rate down and hence incentivise investment. An equilibrium was attained.
3. He proposed a solution of government to kick start the economy by doing projects to increase
employment, while the private sector is unable to invest. It was to re-establish buying power and
pave way for private business expansion. I believe that this will not lead to much crowding out of
private investment as first, there is hardly any, and secondly, there were not much income and
savings.
4.
Lastly, Keynes wasn’t an advocate of big government, rather a believer of markets who wanted
to rescue capitalism from its mechanical faults. But, he believed that planning with many planners
having the ‘right orientation of mind’ can have good effects. It is difficult to discern what would
this right orientation be.
The Principle of Effective Demand
1. Classical economics said that wages will fall till the time we reach full employment. But Keynes
challenged this idea by arguing for a system where there might be unemployment in the
equilibrium. He claimed that increase in consumption will be less than increase in output. So, we
need to introduce some kind of investment in the model to account for this. He does it by
introducing current investment.
2. So, equilibrium will be the point where consumption and investment would take all the output.
This determines employment (which may be less than full employment). Wealthy countries have
low marginal propensity to consume and large amount of existing capital would mean lower
opportunities for investment. So, to increase output, we need to promote investment which can be
done by decreasing interest rate.