 Investment depends on what Keynes calls the 'marginal efficiency

of capital' - if the MEC is above the interest rate, investment will

increase. If it is below, it will fall.

 Assumption #4 - Quantities not Prices Adjust in short run. It is

linked to the earlier assumption that demand may fall short of
supply. If the expected sales falls short of the expected sales
(which means demand falls short of supply), the employer will lay
off workers. The classical economists assumed that it was fall in
wages that reduces the output. However, in Keynesian model, this
laying off reduces the excess supply of output.

 How does demand fall short of supply? Page 89 onwards

 It breeds from the existing 'uncertainty' which influences the
'inducement to invest.' This uncertainty, unlike risk, is
immeasurable. The uncertainty may be small in the short period,
but it increases exponentially as we move from one period to the
next.

 Assumption #4 - The classical economists not only relied on the

perfect knowledge of future events. They also relied on automatic
adjustment mechanisms within the markets. The chief of these
mechanisms was flexible wages (page 93). (Read it again)

 POLICY IMPLICATIONS (Page 95 onwards)

 Two parts: policies to rescue an economy from a slump, and policies
to keep it out of a slump.
 Two policy instruments : monetary and fiscal policy. The General
Theory was based on an assumption of 'closed' economy.
 Why would people want to hold money when there is an option of
buying interest-bearing instruments ? The answer is uncertainty.
 Uncertainty as to the future rate of interest. If these future
rates were foreseeable, people would buy interest-bearing
instruments if it were advantageous for them to do so.
 Liquidity trap ?
 Monetary policy alone cannot rescue us from a liquidity trap. It
needs a supporting fiscal policy to do so.
 Skepticism over credit money economy. The supply of credit is
determined by the demand for credit which expands or contracts
with entrepreneurs' confidence in the future market. Thus, credit
may dry up even in scenarios when money is 'cheap' and expand in
scenarios when it is 'expensive'. In such a case, monetary policy
fails.

 Keynes' solution to the problem of unemployment is to use the

monetary policy to establish a permanent low long-term rate of
interest, and then maintain it.

 Keynes wanted government to reduce the uncertainty - government

policy should make the world more predictable.

 Ch 5 - Skidelsky (2009)
 Accepting the cure provided by Keynesian economics, governments
accepted the responsibility for maintaining high and stable levels
of employment.

 By the 1960s, the Keynesian cure started to wear down. By the

1980s, both theory and policy dialled back to pre-Keynesian ideas.
 Government was seen as a problem.
 Expansionary government policies were accused of fuelling inflation
and crowding out better-informed private investment without
reducing unemployment in the long run.

 However, Skidelsky remarks that the Keynesianism attacked by the

economists was not the Keynesianism left by Keynes.
 Uncertainty is at the core of Keynes' economics.
 Skidelsky also creates a distinction between theory and policy.
 He remarks that Keynesian revolution was largely a policy
revolution without a theory. In fact, he cites Samuelson who said
that even though the theory beyond Keynes' economics was faulty,
his policy prescriptions were practically valid.
 Skidelsky remarks that Keynes relied on uncertainty to explain the
slumps in the economy.

 New Classical Economics:

  It sought to reduce the idea of uncertainty to certainty or
calculable risk - it sought to limit the interventions by government.
 Milton Friedman was the leader of the classical counter attack (but
he was later termed as a monetarist?)
 Keynes never assumed that the economy was ever at full
employment. Friedman also agreed - but he assumed that there can
be an equilibrium level of unemployment which he called the
'natural' rate of unemployment. This natural rate is still used by
many economic models.

 Friedman took the baton from classical economics' method of

deducing outcomes from the logic of individual choice. Rational
self-interest against were forward looking.

 Quantitative easing ?

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
 Paul Krugman, 'Introduction by Paul Krugman' in John Maynard
Keynes, The General Theory of Employment (Palgrave Macmillan
2018)
 The 2008 financial crisis revived the Keynesian economics, which
had been pronounced dead decades before. The policy responses to
2008 crisis were rooted in Keynes's original ideas.
 It is often assumed that Keynes's ideas were a leftist tract, a call
for big government and high taxes. But Krugman remarks that
Keynes was no socialist, he came to save capitalism, not to bury it.
 Keynes did not argue for government takeover of the whole
economy. Rather, his solution was that less intrusive government
policies could ensure effective demand, allowing the economy to
recover.
 Summary of The General Theory in four points:
o Economies often suffer from an overall lack of demand,
which leads to involuntary unemployment.
o The free-market mechanism, which is claimed to correct the
shortfalls in demand, operates very slowly to have a real
effect in the short term.
o The government policies may stimulate demand, and
consequently, can reduce unemployment quickly.
o Sometimes increasing the money supply won't be enough to
persuade the private sector to spend more, and government
spending must step into to recover the economy.
 Relationship between wages and employment?

 Perfect wage flexibility?

 Keynes leaned in favour of the idea of rigidity of wages. He argued
against the argument that fall in wages can increase employment.

 Classical model as Keynes encountered was much harder to fix.

 It was model in which Say's Kaw applied - supply automatically
creates its own demand, because income must be spent. Interest
rates were purely a matter of supply and demand for funds, with no
possible role for money or monetary policy.

 Keynes did not sought to explain the business cycles - booms and
busts. Rather, his focus was on this question: given that overall
demand is depressed, how can we create more employment ?

 Keynes monetary policy prescriptions?

 Krugman remarks that two of the three predictions actually came

true by the events post the 2008 crisis.
 What Keynes missed ?

 Coming back to the main question: given that overall demand is

depressed, how can we create more employment ?
 Mass unemployment was a result of inadequate demand. The
solution to this was, an expansionary fiscal policy.

 Robert Skidelsky, 'Afterword by Robert Skidelsky' in John

Maynard Keynes, The General Theory of Employment (Palgrave
Macmillan 2018) pp. 373
 He disagrees with Krugman on certain points.
 First he says that the idea behind the theory of liquidity
preference is that people accumulate money rather than spend it,
because they regard the future as uncertain and hoard money
against this uncertainty. This prevents the rate of interest from
falling sufficiently to ensure full employment.
 Why money as security ? Because it is not perishable.
 Krugman doesn't explain why people accumulate in the first place.
 Second, Keynes dismissal of monetary policy had nothing to do with
the close to zero interest rates. Rather, it had to with his
judgment about the psychological attitude to liquidity.

 Edward Dickens, 'Keynes's Theory of Monetary Policy: An Essay in

Historical Reconstruction' (2011) 30 Contributions to Political
Economy 1
 Keynes's monetary policy - three concepts:
o Investment multiplier
o Marginal efficiency of capital
o Interest rate

 Robert Skidelsky - Money and Government (2018)

 Ch 5
 Managing expectation plays a key role in Keynes's scheme of
monetary therapy. The message was clear: he who would control
money has to control expectations about future prices.


 Ch 6
 Ch 7

 PART III - WHO ARE THE (TRUE) KEYNESIANS ?