Undergraduate Economist

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A Foreword to Keynes’s General Theory

Posted by Alex M Thomas on September 5th, 2012

Published in 1936, The General Theory of Employment Interest and Money remains a valuable book for both economists and policy makers. The recent financial crisis and the ongoing economic crisis have revived popular interest in this 1936 classic. The year 2009 saw the publication of two concise books on Keynes by two eminent scholars, Skidelsky and Clarke; an earlier blog post reviewed both their works. Not much will be said about the author – John Maynard Keynes, in the following paragraphs. The main objective of this blog post, as the title suggests, is to provide a foreword to The General Theory. By foreword, we mean the following: ‘The introduction to a literary work, usually stating its subject, purpose, scope, method, etc.’ (Oxford English Dictionary).

The rapidly expanding market for economics textbooks has, to a significant extent, substituted the reading of original works. In this environment, where our understanding of Keynes is based upon what Blanchard, Branson, Mankiw or Romer write, the following blog post strives to remain faithful to Keynes unlike the IS-LM version of Keynes proposed by Hicks and popularised by these textbooks. Keynes labelled Ricardo, Marshall and Pigou as Classical economists; this definition is not adhered to in the present blog post for Classical economics is a system of economic theory (to which Ricardo belongs) which is distinct from and a rival to Marginalist economics of which Marshall and Pigou are important members (see Thomas 2011 for more).

For Marshall, Pigou and marginalist economists of today, unemployment is a transitory phenomenon caused by ‘imperfections’ in the operation of the market forces. In their theoretical world characterised by competition, full employment is the ‘general’ case. However, Keynes demonstrated that this notion was based on assumptions contrary to the real world such as flexibility of money wages, absence of store of value function of money and rate of interest as a real phenomenon capable of equilibrating savings and investment and hence can only be considered a ‘special’ case. As he writes, ‘there has been a fundamental misunderstanding of how in this respect the economy in which we live actually works’ (p. 13). Opposed to this state of affairs, Keynes argued that the ‘general’ situation in an economy with competitive markets is the prevalence on unemployment. In other words, the central purpose of Keynes’s work is to demonstrate that unemployment is the usual situation in a competitive economy.

The main subject matter of The General Theory is the determination of aggregate employment and income or ‘the theory of output as a whole’ (Preface, p. vi). This needs to be seen against the then prevalent mode of economic analysis which was largely Marshallian in nature. Marginal productivity theory along with the principle of substitution was employed to understand the allocation of a given level of output; under conditions of competition, in equilibrium, full employment was (and still is) expected to prevail. And questions concerning the determination of the level of output were carried out within a theory whose primary subject matter was allocation, and not determination, of output levels. (On this, see especially Keynes’s preface to the German edition of his 1936 book.)

Marginalist economics, in the 1900s, looked up to the works of Marshall, and Pigou.  Keynes was brought up on a large dose of their works. Theories of production concentrated on determining the output levels in individual markets, and more often on allocation of output. Similarly, theories of distribution examined the allocation of income to workers and capitalists. Policy recommendations were made on the basis of such theories. The remedy to unemployment, according to Pigou and other orthodox economists, consisted in lowering workers’ wages. Economics certainly did not have an apparatus or a framework to study the ‘level of output as a whole’, or macroeconomics as it is called today. Besides output levels, Keynes also stressed the role played by money in ‘real’ analysis – the examination of income, employment, investment, consumption and saving. Rate of interest, according to Keynes, is a monetary phenomenon which depends on liquid preference. In short, the scope of his work remained the same as that of earlier economists – the study of wealth. Today, economics has broadened its scope to include any subject which can be examined by employing some form of the cost-benefit analysis. (See Malthus: The Scope of Political Economy)

Being brought up in the marginalist Marshallian tradition, Keynes attempted to completely break away from their method. In the preface to the German edition, he makes his desire explicit: ‘It was in this [Marshallian] atmosphere that I was brought up. I taught these doctrines myself and it is only within the last decade that I have been conscious of their insufficiency. In my own thought and development, therefore, this book represents a reaction, a transition away from the English classical (or orthodox) tradition.’ However, his attempt was not entirely successful. This is especially visible in his analysis of investment, where he develops the ‘marginal efficiency of capital’; much has been written on this in the context of the capital theory debates. The role he assigned to ‘expectations’ and the links to investment levels have been considered an improvement of the economists’ toolkit and consequently seen as an improvement in the capacity of economic theory to understand reality.

The aim of this blog post has been mainly to put The General Theory in the 1936 context, where Marshallian economics reigned supreme. Today, central governments, central banks and policy makers employ macroeconomic theory to understand the real world and to frame policies which increase output levels, stabilise prices and ensure financial stability. However, majority of these theories remain rooted in the orthodox tradition (variants of Marshall, Walras, Pigou and others resurface in the form of DSGE, New Classical macroeconomics or New Keynesian macroeconomics) which Keynes broke away from. Truly, The General Theory published in 1936 remains an economics classic, which is of enduring value to those who find terrible problems with the current orthodoxy!

3 Responses to “A Foreword to Keynes’s General Theory

  1. Book Lovers chennai Says:

    The objective of general theory is welcome by all.
    This is a good platform to understand the real world situation and their frame policies of investment level and it will helps to promote the output level.
    Thanks for sharing useful info.

  2. Max Says:

    Reading the Treatise on Money, in which Keynes rather adopts Wicksellian restatement of Quantity Theory could be very useful to broaden the scope of understanding the GT.

  3. Jan Says:

    Wren-Lewis drivelling on macroeconomics
    Professor Lars Pålsson Syll
    3 July, 2012 at 13:39

    http://larspsyll.wordpress.com/2012/07/03/wren-lewis-drivelling-on-macroeconomics/
    Back in 1938 Keynes wrote in a letter to Harrod:

    Economics is a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world. It is compelled to be this, because, unlike the typical natural science, the material to which it is applied is, in too many respects, not homogeneous through time. The object of a model is to segregate the semi-permanent or relatively constant factors from those which are transitory or fluctuating so as to develop a logical way of thinking about the latter, and of understanding the time sequences to which they give rise in particular cases … Good economists are scarce because the gift for using “vigilant observation” to choose good models, although it does not require a highly specialised intellectual technique, appears to be a very rare one.

    I came to think of this passage when I read “New Keynesian” macroeconomist Simon Wren-Lewis’s blog today. In a rather amazing post he writes:

    The first, and probably critical, point to make is that when I and most others talk about antagonistic macroeconomic debates, we are referring to debates over current macroeconomic policy rather than the details of some macroeconomic research. The second point is that New Keynesian theory builds on Real Business Cycle foundations, and is therefore in theoretical terms not an alternative to it.

    The current reversion of macro back into schools of thought relates to policy advice. It’s about which models we select, and which we reject, when telling governments what to do. So the interesting question that arises is how this selection process takes place.

    For a number of reasons I’ve talked about elsewhere, the microfoundation of macro and DSGE modelling downplays the role of evidence. More specifically, it allows modellers to be selective about which evidence they focus on (the ‘puzzle’). This may be fine for writing papers, but when it comes to model selection to tackle policy problems it is weak. And this weakness lets in the ideological factors I talked about.

    Again this self-congratulatory attitude. All macroeconomists share the same (mainstream neoclassical) basic theory, so when we discuss and argue it’s only about which policy and model to choose. All the more or less licensed and shared models and policies are already there on the shelf and we just have to decide which one to pick for today’s problem solving.

    This is of course nothing else but pure drivel!

    People like Hyman Minsky, Michal Kalecki, Sidney Weintraub, Johan Åkerman, Gunnar Myrdal, Paul Davidson, Fred Lee, Axel Leijonhufvud, Steve Keen – and yours truly – do not share any theory or models with Real Business Cycle theorists or “New Keynesians”.

    And to say that macroeconomic debates are just about selecting models for policy advice is not true, at least not if you look further than the seminar room at the economics department at Oxford University.

    But it’s nice to see that Wren-Lewis explicitly acknowledges what I have argued for many years now – “New Keynesian” macroeconomic models are at heart based on the modeling strategy of RBC and DSGE – representative agents, rational expectations, equilibrium and all that. And yes, they do have some minor idiosyncracies like “menu costs” and ”price rigidities”. But the differencies are not really that fundamental. The basic model assumptions are the same.

    “New Keynesianism” is a gross misnomer. The macroeconomics of people like Greg Mankiw and Simon Wren-Lewis has a lot to do with Robert Lucas and Thomas Sargent – and very little, or next to nothing, to do with the founder of macroeconomics, John Maynard Keynes.

    If the “New Keynesian” macoeconomic models of Wren-Lewis and others “builds on Real Business Cycle foundations”, they actually regularly assume representative actors, rational expectations, market clearing and equilibrium. But if we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypothesis of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable. Macroeconomic theorists – regardless of being “New Monetarist”, “New Classical” or ”New Keynesian” – ought to do some ontological reflection and heed Keynes’ warnings on using thought-models in economics:

    The object of our analysis is, not to provide a machine, or method of blind manipulation, which will furnish an infallible answer, but to provide ourselves with an organized and orderly method of thinking out particular problems; and, after we have reached a provisional conclusion by isolating the complicating factors one by one, we then have to go back on ourselves and allow, as well as we can, for the probable interactions of the factors amongst themselves. This is the nature of economic thinking. Any other way of applying our formal principles of thought (without which, however, we shall be lost in the wood) will lead us into error.

    As all students of economics know, time is limited. Given that, there has to be better ways to optimize its utilization than spending hours and hours working through or constructing irrelevant “New Keynesian” RBC and DSGE macroeconomic models. I would rather recommend my students allocating their time into constructing better, real and relevant macroeconomic models – models that really help us to explain and understand reality.
    Lars Pålsson Syll received a PhD in economic history in 1991 and a PhD in economics in 1997, both at Lund University. became associate professor in economic history in 1995. Since 2004 been professor of civics at Malmö University.

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