The General Theory of Employment, Interest and Money

• 1. Introduction

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  The General Theory of Employment, Interest and Money arrived in February 1936 with a cover price of five shillings, and its author, the English economist John Maynard Keynes, had told a friend he expected it would take ten years to change how the world thought about its economic problems. The book was bold enough to say so in its opening letter. Writing to George Bernard Shaw on New Year's Day, 1935, Keynes put it plainly: "I believe myself to be writing a book on economic theory which will largely revolutionize... the way the world thinks about its economic problems." He added that he was, in his own mind, quite sure.

  The questions the book planted were audacious ones. Could an economy remain stuck, producing less than its potential, not because of obstacles but simply because not enough people were spending? Was the received wisdom of a hundred years of economics not the general truth it claimed to be, but a special case that rarely applied to the world as it actually existed? And could governments, by adjusting spending or the money supply, pull an entire economy out of a spiral it could not escape on its own?

  Those questions were not rhetorical. They cut against the grain of every major economic institution of Keynes's day. The story of how he built his argument, who helped him build it, and what the world did with it once it arrived is one of the stranger episodes in the history of ideas.

• 2. The Attack on Classical Economics

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  Keynes was not subtle about what he was doing. The first chapter of the General Theory, only half a page long, declared that the classical economics tradition dominated "the governing and academic classes of this generation, as it has for a hundred years past" and then argued that its postulates applied only to a special case, one whose characteristics happened "not to be those of the economic society in which we actually live."

  At the center of that tradition sat Say's law, the proposition Keynes summarized on page 18 as "supply creates its own demand." The logic was tidy: workers produce goods, workers are paid for producing goods, and workers spend those wages on goods. A glut was therefore impossible in the long run. Starting from full employment, output and demand would always balance.

  Keynes rejected this at its root. He argued that the level of employment is determined not by the price of labor but by the level of aggregate demand. If total demand for goods at full employment falls short of total output, the economy must contract until the two are equal. Full employment was not the natural resting point of competitive markets; it was a lucky coincidence.

  The distortions that prevented wages from falling freely to clear the labor market were real and persistent. Employment contracts were written in money terms. Minimum wages and state benefits set floors. Workers resisted pay cuts, and unions gave them the means to do so. Keynes did not view these as removable impurities; he treated them as part of the economic fabric and built his theory around them.

• 3. Animal Spirits and Market Psychology

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  Chapter 12 of the General Theory is the one economists return to most often when markets behave strangely, and it opens on an admission: our existing knowledge does not provide a sufficient basis for a calculated mathematical expectation about the future. Keynes's remedy was not better math but a frank accounting of how decisions actually get made.

  He gave the driving force a name: animal spirits. "Most, probably, of our decisions to do something positive," he wrote, "can only be taken as a result of animal spirits - of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities." When that urge falters, enterprise fades with it.

  Speculators, he argued, operated by a different logic entirely. Their goal was not to judge what an investment was genuinely worth but to anticipate what the market would think it was worth a few months hence. He compared this to a newspaper competition where contestants had to pick the six prettiest faces from a hundred photographs, with the prize going to whoever matched the average of all contestants' choices. Winning required predicting not beauty but what others would call beautiful. Keynes noted that some players practiced this at the fourth, fifth, and higher degrees.

  The danger lay in what happened when speculation swamped enterprise. "Speculators may do no harm as bubbles on a steady stream of enterprise," he wrote. "But the position is serious when enterprise becomes the bubble on a whirlpool of speculation." His proposed remedy was specific: a substantial government transfer tax on all transactions in the United States, to tilt the balance back toward long-term investing.

• 4. The Multiplier and Government Action

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  The concept of the multiplier appears in Chapter 10, and Keynes introduced it through a concrete example. If the marginal propensity to consume is 90 percent, the multiplier is 10, meaning that increased public works would generate ten times as much total employment as the public works themselves directly created.

  Keynes was building on work by R. F. Kahn, who had introduced a related multiplier in 1931. Kahn's version pictured an infinite chain of transactions: spend a sum, the recipient spends a fraction of it, the next recipient spends a fraction of that, and so on. Keynes's own account of the mechanism, though related, did not rely on that infinite series.

  To illustrate how far he was willing to push the point, Keynes offered his famous buried-banknotes provocation. If the Treasury were to fill old bottles with banknotes, bury them in disused coal mines, and leave it to private enterprise to dig them up, there need be no more unemployment and the real income of the community would probably become a good deal greater than it actually was. He acknowledged it would be more sensible to build houses, but if political difficulties blocked that, even the buried-banknote scheme would be better than nothing.

  The argument was a direct challenge to laissez-faire. And the four parameters Keynes identified as governing the state of an economy, the money supply, the consumption demand function, the liquidity demand function, and the schedule of marginal efficiency of capital, gave policymakers two handles: monetary policy, which adjusted the money supply, and the fiscal levers of public spending that could shift the demand for investment.

• 5. Writing the Book

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  Keynes's work on the General Theory began the moment his previous book, the Treatise on Money, was published in 1930. He was already dissatisfied with what he had written. By September 1932 he told his mother he had written nearly a third of a new book on monetary theory.

  He did not work alone. A discussion group called the Cambridge Circus formed immediately after the Treatise appeared and reported to Keynes through Richard Kahn. The Circus disbanded in May 1931, but three of its members, Kahn, Austin Robinson, and Joan Robinson, continued meeting in the Robinsons' house on Trumpington Street in Cambridge. Their comments fed into a document called the Manifesto of 1932, whose ideas Keynes took up in his lectures. Kahn and Joan Robinson were well versed in marginalist theory, and they pushed Keynes toward adopting elements of it he had not initially grasped. During 1934 and 1935, Keynes circulated drafts to Kahn, Robinson, and Roy Harrod.

  His method of composition was unusual. He drafted rapidly in pencil while reclining in an armchair, then sent the pencil draft straight to the printers. They supplied him with galley proofs, which he distributed to advisers and critics for comment. Because he published on his own account, his distributor Macmillan and Co. received only a commission and could not object to the expense. By fixing the retail price at five shillings, below what Macmillan would have charged, Keynes aimed at wide early circulation. The book was finished in December 1935 and published the following February.

  Schumpeter later described Kahn's share in the work as not having fallen very far short of co-authorship. Kahn denied the attribution.

• 6. Reception and Legacy

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  Paul Samuelson wrote that the General Theory caught most economists under the age of 35 with the unexpected virulence of a disease first attacking an isolated tribe. Not everyone was captivated: Etienne Mantoux called it obscure, Frank Knight found it difficult to follow, and Michel DeVroey wrote that many passages were almost indecipherable. Samuelson himself called the analysis unpalatable and incomprehensible. Raul Rojas offered the dissenting view that the book is simply readable and that obscure interpretations of it are the problem.

  The interpretations that spread furthest were built by Harvard economist Alvin Hansen and MIT economist Paul Samuelson, whose 45-degree Keynesian cross diagram gave teachers a clean way to explain aggregate demand, and by Oxford economist John Hicks, who created the IS-LM diagram. Both diagrams still appear in textbooks.

  President Richard Nixon said in 1971 that "we are all Keynesians now," a phrase later repeated often by Nobel laureate Paul Krugman, though its origin lay with the anti-Keynesian economist Milton Friedman, who had meant something different by it. The timing was ironic: within a few years the stagflation of the 1970s, which the Keynesian-Phillips curve framework had not predicted, sent the theory into retreat. Monetarism was waiting, as Geoff Tily wrote, in the wings.

  Post-Keynesian economists argued that the neoclassical synthesis had fundamentally misread Keynes by accepting long-run equilibrium. In 2011, the book appeared on Time magazine's list of the top 100 nonfiction books written in English since 1923. At that point, almost 400 universities were teaching a revised curriculum that took instability seriously, and Keynes's notion of uncertainty had gained new currency under the label radical uncertainty.