Comparisons and Contrasts Between the Textbook “Keynesian” View of the Proper Way to Reduce Unemployment and Keynes’s Own Discussion of the Trade Cycle
John Maynard Keynes (June 1883 – April 1946), one of the founders of modern macroeconomics, was a British economist who till this day is known as one of the most influential economists of his time. Keynes’s ideas greatly affected the theory and practice of modern macroeconomics and in addition enlightened the economic policies of governments. Keynes became famous in the 1930’s when he challenged the views of classical economic thinking during the Great Depression. Classical economists argued that free markets would automatically lead to full employment. Keynes, however, argued that aggregate demand was the determinant of overall economic activity and that low aggregate demand could lead to long periods of high unemployment. Today, “Keynesian Economics” is considered as one of the most influential approaches to economic thought and is covered in modern economic textbooks. The standard textbook interpretation of “Keynesian” macroeconomic policy for a recession/depression is to increase government spending and/or reduce taxes in order to increase aggregate demand, which results in an increase in output and employment. This theory has some similarities to Keynes’s own discussion, however there are more differences. With the help of John Maynard Keynes’s book The General Theory of Employment, Interest, and Money and other sources including online texts and notes provided by Professor Wade Hands, this paper will compare and contrast the textbook Keynesian view of the proper way to reduce unemployment with Keynes own discussion of the trade cycle in his book.
The trade cycle is a theory presented by John Maynard Keynes that illustrates the booms and busts of an economy, that is to say the levels of high employment, output and prices followed by the levels of low employment, output and prices. In his book The General Theory, Keynes discusses the causes and consequences of the trade cycle, arguing that there are a number of determinants that cause an economy to enter a recession/depression. His first argument, and probably the most important, is based around aggregate demand. Keynes maintained the idea that the lack of consumption and investment causes aggregate demand to decrease. With low aggregate demand, we see lower savings and income thus resulting in increased levels of unemployment. As Keynes explains, “fluctuations in the propensity to consume, in the state of liquidity-preference, and in the marginal efficiency of capital have played a part” (GT, pg. 313). These factors have the ability to move an economy towards a recession.
Keynes’s second argument is based around the idea of the marginal efficiency of capital (investment) and how it is the immediate cause of a recession or a bust in the trade cycle. He also argues that this affects consumption. The marginal efficiency of capital (MEC) is the annual percentage yield earned by the last additional unit of capital. Here Keynes explains that “a serious fall in the marginal efficiency of capital also tends to affect adversely the propensity to consume” (GT, pg. 319). Essentially, Keynes explains that a fall in the MEC leads consumers to spend less of their income on goods and services, thus lowering aggregate demand (consumption and investment) and again leading to a recession or bust in the trade cycle.
The third cause of the trade cycle that Keynes argues about is based on the idea of future expectations. Keynes explains that in the later stages of boom in the trade cycle, the hopeful and confident expectations that individuals have, start to blind them and make them less aware, and essentially careless, of the rising costs of production and rise in interest rates. As a result, they become ignorant of what they are purchasing, pay less attention on the future yield of capital-assets and remain unaware of the...
Bibliography: Keynes, John Maynard. The general theory of employment, interest, and money. Amherst, N.Y.: Prometheus Books, 1997. Print.
Krugman, Paul, Robin Wells, and Kathryn Graddy. "Aggregate Demand and Aggregate Supply." Essentials of Economics. 2nd ed. New York: Worth Publishers, 2011. 393-427. Print.
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