Deus ex machina in Euripides' Medea, performed in 2009 in Syracuse, Italy; the sun god sends a golden chariot to rescue Medea.
Deus ex machina (/ˈdeɪəsɛksˈmækɪnə,ˈmɑːk-/DAY-əs ex-MA(H)K-in-ə; Latin:[ˈdɛ.ʊsɛksˈmaːkʰɪnaː]; plural: dei ex machina; 'God from the machine') is a plot device whereby a seemingly unsolvable problem in a story is suddenly or abruptly resolved by an unexpected and unlikely occurrence. Its function is generally to resolve an otherwise irresolvable plot
situation, to surprise the audience, to bring the tale to a happy ending, or act as a comedic device.
Origin of the expression
Deus ex machina is a Latin calque from Greekἀπὸ μηχανῆς θεός (apò mēkhanês theós)'god from the machine'. The term was coined from the conventions of ancient Greek theater,
where actors who were playing gods were brought on stage using a
machine. The machine could be either a crane (mechane) used to lower actors from above or a riser that brought them up through a trapdoor. Aeschylus
introduced the idea and it was used often to resolve the conflict and
conclude the drama. The device is associated mostly with Greek tragedy,
although it also appeared in comedies.
Ancient examples
Aeschylus used the device in his Eumenides but it became an established stage machine with Euripides. More than half of Euripides' extant tragedies employ a deus ex machina in their resolution and some critics claim that Euripides invented it, not Aeschylus. A frequently cited example is Euripides' Medea in which the deus ex machina is a dragon-drawn chariot sent by the sun god Helios, used to convey his granddaughter Medea away from her husband Jason to the safety of Athens. In Alcestis, the heroine agrees to give up her own life to spare the life of her husband Admetus. At the end, Heracles appears and seizes Alcestis from Death, restoring her to life and to Admetus.
Aristophanes' play Thesmophoriazusae
parodies Euripides' frequent use of the crane by making Euripides
himself a character in the play and bringing him on stage by way of the mechane.
The device produced an immediate emotional response in Greek
audiences. They would have a feeling of wonder and astonishment at the
appearance of the gods, which would often add to the moral effect of the
drama.
Modern theatrical examples
Characters ascend into heaven to become gods at the end of the 1650 play Andromède.
Shakespeare uses the device in As You Like It, Pericles, Prince of Tyre, and Cymbeline.[11]John Gay uses it in The Beggar's Opera
where a character breaks the action and rewrites the ending as a
reprieve from hanging for MacHeath. During the politically turbulent
17th and 18th centuries, the deus ex machina was sometimes used to make a controversial thesis more palatable to the powers of the day. For example, in the final scene of Molière's Tartuffe, the heroes are saved from a terrible fate by an agent of the compassionate, all-seeing King Louis XIV – the same king who held Molière's career and livelihood in his hands.
Plot device
Aristotle (in the Poetics 15 1454b1) was the first to use a Greek term equivalent to the Latin phrase deus ex machina to describe the technique as a device to resolve the plot of tragedies. It is said by one person to be undesirable in writing and often implies
a lack of creativity on the part of the author. The reasons for this
are that it damages the story's internal logic and is often so unlikely
that it challenges the reader's suspension of disbelief.
Examples
Avengers: Endgame
writers Christopher Markus and Stephen McFeely admitted the time travel
plot device in the 2019 film was the result of having written
themselves into a corner in the previous movie. Also, the sudden arrival of Captain Marvel in the climax of the film has been criticized as bordering on a deus ex machina because "her late arrival to the final battle ... feels like a function of her powers being too strong".
Lord of the Flies: A passing navy officer rescues the stranded children. William Golding called that a "gimmick"; other critics view it as a deus ex machina.
The abrupt ending conveys the terrible fate that would have afflicted
the children if the officer had not arrived at that moment.
Oliver Twist: Charles Dickens
used the device when Rose Maylie turns out to be the long-lost sister
of Agnes, and therefore Oliver's aunt; she marries her long-time
sweetheart Harry, allowing Oliver to live happily with his savior Mr.
Brownlow.
The War of the Worlds:
The Martians in H. G. Wells's novel have destroyed everything in their
path and apparently triumphed over humanity, but they are suddenly
killed by bacteria.
In medicine
In medicine, the phrase is often used for supposedly "magical remedies" which are not likely to work in practice. For example, in the 2020 COVID-19 outbreak, when double lung transplantation for terminal COVID-19 patients was suggested, it was immediately denounced as a deus ex machina. In 2006, when electronic fetal heart monitoring was being touted as a preventive measure for cerebral palsy, The New England Journal of Medicine denounced it as deus ex machina.
Criticism
The deus ex machina
device is often criticized as inartistic, too convenient, and overly
simplistic. However, champions of the device say that it opens up
ideological and artistic possibilities.
Ancient criticism
Antiphanes was one of the device's earliest critics. He believed that the use of the deus ex machina was a sign that the playwright was unable to properly manage the complications of his plot.
when they don't know what to say
and have completely given up on the play
just like a finger they lift the machine
and the spectators are satisfied.
— Antiphanes
Another critical reference to the device can be found in Plato's dialogue Cratylus, 425d, though it is made in the context of an argument unrelated to drama.
Aristotle criticized the device in his Poetics, where he argued that the resolution of a plot must arise internally, following from previous action of the play:
In the characters, too, exactly as
in the structure of the incidents, [the poet] ought always to seek what
is either necessary or probable, so that it is either necessary or
probable that a person of such-and-such a sort say or do things of the
same sort, and it is either necessary or probable that this [incident]
happen after that one. It is obvious that the solutions of plots, too,
should come about as a result of the plot itself, and not from a
contrivance, as in the Medea and in the passage about sailing home in the Iliad.
A contrivance must be used for matters outside the drama — either
previous events, which are beyond human knowledge, or later ones that
need to be foretold or announced. For we grant that the gods can see
everything. There should be nothing improbable in the incidents;
otherwise, it should be outside the tragedy, e.g., that in Sophocles' Oedipus.
Aristotle praised Euripides, however, for generally ending his plays
with bad fortune, which he viewed as correct in tragedy, and somewhat
excused the intervention of a deity by suggesting that "astonishment"
should be sought in tragic drama:
Irrationalities should be referred
to what people say: That is one solution, and also sometimes that it is
not irrational, since it is probable that improbable things will happen.
Such a device was referred to by Horace in his Ars Poetica
(lines 191–2), where he instructs poets that they should never resort
to a "god from the machine" to resolve their plots "unless a difficulty
worthy of a god's unraveling should happen" [nec deus intersit, nisi dignus uindice nodus inciderit; nec quarta loqui persona laboret].
Modern criticism
Following Aristotle, Renaissance critics continued to view the deus ex machina as an inept plot device, although it continued to be employed by Renaissance dramatists.
Toward the end of the 19th century, Friedrich Nietzsche criticized Euripides for making tragedy an optimistic genre
by use of the device, and was highly skeptical of the "Greek
cheerfulness," prompting what he viewed as the plays' "blissful delight
in life."[29] The deus ex machina as Nietzsche saw it was symptomatic of Socratic culture, which valued knowledge over Dionysiac music and ultimately caused the death of tragedy:
But the new non-Dionysiac spirit is most clearly apparent in the endings
of the new dramas. At the end of the old tragedies there was a sense of
metaphysical conciliation without which it is impossible to imagine our
taking delight in tragedy; perhaps the conciliatory tones from another
world echo most purely in Oedipus at Colonus.
Now, once tragedy had lost the genius of music, tragedy in the
strictest sense was dead: for where was that metaphysical consolation
now to be found? Hence an earthly resolution for tragic dissonance was
sought; the hero, having been adequately tormented by fate, won his
well-earned reward in a stately marriage and tokens of divine honour.
The hero had become a gladiator, granted freedom once he had been
satisfactorily flayed and scarred. Metaphysical consolation had been
ousted by the deus ex machina.
— Friedrich Nietzsche
Nietzsche argued that the deus ex machina creates a false sense of consolation that ought not to be sought in phenomena. His denigration of the plot device has prevailed in critical opinion.
In Euripides the Rationalist (1895), Arthur Woollgar Verrall
surveyed and recorded other late 19th-century responses to the device.
He recorded that some of the critical responses to the term referred to
it as 'burlesque', 'coup de théâtre', and 'catastrophe'. Verrall notes
that critics have a dismissive response to authors who deploy the device
in their writings. He comes to the conclusion that critics feel that
the deus ex machina is evidence of the author's attempt to ruin
the whole of his work and to prevent anyone from putting any importance
on his work.
However, other scholars have looked at Euripides' use of deus ex machina
and described its use as an integral part of the plot, designed for a
specific purpose. Often, Euripides' plays would begin with gods, so it
is argued that it would be natural for the gods to finish the action.
The conflict throughout Euripides' plays would be caused by the meddling
of the gods, so it would make sense both to the playwright and to the
audience of the time that the gods would resolve all conflict that they
began. Half of Euripides' eighteen extant plays end with the use of deus ex machina,
therefore it was not simply a device to relieve the playwright of the
embarrassment of a confusing plot-ending. This device enabled him to
bring about a natural and more dignified dramatic and tragic ending.
Other champions of the device believe that it can be a
spectacular agent of subversion. It can be used to undercut generic
conventions and challenge cultural assumptions and the privileged role
of tragedy as a literary/theatrical model.
Some 20th-century revisionist criticism suggests that deus ex machina
cannot be viewed in these simplified terms, and contends that the
device allows mortals to "probe" their relationship with the divine. Rush Rehm in particular cites examples of Greek tragedy in which the deus ex machina
complicates the lives and attitudes of characters confronted by the
deity, while simultaneously bringing the drama home to its audience. Sometimes, the unlikeliness of the deus ex machina plot device is employed deliberately. An example is shown through the comic effect generated in Monty Python's Life of Brian, when Brian, who lives in Judea at the time of Christ, is saved from a high fall by a passing alien spaceship.
Keynesian economists generally argue that aggregate demand is volatile and unstable and that, consequently, a market economy often experiences inefficient macroeconomic outcomes, including recessions
when demand is too low and inflation when demand is too high. Further,
they argue that these economic fluctuations can be mitigated by economic
policy responses coordinated between a government and their central bank. In particular, fiscal policy actions taken by the government and monetary policy actions taken by the central bank, can help stabilize economic output, inflation, and unemployment over the business cycle. Keynesian economists generally advocate a regulated market economy – predominantly private sector, but with an active role for government intervention during recessions and depressions.
Keynesian economics has developed new directions to study wider
social and institutional patterns during the past several decades.
Post-Keynesian and New Keynesian economists have developed Keynesian
thought by adding concepts about income distribution and labor market
frictions and institutional reform. Alejandro Antonio advocates for
“equality of place” instead of “equality of opportunity” by supporting
structural economic changes and universal service access and worker
protections. Greenwald and Stiglitz represent New Keynesian economists
who show how contemporary market failures regarding credit rationing
and wage rigidity can lead to unemployment persistence in modern
economies. Scholars including K.H. Lee explain how uncertainty remains
important according to Keynes because expectations and conventions
together with psychological behaviour known as "animal spirits" affect
investment and demand. Tregub's empirical research of French consumption
patterns between 2001 and 2011 serves as contemporary evidence for
demand-based economic interventions. The ongoing developments prove
that Keynesian economics functions as a dynamic and lasting framework to
handle economic crises and create inclusive economic policies.
Macroeconomics
is the study of the factors applying to an economy as a whole.
Important macroeconomic variables include the overall price level, the interest rate, the level of employment, and income (or equivalently output) measured in real terms.
The classical tradition of partial equilibrium theory
had been to split the economy into separate markets, each of whose
equilibrium conditions could be stated as a single equation determining a
single variable. The theoretical apparatus of supply and demand curves developed by Fleeming Jenkin and Alfred Marshall provided a unified mathematical basis for this approach, which the Lausanne School generalized to general equilibrium theory.
For macroeconomics, relevant partial theories included the Quantity theory of money determining the price level and the classical theory of the interest rate.
In regards to employment, the condition referred to by Keynes as the
"first postulate of classical economics" stated that the wage is equal
to the marginal product, which is a direct application of the marginalist principles developed during the nineteenth century (see The General Theory). Keynes sought to supplant all three aspects of the classical theory.
Although Keynes's work was crystallized and given impetus by the advent of the Great Depression, it was part of a long-running debate within economics over the existence and nature of general gluts.
A number of the policies Keynes advocated to address the Great
Depression (notably government deficit spending at times of low private
investment or consumption), and many of the theoretical ideas he
proposed (effective demand, the multiplier, the paradox of thrift), had been advanced by authors in the 19th and early 20th centuries. (E.g. J. M. Robertson raised the paradox of thrift in 1892.) Keynes's unique contribution was to provide a general theory of these, which proved acceptable to the economic establishment.
Numerous concepts were developed earlier and independently of Keynes by the Stockholm school during the 1930s; these accomplishments were described in a 1937 article, published in response to the 1936 General Theory, sharing the Swedish discoveries.
Keynes's early writings
In 1923, Keynes published his first contribution to economic theory, A Tract on Monetary Reform, whose point of view is classical but incorporates ideas that later played a part in the General Theory. In particular, looking at the hyperinflation in European economies, he drew attention to the opportunity cost of holding money (identified with inflation rather than interest) and its influence on the velocity of circulation.
In 1930, he published A Treatise on Money,
intended as a broad treatment of its subject "which would confirm his
stature as a serious academic scholar, rather than just as the author of
stinging polemics", and marks a large step in the direction of his later views. In it, he attributes unemployment to wage stickiness and treats saving and investment as governed by independent decisions: the former varying positively with the interest rate, the latter negatively. The velocity of circulation is expressed as a function of the rate of interest. He interpreted his treatment of liquidity as implying a purely monetary theory of interest.
Keynes's younger colleagues of the Cambridge Circus and Ralph Hawtrey believed that his arguments implicitly assumed full employment, and this influenced the direction of his subsequent work.[20] During 1933, he wrote essays on various economic topics "all of which are cast in terms of movement of output as a whole".
Development of The General Theory
At the time that Keynes wrote the General Theory,
it had been a tenet of mainstream economic thought that the economy
would automatically revert to a state of general equilibrium: it had
been assumed that, because the needs of consumers are always greater
than the capacity of the producers to satisfy those needs, everything
that is produced would eventually be consumed once the appropriate price
was found for it. This perception is reflected in Say's law and in the writing of David Ricardo, which states that individuals produce so that they can either consume
what they have manufactured or sell their output so that they can buy
someone else's output. This argument rests upon the assumption that if a
surplus of goods or services exists, they would naturally drop in price
to the point where they would be consumed.
Given the backdrop of high and persistent unemployment during the
Great Depression, Keynes argued that there was no guarantee that the
goods that individuals produce would be met with adequate effective
demand, and periods of high unemployment could be expected, especially
when the economy was contracting in size. He saw the economy as unable
to maintain itself at full employment automatically, and believed that
it was necessary for the government to step in and put purchasing power
into the hands of the working population through government spending.
Thus, according to Keynesian theory, some individually rational microeconomic-level
actions such as not investing savings in the goods and services
produced by the economy, if taken collectively by a large proportion of
individuals and firms, can lead to outcomes wherein the economy operates
below its potential output and growth rate.
Prior to Keynes, a situation in which aggregate demand for goods and services did not meet supply was referred to by classical economists as a general glut,
although there was disagreement among them as to whether a general glut
was possible. Keynes argued that when a glut occurred, it was the
over-reaction of producers and the laying off of workers that led to a
fall in demand and perpetuated the problem. Keynesians therefore
advocate an active stabilization policy to reduce the amplitude of the
business cycle, which they rank among the most serious of economic
problems. According to the theory, government spending can be used to
increase aggregate demand, thus increasing economic activity, reducing
unemployment and deflation.
Origins of the multiplier
The Liberal Party
fought the 1929 General Election on a promise to "reduce levels of
unemployment to normal within one year by utilising the stagnant labour
force in vast schemes of national development". David Lloyd George launched his campaign in March with a policy document, We can cure unemployment, which tentatively claimed that, "Public works would lead to a second round of spending as the workers spent their wages." Two months later Keynes, then nearing completion of his Treatise on money, and Hubert Henderson
collaborated on a political pamphlet seeking to "provide academically
respectable economic arguments" for Lloyd George's policies. It was titled Can Lloyd George do it? and endorsed the claim that "greater trade activity would make for greater trade activity ... with a cumulative effect". This became the mechanism of the "ratio" published by Richard Kahn in his 1931 paper "The relation of home investment to unemployment", described by Alvin Hansen as "one of the great landmarks of economic analysis". The "ratio" was soon rechristened the "multiplier" at Keynes's suggestion.
The multiplier of Kahn's paper is based on a respending mechanism familiar nowadays from textbooks. Samuelson puts it as follows:
Let's suppose that I hire unemployed resources to build a
$1000 woodshed. My carpenters and lumber producers will get an extra
$1000 of income... If they all have a marginal propensity to consume of
2/3, they will now spend $666.67 on new consumption goods. The producers
of these goods will now have extra incomes... they in turn will spend
$444.44 ... Thus an endless chain of secondary consumption respending is set in motion by my primary investment of $1000.
Samuelson's treatment closely follows Joan Robinson's account of 1937 and is the main channel by which the multiplier has influenced
Keynesian theory. It differs significantly from Kahn's paper and even
more from Keynes's book.
The designation of the initial spending as "investment" and the
employment-creating respending as "consumption" echoes Kahn faithfully,
though he gives no reason why initial consumption or subsequent
investment respending should not have exactly the same effects. Henry Hazlitt, who considered Keynes as much a culprit as Kahn and Samuelson, wrote that ...
... in connection with the multiplier (and indeed most of the time) what Keynes is referring to as "investment" really means any addition to spending for any purpose... The word "investment" is being used in a Pickwickian, or Keynesian, sense.
Kahn envisaged money as being passed from hand to hand, creating employment at each step, until it came to rest in a cul-de-sac (Hansen's term was "leakage"); the only culs-de-sac
he acknowledged were imports and hoarding, although he also said that a
rise in prices might dilute the multiplier effect. Jens Warming
recognised that personal saving had to be considered, treating it as a "leakage" (p. 214) while recognising on p. 217 that it might in fact be invested.
The textbook multiplier gives the impression that making society
richer is the easiest thing in the world: the government just needs to
spend more. In Kahn's paper, it is harder. For him, the initial
expenditure must not be a diversion of funds from other uses, but an
increase in the total expenditure: something impossible – if understood
in real terms – under the classical theory that the level of expenditure
is limited by the economy's income/output. On page 174, Kahn rejects
the claim that the effect of public works is at the expense of
expenditure elsewhere, admitting that this might arise if the revenue is
raised by taxation, but says that other available means have no such
consequences. As an example, he suggests that the money may be raised by
borrowing from banks, since ...
... it is always within the power of the banking system
to advance to the Government the cost of the roads without in any way
affecting the flow of investment along the normal channels.
This assumes that banks are free to create resources to answer any demand. But Kahn adds that ...
... no such hypothesis is really necessary. For it will be demonstrated later on that, pari passu
with the building of roads, funds are released from various sources at
precisely the rate that is required to pay the cost of the roads.
The demonstration relies on "Mr Meade's relation" (due to James Meade) asserting that the total amount of money that disappears into culs-de-sac is equal to the original outlay, which in Kahn's words "should bring relief and consolation to those who are worried about the monetary sources" (p. 189).
A respending multiplier had been proposed earlier by Hawtrey in a
1928 Treasury memorandum ("with imports as the only leakage"), but the
idea was discarded in his own subsequent writings. Soon afterwards the Australian economist Lyndhurst Giblin published a multiplier analysis in a 1930 lecture (again with imports as the only leakage). The idea itself was much older. Some Dutch mercantilists had believed in an infinite multiplier for military expenditure (assuming no import "leakage"), since ...
... a war could support itself for an unlimited period if
only money remained in the country ... For if money itself is
"consumed", this simply means that it passes into someone else's
possession, and this process may continue indefinitely.
Multiplier doctrines had subsequently been expressed in more theoretical terms by the Dane Julius Wulff (1896), the Australian Alfred de Lissa (late 1890s), the German/American Nicholas Johannsen (same period), and the Dane Fr. Johannsen (1925/1927). Kahn himself said that the idea was given to him as a child by his father.
Public policy debates
As
the 1929 election approached "Keynes was becoming a strong public
advocate of capital development" as a public measure to alleviate
unemployment. Winston Churchill, the Conservative Chancellor, took the opposite view:
It is the orthodox Treasury dogma, steadfastly held ...
[that] very little additional employment and no permanent additional
employment can, in fact, be created by State borrowing and State
expenditure.
Keynes pounced on a flaw in the Treasury view. Cross-examining Sir Richard Hopkins, a Second Secretary in the Treasury, before the Macmillan Committee
on Finance and Industry in 1930 he referred to the "first proposition"
that "schemes of capital development are of no use for reducing
unemployment" and asked whether "it would be a misunderstanding of the
Treasury view to say that they hold to the first proposition". Hopkins
responded that "The first proposition goes much too far. The first
proposition would ascribe to us an absolute and rigid dogma, would it
not?"
Later the same year, speaking in a newly created Committee of
Economists, Keynes tried to use Kahn's emerging multiplier theory to
argue for public works, "but Pigou's and Henderson's objections ensured
that there was no sign of this in the final product". In 1933 he gave wider publicity to his support for Kahn's multiplier in
a series of articles titled "The road to prosperity" in The Times newspaper.
A. C. Pigou
was at the time the sole economics professor at Cambridge. He had a
continuing interest in the subject of unemployment, having expressed the
view in his popular Unemployment (1913) that it was caused by "maladjustment between wage-rates and demand" – a view Keynes may have shared prior to the years of the General Theory.
Nor were his practical recommendations very different: "on many
occasions in the thirties" Pigou "gave public support [...] to State
action designed to stimulate employment". Where the two men differed is in the link between theory and practice.
Keynes was seeking to build theoretical foundations to support his
recommendations for public works while Pigou showed no disposition to
move away from classical doctrine. Referring to him and Dennis Robertson,
Keynes asked rhetorically: "Why do they insist on maintaining theories
from which their own practical conclusions cannot possibly follow?"
Keynes set forward the ideas that became the basis for Keynesian economics in his main work, The General Theory of Employment, Interest and Money (1936). It was written during the Great Depression,
when unemployment rose to 25% in the United States and as high as 33%
in some countries. It is almost wholly theoretical, enlivened by
occasional passages of satire and social commentary. The book had a
profound impact on economic thought, and ever since it was published
there has been debate over its meaning.
Keynes and classical economics
Keynes begins the General Theory with a summary of the classical theory of employment, which he encapsulates in his formulation of Say's Law as the dictum "Supply creates its own demand".
He also wrote that although his theory was explained in terms of an Anglo-Saxon laissez faire
economy, his theory was also more general in the sense that it would be
easier to adapt to "totalitarian states" than a free market policy
would.
Under the classical theory, the wage rate is determined by the marginal productivity of labour, and as many people are employed as are willing to work at that rate. Unemployment may arise through friction
or may be "voluntary", in the sense that it arises from a refusal to
accept employment owing to "legislation or social practices ... or mere
human obstinacy", but "...the classical postulates do not admit of the
possibility of the third category," which Keynes defines as involuntary unemployment.
Keynes raises two objections to the classical theory's assumption
that "wage bargains ... determine the real wage". The first lies in the
fact that "labour stipulates (within limits) for a money-wage rather
than a real wage". The second is that classical theory assumes that,
"The real wages of labour depend on the wage bargains which labour makes
with the entrepreneurs," whereas, "If money wages change, one would
have expected the classical school to argue that prices would change in
almost the same proportion, leaving the real wage and the level of
unemployment practically the same as before." Keynes considers his second objection the more fundamental, but most
commentators concentrate on his first one: it has been argued that the quantity theory of money protects the classical school from the conclusion Keynes expected from it.
Keynesian unemployment
Saving and investment
Saving is that part of income not devoted to consumption, and consumption is that part of expenditure not allocated to investment, i.e., to durable goods. Hence saving encompasses hoarding (the accumulation of income as cash)
and the purchase of durable goods. The existence of net hoarding, or of a
demand to hoard, is not admitted by the simplified liquidity preference
model of the General Theory.
Once he rejects the classical theory that unemployment is due to
excessive wages, Keynes proposes an alternative based on the
relationship between saving and investment. In his view, unemployment
arises whenever entrepreneurs' incentive to invest fails to keep pace
with society's propensity to save (propensity is one of Keynes's
synonyms for "demand"). The levels of saving and investment are
necessarily equal, and income is therefore held down to a level where
the desire to save is no greater than the incentive to invest.
The incentive to invest arises from the interplay between the
physical circumstances of production and psychological anticipations of
future profitability; but once these things are given the incentive is
independent of income and depends solely on the rate of interest r. Keynes designates its value as a function of r as the "schedule of the marginal efficiency of capital".
The propensity to save behaves quite differently. Saving is simply that part of income not devoted to consumption, and:
... the prevailing psychological law seems to be that
when aggregate income increases, consumption expenditure will also
increase but to a somewhat lesser extent.
Keynes adds that "this psychological law was of the utmost importance in the development of my own thought".
Liquidity preference
Determination of income according to the General Theory
Keynes viewed the money supply
as one of the main determinants of the state of the real economy. The
significance he attributed to it is one of the innovative features of
his work, and was influential on the politically hostile monetarist school.
Money supply comes into play through the liquidity preference
function, which is the demand function that corresponds to money
supply. It specifies the amount of money people will seek to hold
according to the state of the economy. In Keynes's first (and simplest)
account – that of Chapter 13 – liquidity preference is determined solely
by the interest ratesr—which is seen as the earnings forgone by holding wealth in liquid form: hence liquidity preference can be written L(r ) and in equilibrium must equal the externally fixed money supply M̂.
Keynes's economic model
Money supply, saving and investment combine to determine the level of income as illustrated in the diagram, where the top graph shows money supply (on the vertical axis) against interest rate. M̂ determines the ruling interest rate r̂ through the liquidity preference function. The rate of interest determines the level of investment Î through
the schedule of the marginal efficiency of capital, shown as a blue
curve in the lower graph. The red curves in the same diagram show what
the propensities to save are for different incomes Y ; and the income Ŷ
corresponding to the equilibrium state of the economy must be the one
for which the implied level of saving at the established interest rate
is equal to Î.
In Keynes's more complicated liquidity preference theory
(presented in Chapter 15) the demand for money depends on income as well
as on the interest rate and the analysis becomes more complicated.
Keynes never fully integrated his second liquidity preference doctrine
with the rest of his theory, leaving that to John Hicks: see the IS-LM model below.
Wage rigidity
Keynes
rejects the classical explanation of unemployment based on wage
rigidity, but it is not clear what effect the wage rate has on
unemployment in his system. He treats wages of all workers as
proportional to a single rate set by collective bargaining, and chooses
his units so that this rate never appears separately in his discussion.
It is present implicitly in those quantities he expresses in wage units,
while being absent from those he expresses in money terms. It is
therefore difficult to see whether, and in what way, his results differ
for a different wage rate, nor is it clear what he thought about the
matter.
Remedies for unemployment
Monetary remedies
An
increase in the money supply, according to Keynes's theory, leads to a
drop in the interest rate and an increase in the amount of investment
that can be undertaken profitably, bringing with it an increase in total
income.
Fiscal remedies
Keynes'
name is associated with fiscal, rather than monetary, measures but they
receive only passing (and often satirical) reference in the General Theory. He mentions "increased public works" as an example of something that brings employment through the multiplier, but this is before he develops the relevant theory, and he does not follow up when he gets to the theory.
Later in the same chapter he tells us that:
Ancient Egypt was doubly fortunate, and doubtless owed to
this its fabled wealth, in that it possessed two activities, namely,
pyramid-building as well as the search for the precious metals, the
fruits of which, since they could not serve the needs of man by being
consumed, did not stale with abundance. The Middle Ages built cathedrals
and sang dirges. Two pyramids, two masses for the dead, are twice as
good as one; but not so two railways from London to York.
But again, he does not get back to his implied recommendation to
engage in public works, even if not fully justified from their direct
benefits, when he constructs the theory. On the contrary he later
advises us that ...
... our final task might be to select those variables
which can be deliberately controlled or managed by central authority in
the kind of system in which we actually live ...
and this appears to look forward to a future publication rather than to a subsequent chapter of the General Theory.
Keynesian models and concepts
Aggregate demand
Keynes–Samuelson cross
Keynes' view of saving and investment was his most important
departure from the classical outlook. It can be illustrated using the "Keynesian cross" devised by Paul Samuelson. The horizontal axis denotes total income and the purple curve shows C (Y ), the propensity to consume, whose complement S (Y ) is the propensity to save: the sum of these two functions is equal to total income, which is shown by the broken line at 45°.
The horizontal blue line I (r ) is the schedule of the marginal efficiency of capital whose value is independent of Y.
The schedule of the marginal efficiency of capital is dependent on the
interest rate, specifically the interest rate cost of a new investment.
If the interest rate charged by the financial sector to the productive
sector is below the marginal efficiency of capital at that level of
technology and capital intensity then investment is positive and grows
the lower the interest rate is, given the diminishing return of capital.
If the interest rate is above the marginal efficiency of capital then
investment is equal to zero. Keynes interprets this as the demand for
investment and denotes the sum of demands for consumption and investment
as "aggregate demand",
plotted as a separate curve. Aggregate demand must equal total income,
so equilibrium income must be determined by the point where the
aggregate demand curve crosses the 45° line. This is the same horizontal position as the intersection of I (r ) with S (Y ).
The equation I (r ) = S (Y ) had been
accepted by the classics, who had viewed it as the condition of
equilibrium between supply and demand for investment funds and as
determining the interest rate (see the classical theory of interest). But insofar as they had had a concept of aggregate demand, they had seen the demand for investment as being given by S (Y ),
since for them saving was simply the indirect purchase of capital
goods, with the result that aggregate demand was equal to total income
as an identity rather than as an equilibrium condition. Keynes takes
note of this view in Chapter 2, where he finds it present in the early
writings of Alfred Marshall but adds that "the doctrine is never stated to-day in this crude form".
The equation I (r ) = S (Y ) is accepted by Keynes for some or all of the following reasons:
As a consequence of the principle of effective demand, which asserts that aggregate demand must equal total income (Chapter 3).
As a consequence of the identity of saving with investment (Chapter
6) together with the equilibrium assumption that these quantities are
equal to their demands.
In agreement with the substance of the classical theory of the
investment funds market, whose conclusion he considers the classics to
have misinterpreted through circular reasoning (Chapter 14).
The Keynesian multiplier
Keynes introduces his discussion of the multiplier in Chapter 10 with a reference to Kahn's earlier paper (see below).
He designates Kahn's multiplier the "employment multiplier" in
distinction to his own "investment multiplier" and says that the two are
only "a little different". Kahn's multiplier has consequently been understood by much of the
Keynesian literature as playing a major role in Keynes's own theory, an
interpretation encouraged by the difficulty of understanding Keynes's
presentation. Kahn's multiplier gives the title ("The multiplier model")
to the account of Keynesian theory in Samuelson's Economics and is almost as prominent in Alvin Hansen's Guide to Keynes and in Joan Robinson's Introduction to the Theory of Employment.
Keynes states that there is ...
... a confusion between the logical theory of the
multiplier, which holds good continuously, without time-lag ... and the
consequence of an expansion in the capital goods industries which take
gradual effect, subject to a time-lag, and only after an interval ...
and implies that he is adopting the former theory. And when the multiplier eventually emerges as a component of Keynes's
theory (in Chapter 18) it turns out to be simply a measure of the change
of one variable in response to a change in another. The schedule of the
marginal efficiency of capital is identified as one of the independent
variables of the economic system: "What [it] tells us, is ... the point to which the output of new investment will be pushed ..." The multiplier then gives "the ratio ... between an increment of
investment and the corresponding increment of aggregate income".
G. L. S. Shackle regarded Keynes' move away from Kahn's multiplier as ...
... a retrograde step ... For when we look upon the
Multiplier as an instantaneous functional relation ... we are merely
using the word Multiplier to stand for an alternative way of looking at
the marginal propensity to consume ...,
which G. M. Ambrosi cites as an instance of "a Keynesian commentator
who would have liked Keynes to have written something less 'retrograde'".
The value Keynes assigns to his multiplier is the reciprocal of the marginal propensity to save: k = 1 / S '(Y ).
This is the same as the formula for Kahn's multiplier in a closed
economy assuming that all saving (including the purchase of durable
goods), and not just hoarding, constitutes leakage. Keynes gave his
formula almost the status of a definition (it is put forward in advance
of any explanation).
His multiplier is indeed the value of "the ratio ... between an
increment of investment and the corresponding increment of aggregate
income" as Keynes derived it from his Chapter 13 model of liquidity
preference, which implies that income must bear the entire effect of a
change in investment. But under his Chapter 15 model a change in the
schedule of the marginal efficiency of capital has an effect shared
between the interest rate and income in proportions depending on the
partial derivatives of the liquidity preference function. Keynes did not
investigate the question of whether his formula for multiplier needed
revision.
The liquidity trap
The liquidity trap
The liquidity trap is a phenomenon that may impede the effectiveness of monetary policies in reducing unemployment.
Economists generally think the rate of interest will not fall
below a certain limit, often seen as zero or a slightly negative number.
Keynes suggested that the limit might be appreciably greater than zero
but did not attach much practical significance to it. The term
"liquidity trap" was coined by Dennis Robertson in his comments on the General Theory, but it was John Hicks in "Mr. Keynes and the Classics" who recognised the significance of a slightly different concept.
If the economy is in a position such that the liquidity
preference curve is almost vertical, as must happen as the lower limit
on r is approached, then a change in the money supply M̂ makes almost no difference to the equilibrium rate of interest r̂ or, unless there is compensating steepness in the other curves, to the resulting income Ŷ. As Hicks put it, "Monetary means will not force down the rate of interest any further."
Paul Krugman has worked extensively on the liquidity trap,
claiming that it was the problem confronting the Japanese economy around
the turn of the millennium. In his later words:
Short-term interest rates were close to zero, long-term
rates were at historical lows, yet private investment spending remained
insufficient to bring the economy out of deflation. In that environment,
monetary policy was just as ineffective as Keynes described. Attempts
by the Bank of Japan to increase the money supply simply added to
already ample bank reserves and public holdings of cash...
The IS–LM model
IS–LM plot
Hicks showed how to analyse Keynes' system when liquidity preference
is a function of income as well as of the rate of interest. Keynes's
admission of income as an influence on the demand for money is a step
back in the direction of classical theory, and Hicks takes a further
step in the same direction by generalizing the propensity to save to
take both Y and r as arguments. Less classically he extends this generalization to the schedule of the marginal efficiency of capital.
The IS-LM model uses two equations to express Keynes' model. The first, now written I (Y, r ) = S (Y,r ), expresses the principle of effective demand. We may construct a graph on (Y, r ) coordinates and draw a line connecting those points satisfying the equation: this is the IS curve. In the same way we can write the equation of equilibrium between liquidity preference and the money supply as L(Y ,r ) = M̂ and draw a second curve – the LM curve – connecting points that satisfy it. The equilibrium values Ŷ of total income and r̂ of interest rate are then given by the point of intersection of the two curves.
If we follow Keynes's initial account under which liquidity preference depends only on the interest rate r, then the LM curve is horizontal.
... modern teaching has been confused by J. R. Hicks' attempt to reduce the General Theory
to a version of static equilibrium with the formula IS–LM. Hicks has
now repented and changed his name from J. R. to John, but it will take a
long time for the effects of his teaching to wear off.
Hicks subsequently relapsed.
Keynesian economic policies
Active fiscal policy
Typical intervention strategies under different conditions
Keynes argued that the solution to the Great Depression was to stimulate the country ("incentive to invest") through some combination of two approaches:
A reduction in interest rates (monetary policy), and
Government investment in infrastructure (fiscal policy).
If the interest rate at which businesses and consumers can borrow
decreases, investments that were previously uneconomic become
profitable, and large consumer sales normally financed through debt
(such as houses, automobiles, and, historically, even appliances like
refrigerators) become more affordable. A principal function of central banks in countries that have them is to influence this interest rate through a variety of mechanisms collectively called monetary policy.
This is how monetary policy that reduces interest rates is thought to
stimulate economic activity, i.e., "grow the economy"—and why it is
called expansionary monetary policy.
Expansionary fiscal policy consists of increasing net public
spending, which the government can effect by a) taxing less, b) spending
more, or c) both. Investment and consumption by government raises
demand for businesses' products and for employment, reversing the
effects of the aforementioned imbalance. If desired spending exceeds
revenue, the government finances the difference by borrowing from capital markets
by issuing government bonds. This is called deficit spending. Two
points are important to note at this point. First, deficits are not
required for expansionary fiscal policy, and second, it is only change
in net spending that can stimulate or depress the economy. For example,
if a government ran a deficit of 10% both last year and this year, this
would represent neutral fiscal policy. In fact, if it ran a deficit of
10% last year and 5% this year, this would actually be contractionary.
On the other hand, if the government ran a surplus of 10% of GDP last
year and 5% this year, that would be expansionary fiscal policy, despite
never running a deficit at all.
Contrary to some critical characterizations of it, Keynesianism does not consist solely of deficit spending, since it recommends adjusting fiscal policies according to cyclical circumstances. An example of a counter-cyclical policy is raising taxes to cool the
economy and to prevent inflation when there is abundant demand-side
growth, and engaging in deficit spending on labour-intensive
infrastructure projects to stimulate employment and stabilize wages
during economic downturns.
Keynes's ideas influenced US President Franklin D. Roosevelt's
view that insufficient buying-power caused the Depression. During his
presidency, Roosevelt adopted some aspects of Keynesian economics,
especially after 1937, when, in the depths of the Depression, the United
States suffered from recession yet again following fiscal contraction.
But to many the true success of Keynesian policy can be seen at the
onset of World War II,
which provided a kick to the world economy, removed uncertainty, and
forced the rebuilding of destroyed capital. Keynesian ideas became
almost official in social-democratic Europe after the war and in the U.S. in the 1960s.
The Keynesian advocacy of deficit spending contrasted with the classical and neoclassical
economic analysis of fiscal policy. They admitted that fiscal stimulus
could actuate production. But, to these schools, there was no reason to
believe that this stimulation would outrun the side-effects that "crowd out" private investment: first, it would increase the demand for labour and raise wages, hurting profitability; Second, a government deficit increases the stock of government bonds, reducing their market price and encouraging high interest rates, making it more expensive for business to finance fixed investment. Thus, efforts to stimulate the economy would be self-defeating.
The Keynesian response is that such fiscal policy is appropriate only when unemployment is persistently high, above the non-accelerating inflation rate of unemployment
(NAIRU). In that case, crowding out is minimal. Further, private
investment can be "crowded in": Fiscal stimulus raises the market for
business output, raising cash flow and profitability, spurring business
optimism. To Keynes, this accelerator effect meant that government and business could be complements rather than substitutes in this situation.
Second, as the stimulus occurs, gross domestic product rises—raising the amount of saving,
helping to finance the increase in fixed investment. Finally,
government outlays need not always be wasteful: government investment in
public goods
that is not provided by profit-seekers encourages the private sector's
growth. That is, government spending on such things as basic research,
public health, education, and infrastructure could help the long-term
growth of potential output.
Keynesian economists believe that adding to profits and incomes
during boom cycles through tax cuts, and removing income and profits
from the economy through cuts in spending during downturns, tends to
exacerbate the negative effects of the business cycle. This effect is
especially pronounced when the government controls a large fraction of
the economy, as increased tax revenue may aid investment in state
enterprises in downturns, and decreased state revenue and investment
harm those enterprises.
Views on trade imbalance
In the last few years of his life, Keynes was much preoccupied with the question of balance in international trade. He was the leader of the British delegation to the United Nations Monetary and Financial Conference in 1944 that established the Bretton Woods system of international currency management.
He was the principal author of a proposal – the so-called Keynes Plan – for an International Clearing Union.
The two governing principles of the plan were that the problem of
settling outstanding balances should be solved by 'creating' additional
'international money', and that debtor and creditor should be treated
almost alike as disturbers of equilibrium. In the event, though, the
plans were rejected, in part because "American opinion was naturally
reluctant to accept the principle of equality of treatment so novel in
debtor-creditor relationships".
The new system is not founded on free trade (liberalization of foreign trade)
but rather on regulating international trade to eliminate trade
imbalances. Nations with a surplus would have a powerful incentive to
get rid of it, which would automatically clear other nations' deficits. Keynes proposed a global bank that would issue its own currency—the bancor—which
was exchangeable with national currencies at fixed rates of exchange
and would become the unit of account between nations, which means it
would be used to measure a country's trade deficit or trade surplus.
Every country would have an overdraft facility in its bancor account at
the International Clearing Union. He pointed out that surpluses lead to
weak global aggregate demand – countries running surpluses exert a
"negative externality" on trading partners, and posed far more than
those in deficit, a threat to global prosperity. Keynes thought that
surplus countries should be taxed to avoid trade imbalances. In "National Self-Sufficiency" The Yale Review, Vol. 22, no. 4 (June 1933), he already highlighted the problems created by free trade.
His view, supported by many economists and commentators at the
time, was that creditor nations may be just as responsible as debtor
nations for disequilibrium in exchanges and that both should be under an
obligation to bring trade back into a state of balance. Failure for
them to do so could have serious consequences. In the words of Geoffrey Crowther, then editor of The Economist,
"If the economic relationships between nations are not, by one means or
another, brought fairly close to balance, then there is no set of
financial arrangements that can rescue the world from the impoverishing
results of chaos."
These ideas were informed by events prior to the Great Depression
when – in the opinion of Keynes and others – international lending,
primarily by the U.S., exceeded the capacity of sound investment and so
got diverted into non-productive and speculative uses, which in turn
invited default and a sudden stop to the process of lending.
Influenced by Keynes, economic texts in the immediate post-war
period put a significant emphasis on balance in trade. For example, the
second edition of the popular introductory textbook, An Outline of Money, devoted the last three of its ten chapters to questions of foreign
exchange management and in particular the 'problem of balance'. However,
in more recent years, since the end of the Bretton Woods system in 1971, with the increasing influence of Monetarist
schools of thought in the 1980s, and particularly in the face of large
sustained trade imbalances, these concerns – and particularly concerns
about the destabilizing effects of large trade surpluses – have largely
disappeared from mainstream economics discourse and Keynes' insights have slipped from view. They received attention again during the 2008 financial crisis.
Views on free trade and protectionism
The turning point of the Great Depression
At the beginning of his career, Keynes was an economist close to Alfred Marshall,
deeply convinced of the benefits of free trade. From the crisis of 1929
onwards, noting the commitment of the British authorities to defend the
gold parity of the pound sterling and the rigidity of nominal wages, he
gradually adhered to protectionist measures.
On 5 November 1929, when heard by the Macmillan Committee
to bring the British economy out of the crisis, Keynes indicated that
the introduction of tariffs on imports would help to rebalance the trade
balance. The committee's report states in a section entitled "import
control and export aid", that in an economy where there is not full
employment, the introduction of tariffs can improve production and
employment. Thus the reduction of the trade deficit favours the
country's growth.
In January 1930, in the Economic Advisory Council, Keynes
proposed the introduction of a system of protection to reduce imports.
In the autumn of 1930, he proposed a uniform tariff of 10% on all
imports and subsidies of the same rate for all exports.[92] In the Treatise on Money,
published in the autumn of 1930, he took up the idea of tariffs or
other trade restrictions with the aim of reducing the volume of imports
and rebalancing the balance of trade.[92]
On 7 March 1931, in the New Statesman and Nation, he wrote an article entitled Proposal for a Tariff Revenue.
He pointed out that the reduction of wages led to a reduction in
national demand which constrained markets. Instead, he proposes the idea
of an expansionary policy combined with a tariff system to neutralize
the effects on the balance of trade. The application of customs tariffs
seemed to him "unavoidable, whoever the Chancellor of the Exchequer
might be". Thus, for Keynes, an economic recovery policy is only fully
effective if the trade deficit is eliminated. He proposed a 15% tax on
manufactured and semi-manufactured goods and 5% on certain foodstuffs
and raw materials, with others needed for exports exempted (wool,
cotton).
In 1932, in an article entitled The Pro- and Anti-Tariffs, published in The Listener,
he envisaged the protection of farmers and certain sectors such as the
automobile and iron and steel industries, considering them indispensable
to Britain.
The critique of the theory of comparative advantage
In
the post-crisis situation of 1929, Keynes judged the assumptions of the
free trade model unrealistic. He criticized, for example, the
neoclassical assumption of wage adjustment.
As early as 1930, in a note to the Economic Advisory Council, he
doubted the intensity of the gain from specialization in the case of
manufactured goods. While participating in the MacMillan Committee, he
admitted that he no longer "believed in a very high degree of national
specialisation" and refused to "abandon any industry which is unable,
for the moment, to survive". He also criticized the static dimension of
the theory of comparative advantage, which, in his view, by fixing
comparative advantages definitively, led in practice to a waste of
national resources.
In the Daily Mail of 13 March 1931, he called the assumption of
perfect sectoral labour mobility "nonsense" since it states that a
person made unemployed contributes to a reduction in the wage rate until
he finds a job. But for Keynes, this change of job may involve costs
(job search, training) and is not always possible. Generally speaking,
for Keynes, the assumptions of full employment and automatic return to
equilibrium discredit the theory of comparative advantage.
In July 1933, he published an article in the New Statesman and Nation entitled National Self-Sufficiency,
in which he criticized the argument of the specialization of economies,
which is the basis of free trade. He thus proposed the search for a
certain degree of self-sufficiency. Instead of the specialization of
economies advocated by the Ricardian theory of comparative advantage, he
prefers the maintenance of a diversity of activities for nations. In it he refutes the principle of peacemaking trade. His vision of
trade became that of a system where foreign capitalists compete for new
markets. He defends the idea of producing on national soil when possible
and reasonable and expresses sympathy for the advocates of protectionism. He notes in National Self-Sufficiency:
A considerable degree of
international specialization is necessary in a rational world in all
cases where it is dictated by wide differences of climate, natural
resources, native aptitudes, level of culture and density of population.
But over an increasingly wide range of industrial products, and perhaps
of agricultural products also, I have become doubtful whether the
economic loss of national self-sufficiency is great enough to outweigh
the other advantages of gradually bringing the product and the consumer
within the ambit of the same national, economic, and financial
organization. Experience accumulates to prove that most modern processes
of mass production can be performed in most countries and climates with
almost equal efficiency.
He also writes in National Self-Sufficiency:
I
sympathize, therefore, with those who would minimize, rather than with
those who would maximize, economic entanglement among nations. Ideas,
knowledge, science, hospitality, travel—these are the things which
should of their nature be international. But let goods be homespun
whenever it is reasonably and conveniently possible, and, above all, let
finance be primarily national.
Later, Keynes had a written correspondence with James Meade
centred on the issue of import restrictions. Keynes and Meade discussed
the best choice between quota and tariff. In March 1944 Keynes began a
discussion with Marcus Fleming after the latter had written an article entitled Quotas versus depreciation. On this occasion, we see that he has definitely taken a protectionist stance after the Great Depression.
He considered that quotas could be more effective than currency
depreciation in dealing with external imbalances. Thus, for Keynes,
currency depreciation was no longer sufficient, and protectionist
measures became necessary to avoid trade deficits. To avoid the return
of crises due to a self-regulating economic system, it seemed essential
to him to regulate trade and stop free trade (deregulation of foreign
trade).
He points out that countries that import more than they export
weaken their economies. When the trade deficit increases, unemployment
rises and GDP slows down. And surplus countries exert a "negative
externality" on their trading partners. They get richer at the expense
of others and destroy the output of their trading partners. John Maynard
Keynes believed that the products of surplus countries should be taxed
to avoid trade imbalances. Thus he no longer believes in the theory of comparative advantage (on which free trade is based) which states that the trade deficit does not matter, since trade is mutually beneficial.
This also explains his desire to replace the liberalization of international trade (Free Trade) with a regulatory system aimed at eliminating trade imbalances in his proposals for the Bretton Woods Agreement.
Keynes's ideas became widely accepted after World War II,
and until the early 1970s, Keynesian economics provided the main
inspiration for economic policy makers in Western industrialized
countries. Governments prepared high quality economic statistics on an ongoing
basis and tried to base their policies on the Keynesian theory that had
become the norm. In the early era of social liberalism and social democracy, most western capitalist countries enjoyed low, stable unemployment and modest inflation, an era called the Golden Age of Capitalism.
In terms of policy, the twin tools of post-war Keynesian
economics were fiscal policy and monetary policy. While these are
credited to Keynes, others, such as economic historian David Colander, argue that they are, rather, due to the interpretation of Keynes by Abba Lerner in his theory of functional finance, and should instead be called "Lernerian" rather than "Keynesian".
Through the 1950s, moderate degrees of government demand leading
industrial development, and use of fiscal and monetary counter-cyclical
policies continued, and reached a peak in the "go go" 1960s, where it
seemed to many Keynesians that prosperity was now permanent. In 1971,
Republican US President Richard Nixon even proclaimed "I am now a Keynesian in economics."
Beginning in the late 1960s, a new classical macroeconomics movement arose, critical of Keynesian assumptions (see sticky prices),
and seemed, especially in the 1970s, to explain certain phenomena
better. It was characterized by explicit and rigorous adherence to microfoundations, as well as use of increasingly sophisticated mathematical modelling.
With the oil shock of 1973,
and the economic problems of the 1970s, Keynesian economics began to
fall out of favour. During this time, many economies experienced high
and rising unemployment, coupled with high and rising inflation,
contradicting the Phillips curve's prediction. This stagflation
meant that the simultaneous application of expansionary
(anti-recession) and contractionary (anti-inflation) policies appeared
necessary. This dilemma led to the end of the Keynesian near-consensus
of the 1960s, and the rise throughout the 1970s of ideas based upon more
classical analysis, including monetarism, supply-side economics, and new classical economics.
However, by the late 1980s, certain failures of the new classical models, both theoretical (see Real business cycle theory) and empirical (see the "Volcker recession") hastened the emergence of New Keynesian economics,
a school that sought to unite the most realistic aspects of Keynesian
and neo-classical assumptions and place them on more rigorous
theoretical foundation than ever before.
One line of thinking, utilized also as a critique of the notably
high unemployment and potentially disappointing GNP growth rates
associated with the new classical models by the mid-1980s, was to
emphasize low unemployment and maximal economic growth at the cost of
somewhat higher inflation (its consequences kept in check by indexing
and other methods, and its overall rate kept lower and steadier by such
potential policies as Martin Weitzman's share economy).
In the postwar era, Keynesian analysis was combined with neoclassical economics to produce what is generally termed the "neoclassical synthesis", yielding neo-Keynesian economics, which dominated mainstream macroeconomic thought.
Though it was widely held that there was no strong automatic tendency
to full employment, many believed that if government policy were used to
ensure it, the economy would behave as neoclassical theory predicted.
This post-war domination by neo-Keynesian economics was broken during
the stagflation of the 1970s. There was a lack of consensus among macroeconomists in the 1980s, and during this period New Keynesian economics was developed, ultimately becoming- along with new classical macroeconomics- a part of the current consensus, known as the new neoclassical synthesis.
Post-Keynesian economists, on the other hand, reject the
neoclassical synthesis and, in general, neoclassical economics applied
to the macroeconomy. Post-Keynesian economics is a heterodox school
that holds that both neo-Keynesian economics and New Keynesian
economics are incorrect, and a misinterpretation of Keynes's ideas. The
post-Keynesian school encompasses a variety of perspectives, but has
been far less influential than the other more mainstream Keynesian
schools.[]
Interpretations of Keynes have emphasized his stress on the
international coordination of Keynesian policies, the need for
international economic institutions, and the ways in which economic
forces could lead to war or could promote peace.
Keynesianism and liberalism
In a 2014 paper, economist Alan Blinder
argues that, "for not very good reasons", public opinion in the United
States has associated Keynesianism with liberalism, and he states that
such is incorrect. For example, both Presidents Ronald Reagan (1981–89) and George W. Bush (2001–09)
supported policies that were, in fact, Keynesian, even though both men
were conservative leaders. And tax cuts can provide highly helpful
fiscal stimulus during a recession, just as much as infrastructure
spending can. Blinder concludes: "If you are not teaching your students
that 'Keynesianism' is neither conservative nor liberal, you should be."
Other schools of economic thought
The
Keynesian schools of economics are situated alongside a number of other
schools that have the same perspectives on what the economic issues
are, but differ on what causes them and how best to resolve them. Today,
most of these schools of thought have been subsumed into modern
macroeconomic theory.
The Stockholm school
rose to prominence at about the same time that Keynes published his
General Theory and shared a common concern in business cycles and
unemployment. The second generation of Swedish economists also advocated
government intervention through spending during economic downturns although opinions are divided over whether they conceived the essence of Keynes's theory before he did.
There was debate between monetarists
and Keynesians in the 1960s over the role of government in stabilizing
the economy. Both monetarists and Keynesians agree that issues such as
business cycles, unemployment, and deflation are caused by inadequate
demand. However, they had fundamentally different perspectives on the
capacity of the economy to find its own equilibrium, and the degree of
government intervention that would be appropriate. Keynesians emphasized
the use of discretionary fiscal policy and monetary policy, while monetarists argued the primacy of monetary policy, and that it should be rules-based.
The debate was largely resolved in the 1980s. Since then,
economists have largely agreed that central banks should bear the
primary responsibility for stabilizing the economy, and that monetary
policy should largely follow the Taylor rule – which many economists credit with the Great Moderation. The 2008 financial crisis,
however, has convinced many economists and governments of the need for
fiscal interventions and highlighted the difficulty in stimulating
economies through monetary policy alone during a liquidity trap.
Some Marxist economists criticized Keynesian economics. For example, in his 1946 appraisal Paul Sweezy—while admitting that there was much in the General Theory's
analysis of effective demand that Marxists could draw on—described
Keynes as a prisoner of his neoclassical upbringing. Sweezy argued that
Keynes had never been able to view the capitalist system as a totality.
He argued that Keynes regarded the class struggle carelessly, and
overlooked the class role of the capitalist state, which he treated as a
deus ex machina, and some other points. While Michał Kalecki was generally enthusiastic about the Keynesian Revolution,
he predicted that it would not endure, in his article "Political
Aspects of Full Employment". In the article Kalecki predicted that the
full employment delivered by Keynesian policy would eventually lead to a
more assertive working class and weakening of the social position of
business leaders, causing the elite to use their political power to
force the displacement of the Keynesian policy even though profits would
be higher than under a laissez faire system: The elites would not care
about risking the higher profits in the pursuit of reclaiming prestige
in the society and the political power.
James M. Buchanan criticized Keynesian economics on the grounds that governments would in
practice be unlikely to implement theoretically optimal policies. The implicit assumption
underlying the Keynesian fiscal revolution, according to Buchanan, was
that economic policy would be made by wise men, acting without regard to
political pressures or opportunities, and guided by disinterested
economic technocrats. He argued that this was an unrealistic assumption
about political, bureaucratic and electoral behaviour. Buchanan blamed
Keynesian economics for what he considered a decline in America's fiscal
discipline. Buchanan argued that deficit spending would evolve into a permanent
disconnect between spending and revenue, precisely because it brings
short-term gains, so, ending up institutionalizing irresponsibility in
the federal government, the largest and most central institution in our
society.
Martin Feldstein
argues that the legacy of Keynesian economics–the misdiagnosis of
unemployment, the fear of saving, and the unjustified government
intervention–affected the fundamental ideas of policy makers. Milton Friedman
thought that Keynes's political bequest was harmful for two reasons.
First, he thought whatever the economic analysis, benevolent
dictatorship is likely sooner or later to lead to a totalitarian
society. Second, he thought Keynes's economic theories appealed to a
group far broader than economists primarily because of their link to his
political approach. Alex Tabarrok
argues that Keynesian politics–as distinct from Keynesian policies–has
failed pretty much whenever it's been tried, at least in liberal
democracies.
In response to this argument, John Quiggin, wrote about these theories' implication for a liberal democratic order.
He thought that if it is generally accepted that democratic politics is
nothing more than a battleground for competing interest groups, then
reality will come to resemble the model.
Paul Krugman wrote "I don't think we need to take that as an immutable fact of life; but still, what are the alternatives?" Daniel Kuehn, criticized James M. Buchanan. He argued, "if you have a
problem with politicians – criticize politicians," not Keynes. He also argued that empirical evidence makes it pretty clear that Buchanan was wrong. James Tobin argued, if advising government officials, politicians, voters, it's not for economists to play games with them. Keynes implicitly rejected this argument, in "soon or late it is ideas
not vested interests which are dangerous for good or evil."
Brad DeLong
has argued that politics is the main motivator behind objections to the
view that government should try to serve a stabilizing macroeconomic
role. Paul Krugman
argued that a regime that by and large lets markets work, but in which
the government is ready both to rein in excesses and fight slumps is
inherently unstable, due to intellectual instability, political
instability, and financial instability.
Another influential school of thought was based on the Lucas critique of Keynesian economics. This called for greater consistency with microeconomic theory based on rational choice theory, and in particular emphasized the idea of rational expectations.
Lucas and others argued that Keynesian economics required remarkably
foolish and short-sighted behaviour from people, which totally
contradicted the economic understanding of their behaviour at a micro
level. New classical economics introduced a set of macroeconomic theories that were based on optimizing microeconomic behaviour. These models have been developed into the real business-cycle theory, which argues that business cycle fluctuations can to a large extent be accounted for by real (in contrast to nominal) shocks.
Beginning in the late 1950s new classical macroeconomists began
to disagree with the methodology employed by Keynes and his successors.
Keynesians emphasized the dependence of consumption on disposable income
and, also, of investment on current profits and current cash flow. In
addition, Keynesians posited a Phillips curve
that tied nominal wage inflation to unemployment rate. To support these
theories, Keynesians typically traced the logical foundations of their
model (using introspection) and supported their assumptions with
statistical evidence. New classical theorists demanded that macroeconomics be grounded on the
same foundations as microeconomic theory, profit-maximizing firms and
rational, utility-maximizing consumers.
The result of this shift in methodology produced several important divergences from Keynesian macroeconomics:
F.A. Hayek,
an Austrian-style economist described Keynesianism as a system of
"economics of abundance" stating it is, "a system of economics which is
based on the assumption that no real scarcity exists, and that the only
scarcity with which we need concern ourselves is the artificial scarcity
created by the determination of people not to sell their services and
products below certain arbitrarily fixed prices." Ludwig von Mises,
another Austrian economist, describes a Keynesian system as believing
it can solve most problems with "more money and credit" which leads to a
system of "inflationism" in which "prices (of goods) rise higher and higher." Murray Rothbard
wrote that Keynesian-style governmental regulation of money and credit
created a "dismal monetary and banking situation," since it allows for
the central bankers that have the exclusive ability to print money to be "unchecked and out of control." Rothbard went on to say in an interview that, "There is one good thing about (Karl) Marx: he was not a Keynesian."
Others
The social historianC. J. Coventry argues in Keynes from Below: A Social History of Second World War Keynesian Economics
(2023) that Keynes and Keynesian economics was unpopular in the United
Kingdom and Australia in the 1940s. Many workers and trades unions, as
well as figures in the British Labour Party and Australian Labor Party,
saw Keynesianism as a means of stopping socialism. Keynes was largely
supported by business leaders, bankers and conservative parties, or
tripartite third way Catholics eager to avoid socialism after the Second
World War. While Coventry agrees that the Keynesianism has considerable benefits,
he argues that these benefits arose from the next phase of capitalism
with many of the disadvantages being forced onto peoples in the third
world, such as in British Malaya where there was bloodshed for crucial resources.
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