The General Theory of Employment, Interest and Money

Summary

The General Theory of Employment, Interest and Money, published by Macmillan in London in February 1936, is John Maynard Keynes's attempt to explain why an economy can remain for long periods with many people out of work. Written during the Great Depression, it argues that the classical economics Keynes had been taught describes only a special case, one of full employment, and that a more general theory is needed for the world as it is. The book has six books in twenty-four chapters. Book I sets out the problem. Keynes challenges two postulates of classical theory, chiefly the idea that workers can always price themselves into jobs by accepting lower money wages, and he rejects the principle, associated with J. B. Say, that supply creates its own demand. In its place he puts the principle of effective demand: the level of employment depends on how much firms expect to sell, which depends on total spending on consumption and investment. There can therefore be involuntary unemployment, people willing to work at current wages who cannot find work. Book II defines the units and terms, insisting that saving and investment are always equal in total, though the decisions behind them are made by different people for different reasons. Book III treats the propensity to consume: as incomes rise, people spend more but not by as much. From this follows the multiplier: an increase in investment raises income by a larger amount, because each round of spending becomes someone else's income. Book IV, the longest, examines the inducement to invest. Investment depends on the marginal efficiency of capital, the expected return on new capital goods, compared with the rate of interest. Chapter 12 describes how long-term expectations rest on fragile convention, comparing the stock market to a newspaper beauty contest and attributing much enterprise to animal spirits, a spontaneous urge to act rather than calculation. Keynes then argues that the rate of interest is not the price that balances saving and investment but the reward for parting with liquidity; it is set by liquidity preference and the quantity of money, and may stay too high to call forth enough investment. Book V considers money wages and prices and argues that cutting money wages is an unreliable remedy for unemployment. Book VI offers short notes on the trade cycle, on the mercantilists, usury laws, Silvio Gesell and Mandeville's Fable of the Bees, and closes with Concluding Notes on social philosophy. There Keynes proposes that the state influence the propensity to consume through taxation and the interest rate, and accept a somewhat comprehensive socialisation of investment, while defending private enterprise and individual liberty in most of economic life. He ends by asserting the long-run power of ideas over vested interests. Because the work is still under copyright in the United States, the library offers summary and guide only, with two brief quotations.

Plot or Argument

• Book I: Introduction (chapters 1-3)

  Keynes calls classical theory a special case, disputes its postulates about the labour market and Say's principle that supply creates its own demand, and introduces effective demand as the determinant of employment.

• Book II: Definitions and Ideas (chapters 4-7)

  Units of measurement, the role of expectations in production decisions, and careful definitions of income, saving and investment establish that aggregate saving always equals aggregate investment.

• Book III: The Propensity to Consume (chapters 8-10)

  Consumption rises with income but by less, depending on objective and subjective factors. Chapter 10 develops the multiplier, by which new investment raises income and employment by a larger amount.

• Book IV: The Inducement to Invest, part one (chapters 11-12)

  Investment depends on the marginal efficiency of capital against the rate of interest. Chapter 12 treats the state of long-term expectation: convention, speculation versus enterprise, the beauty-contest analogy and animal spirits.

• Book IV: The Inducement to Invest, part two (chapters 13-18)

  Keynes's theory of interest as the price of liquidity, the motives for holding money, criticism of the classical theory of interest, observations on the nature of capital and the properties of money, and a restatement of the whole theory in chapter 18.

• Book V: Money-Wages and Prices (chapters 19-21)

  A fall in money wages may not raise employment, since it can reduce demand and raise the burden of debt. Keynes analyses the employment function and a theory of prices tied to effective demand.

• Book VI: Short Notes Suggested by the General Theory (chapters 22-24)

  Notes on the trade cycle and on earlier writers, including the mercantilists, the usury laws, Gesell and Mandeville, are followed by the Concluding Notes on social philosophy, which propose a larger public role in investment while defending individualism and closing on the power of ideas.

Lessons

• One person's spending is another's income

  The multiplier rests on a simple observation: when a firm spends on a new factory, the builders spend their wages, and so on in diminishing rounds. Keynes uses it to argue that a fall in investment can shrink income far more than its own size. The idea changed how governments thought about depressions.

  • How does the multiplier work, step by step?
  • What limits the size of the multiplier in Keynes's account?

• Expectations and animal spirits

  In chapter 12 Keynes argues that most long-term investment cannot be based on exact calculation, because the future is uncertain. Business confidence rests on convention and on a spontaneous urge to act. When confidence collapses, investment can fall regardless of how sound the underlying projects are.

  • What does Keynes mean by comparing the stock market to a beauty contest?
  • Is it reasonable for an economy to depend on animal spirits?
  • Can government policy restore confidence, or only replace it?

• Saving is not always a public virtue

  Keynes argues that if everyone tries to save more in a slump, total income may fall so that total saving does not rise at all. He revisits Mandeville's Fable of the Bees and earlier writers who worried about underconsumption. The argument sits uneasily with the traditional praise of thrift, and readers have debated where each view applies.

  • Why might an increase in thrift reduce income in Keynes's view?
  • Is thrift still a virtue for the individual even if Keynes is right about the economy as a whole?

• Ideas rule the world

  The book closes by claiming that the ideas of economists and political philosophers matter more than vested interests, often decades after they are written. Keynes intended his own book to change policy through changing minds. The claim can be tested against the book's own later history and the rival ideas it provoked.

  • Do you agree that ideas matter more than interests in shaping policy?
  • How did later economists such as Hayek and Friedman try to change the ideas Keynes's book had spread?

Context

Keynes wrote amid the Great Depression, when unemployment in Britain had stayed high through the 1920s and rose sharply after 1929, and when the United States saw a quarter of its workforce idle at the worst point. The prevailing economics, taught at Cambridge by Alfred Marshall and A. C. Pigou, held that markets tend toward full employment if wages and prices are flexible. Keynes had urged public works in the 1929 pamphlet Can Lloyd George Do It? and now sought a full theoretical case.

Composition

Keynes worked on the book from about 1932 to 1935, testing drafts with younger Cambridge colleagues including Richard Kahn, Joan Robinson and Roy Harrod; Kahn's 1931 article had introduced the employment multiplier. Macmillan published it in London in February 1936, at a deliberately low price of five shillings so that students could buy it. It followed Keynes's two-volume Treatise on Money (1930) and his controversy with F. A. Hayek in the early 1930s over that work.

Reception

The book quickly reshaped economics. John Hicks's 1937 IS-LM model translated its ideas into a compact system that dominated teaching for decades, and Keynesian demand management guided policy in many Western countries after 1945. Critics questioned it from several sides: Pigou and other classical economists objected to its treatment of earlier theory; Hayek and the Austrian school argued that it neglected the structure of capital and the dangers of inflation and expanding state direction; Milton Friedman and the monetarists stressed the role of the money supply; and later rational-expectations economists such as Robert Lucas challenged its foundations. Its defenders and successors, from the neoclassical synthesis to the post-Keynesians, have disagreed among themselves over what Keynes meant.

Comparisons

• the-wealth-of-nations

  Smith's account of the division of labour, capital accumulation and the invisible hand stands at the head of the classical tradition Keynes calls a special case; Smith praises parsimony as the source of capital, while Keynes asks when saving fails to become investment.

• hayek-the-road-to-serfdom

  Hayek, Keynes's opponent in the early-1930s debate over the Treatise on Money, warned in 1944 that extensive economic planning endangers liberty; Keynes wrote to Hayek that he agreed with much of the book while doubting where Hayek drew the line.

• bastiat-the-law

  Bastiat's defence of limited government and his warnings about using law to redistribute wealth offer a nineteenth-century French statement of the liberal view against which Keynes's proposals for state influence over investment can be weighed.

• weber-the-protestant-ethic-and-the-spirit-of-capitalism

  Weber traces the moral roots of saving and disciplined work; Keynes questions whether the habit of saving always serves the common good in a slump.

Quotes

For Students

A reading companion for classical Christian high school students. See the student guide.

Reading Guide

Watch for

• The opening claim in chapter 1 that classical theory is only a special case, and the challenge to Say's principle in chapters 2-3.
• The multiplier in chapter 10, and how a single act of investment spreads through incomes.
• Chapter 12's account of long-term expectation, the beauty contest and animal spirits.
• The theory of interest as a reward for parting with liquidity in chapters 13 and 15.
• The Concluding Notes in chapter 24, which weigh state action against individualism.

Key terms and names

Effective demand

The total spending on consumption and investment that firms expect; Keynes argues it sets the level of output and employment.

Involuntary unemployment

Unemployment of people willing to work at the going wage who cannot find jobs, which Keynes says classical theory cannot explain.

Propensity to consume

The relation between income and spending on consumption; as income rises, consumption rises by less.

Multiplier

The ratio by which a change in investment changes total income, because spending passes through successive rounds of income.

Marginal efficiency of capital

The expected rate of return on an additional capital asset, compared with the interest rate in deciding whether to invest.

Liquidity preference

The desire to hold wealth as money rather than less liquid assets, for transactions, precaution and speculation; in Keynes's theory it helps set the interest rate.

Animal spirits

Chapter 12's name for the spontaneous urge to action, rather than calculation, that drives much investment under uncertainty.

Seminar Questions

1. Comprehension What does Keynes mean by calling classical economics a special case?
2. Comprehension How does the multiplier in chapter 10 turn one act of investment into a larger rise in income?
3. Comprehension According to Keynes, what determines the rate of interest, and how does that differ from the classical view?
4. Interpretation Why does Keynes think that cutting money wages may fail to cure unemployment?
5. Interpretation How do convention and animal spirits in chapter 12 make the economy unstable?
6. Interpretation In chapter 24, how does Keynes reconcile a larger public role in investment with his defence of individualism, and how would Hayek answer him?
7. Big Question When people cannot find work through no fault of their own, what does justice ask of the rest of society, and who should act: families, churches, or the state?

Faith Connections

• Matthew 20:1-16 (Scripture)

  In the parable of the labourers in the vineyard, men stand idle in the marketplace because no one has hired them. The parable concerns grace, not economics, but its picture of willing workers without employment matches the condition Keynes set out to explain.

• Luke 12:16-21 (Scripture)

  The rich fool tears down his barns to build bigger ones and store up goods. Keynes's argument that hoarded saving can depress income gives a different, economic angle on a parable that warns against trusting in stored wealth.

• Leo XIII, Rerum Novarum (1891) (Great Conversation)

  The encyclical defends private property while calling on the state to protect workers and the common good. Keynes's Concluding Notes seek a similar middle course between unregulated markets and state ownership, though from secular premises.

Logic and Rhetoric

Central argument: Employment depends on effective demand, the spending on consumption and investment that firms expect. Consumption rises less than income, so a gap must be filled by investment. Investment depends on uncertain expectations and on an interest rate set by the demand for liquid money, not by the supply of saving. Nothing guarantees that these will produce enough investment to employ everyone, and wage cuts may not help. Therefore an economy can rest at high unemployment, and public policy on interest, taxation and investment is needed to sustain demand.

Rhetorical device: analogy. In chapter 12 Keynes compares professional investment to a newspaper contest in which competitors pick not the prettiest faces but those they think others will pick, making the point that markets can turn on guesses about average opinion.

Debate: Resolved: In a deep recession, governments should spend more rather than balance their budgets.

Writing Prompts

Essay: Explain how Keynes's chapter 12 on expectations changes the picture of a market economy you find in earlier economists, and evaluate whether animal spirits are a weakness or a strength of free enterprise.

Comparison with The Road to Serfdom: Keynes in chapter 24 and Hayek in The Road to Serfdom both claim to defend individual liberty. Compare their views of what the state should do in economic life, presenting each argument at its strongest, and explain where you think the decisive disagreement lies.

Medical Lens

The book is economic, not medical, but chapter 12 builds its theory of investment on psychology: confidence, convention, spontaneous optimism and the animal spirits that move enterprise when calculation cannot. Keynes compares the entrepreneur's setting aside of the thought of ultimate loss to a healthy man's setting aside of the expectation of death. Readers interested in the psychology of decision under uncertainty can read the chapter alongside later work in behavioural economics, though that link is a later interpretation.

• Chapter 12, section VII

  Animal spirits and spontaneous optimism as the basis of enterprise, with the comparison to a healthy man's disregard of death.

  Mind Body

Creative Prompts

• Classroom

  Run a classroom multiplier: one student spends ten imaginary dollars, the recipient spends most of it, and so on; tally the total and relate it to chapter 10.

• Essay

  Explain Keynes's beauty-contest analogy from chapter 12 and argue whether it describes markets you have observed.

• Dialogue

  Write a dialogue between Keynes and Hayek in 1944 about whether a larger public role in investment can coexist with personal liberty, keeping each man's strongest case in his own terms.

Further Reading

• The Economic Consequences of the Peace, John Maynard Keynes

• Essays in Persuasion, John Maynard Keynes

• John Maynard Keynes, Robert Skidelsky

• Keynes Hayek: The Clash That Defined Modern Economics, Nicholas Wapshott

• A Monetary History of the United States, 1867-1960, Milton Friedman and Anna Jacobson Schwartz