The Fall and Rise of Keynesian Economics by John Eatwell & Murray Milgate

Author:John Eatwell & Murray Milgate [Eatwell, John & Milgate, Murray]
Language: eng
Format: epub, pdf
Tags: economics, Business & Economics, Macroeconomics
ISBN: 9780199924271
Publisher: Oxford University Press
Published: 2011-03-17T07:40:22+00:00

Keynes's Theory of Output

The argument of Keynes's General Theory is constructed in two essentially distinct parts. In the first section of the book, chapters 1 to 10, Keynes advances the proposition that the equality between desired saving and the volume of investment is maintained by variations in the level of aggregate output and employment. Then, in chapters 11 to 18, he attempts to argue that there is no tendency for the level of investment to adjust to a level commensurate with full-employment saving. This involves both the formulation of his own theory of investment and a critique of the neoclassical theory (see Milgate, 1982). The structure of the book thus mirrors the intellectual development that led to the formulation of the basic propositions of the General Theory:

the initial novelty [of the General Theory] lies in my maintaining that it is not the rate of interest, but the level of incomes which ensures equality between saving and investment. The arguments which lead up to this initial conclusion are independent of my subsequent theory of the rate of interest, and in fact I reached it before I had reached the latter theory. But the result of it was to leave the rate of interest in the air. If the rate of interest is not determined by saving and investment in the same way in which price is determined by supply and demand, how is it determined? One naturally began by supposing that the rate of interest must be determined in some sense by productivity—that it was, perhaps, simply the monetary equivalent of the marginal efficiency of capital, the latter being independently fixed by physical and technical considerations in conjunction with the expected demand. It was only when this line of approach led repeatedly to what seemed to be circular reasoning, that I hit on what I now think to be the true explanation. The resulting theory, whether right or wrong, is exceedingly simple—namely, that the rate of interest on a loan of given quality and maturity has to be established at the level which, in the opinion of those who have the opportunity of choice, i.e., of wealth holders—equalises the attractions of holding idle cash and of holding the loan. It would be true to say that this by itself does not carry us very far. But it gives us firm and intelligible ground from which to proceed. (Keynes, 1937, p. 250)

The initial novelty is based on the proposition that, while saving is independent on the level of income (output), the volume of investment that entrepreneurs may undertake at any one time is independent of the current level of income. This independence derives from the existence of the monetary system—that is, of money, credit, and finance. The prospective investor can acquire purchasing power, or command over real resources, from the financial sector in excess of the current flow of savings:

If investment is proceeding at a steady rate, the finance (or commitments to finance) required can be supplied from a revolving fund of

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