John Maynard Keynes Born: 5 June 1883 in Cambridge, Cambridge shire, England Died: 21 April 1946 in Firle, Sussex, England

John Maynard Keynes

BornBorn: 5 June 1883 in Cambridge, : 5 June 1883 in Cambridge, Cambridge shire, EnglandCambridge shire, England

DiedDied: 21 April 1946 in Firle, : 21 April 1946 in Firle, Sussex, EnglandSussex, England

John Maynard Keynes

John Maynard Keynes was probably John Maynard Keynes was probably the most influential economist of the most influential economist of the first half of the twentieth the first half of the twentieth century. century.

The son of a professor of The son of a professor of economics, john Neville Keynes, economics, john Neville Keynes, and destined by family connection and destined by family connection to be influential in the narrow to be influential in the narrow British university world. British university world.

He studied at CambridgeHe studied at Cambridge

Member of the "Bloomsbury Group”

That glittering group of bohemian thinkers That glittering group of bohemian thinkers and doers who revolted against the manners and doers who revolted against the manners and morals of Victorian England included and morals of Victorian England included the great economist john Maynard Keynes; the great economist john Maynard Keynes; Virginia Woolf and her husband, Leonard, a Virginia Woolf and her husband, Leonard, a famed British civil servant; The novelist famed British civil servant; The novelist E.M. Forester; And any number of poets, E.M. Forester; And any number of poets, philosophers, artists and titled philosophers, artists and titled eccentrics. They flaunted convention, eccentrics. They flaunted convention, scoffed at religion, and had mad affairs scoffed at religion, and had mad affairs with one another, writing down every wordwith one another, writing down every word in diaries and letters in the secure in diaries and letters in the secure belief history would want to know.belief history would want to know.

Quotes by Keynes:

I do not know which makes a man more I do not know which makes a man more conservative --to know nothing but the conservative --to know nothing but the present, or nothing but the past.present, or nothing but the past.

The day isn't far off when the economic The day isn't far off when the economic problem will take the back seat where it problem will take the back seat where it belongs, and the heart and head will be belongs, and the heart and head will be occupied or reoccupied, by our real occupied or reoccupied, by our real problems of life and of human relations, problems of life and of human relations, of creation and behavior and religion.of creation and behavior and religion.

It is ideas, not vested interests, which It is ideas, not vested interests, which are dangerous for good or evil.are dangerous for good or evil.

Quotes by Keynes (cont):

The difficulty lies, not in the The difficulty lies, not in the new ideas, but in escaping from new ideas, but in escaping from the old ones which ramify . . . the old ones which ramify . . . into every corner of our minds.into every corner of our minds.

Most men love money and security Most men love money and security more, and creation and more, and creation and construction less, as they get construction less, as they get older.older.

Quotes by Keynes (cont):

Keynes was on the staff of the British Keynes was on the staff of the British delegation that negotiated peace after delegation that negotiated peace after World War I, but he regarded the terms World War I, but he regarded the terms as the seeds of disaster, resigned in as the seeds of disaster, resigned in protest, and wrote his criticisms in protest, and wrote his criticisms in The Economic Consequences of the Peace The Economic Consequences of the Peace (1919), "...bursting" (as Schumpeter (1919), "...bursting" (as Schumpeter wrote) "into international fame when wrote) "into international fame when men of equal insight but less courage men of equal insight but less courage and men of equal courage but less and men of equal courage but less insight kept silent."insight kept silent."

Between the Wars

Between the wars he worked with the Between the wars he worked with the British treasury and increase the British treasury and increase the wealth of the treasury by performing wealth of the treasury by performing brilliant international transactions.brilliant international transactions.

He was an economist who made important He was an economist who made important contributions to probability theory and contributions to probability theory and mathematical economics. He became a mathematical economics. He became a lecturer in economics at Cambridge, lecturer in economics at Cambridge, where he was educated, until the start where he was educated, until the start of World War I when he worked for the of World War I when he worked for the government.government.

Probability

In 1921 his Treatise on Probability was In 1921 his Treatise on Probability was published although it had been completed 10 published although it had been completed 10 years earlier. It was an attempt to put years earlier. It was an attempt to put probability on a firm mathematical basis.probability on a firm mathematical basis.

Russell said:Russell said:

The mathematical calculus is astonishingly The mathematical calculus is astonishingly

powerful ... the book is one which it is powerful ... the book is one which it is

impossible to praise too highly .impossible to praise too highly .

General Theory Keynes became editor of the Economic Keynes became editor of the Economic Journal, certainly one of the most Journal, certainly one of the most important of journals of professional important of journals of professional work and research in economics then as work and research in economics then as now. After the disaster of the Great now. After the disaster of the Great Depression, Keynes was the leading Depression, Keynes was the leading figure in a group of (mostly) younger figure in a group of (mostly) younger and very creative economists who and very creative economists who attempted to understand and explain the attempted to understand and explain the disaster. Borrowing freely from their disaster. Borrowing freely from their ideas, Keynes published The General ideas, Keynes published The General Theory of Employment, Interest and Theory of Employment, Interest and Money, Money,

GENERAL THEORY (CONT)

which (again quoting Schumpeter) which (again quoting Schumpeter) "was a similar feat of "was a similar feat of leadership. It taught England, in leadership. It taught England, in the form of an apparently general the form of an apparently general analysis, his own personal view analysis, his own personal view of her social and economic of her social and economic situation and also his own situation and also his own personal view of 'what should be personal view of 'what should be done about it.'"done about it.'"


The General Theory, as it is The General Theory, as it is known, also founded modern known, also founded modern macroeconomics, and virtually all macroeconomics, and virtually all of the work in that field emerges of the work in that field emerges from Keynes' work, if not from Keynes' work, if not positively as extensions and positively as extensions and adaptations then negatively as adaptations then negatively as criticism or the extension of criticism or the extension of criticism of it.criticism of it.


CONCEPTSCONCEPTS Consumption FunctionConsumption Function

10

0'

)(

0

bwhere

bYCC

functionlinaraofcasetheinand

fwhere

YfC

d

D

GENERAL THEORY (CONT) CONCEPTS (continuation)CONCEPTS (continuation)

Consumption Function (continuation)Consumption Function (continuation) With the Use of The Hicks-Hansen With the Use of The Hicks-Hansen

graphsgraphsC

YD


CONCEPTSCONCEPTSMarginal Propensity to ConsumeMarginal Propensity to Consume Additional Consumption based on Additional Consumption based on

additional Disposable Incomeadditional Disposable Income Greater than zero but less than 1Greater than zero but less than 1


CONCEPTS (continuation)CONCEPTS (continuation) Consumption Function (continuation)Consumption Function (continuation)

C

YD

YD

C

CO


CONCEPTSCONCEPTS Marginal Propensity to SaveMarginal Propensity to Save Additional Consumption based on Additional Consumption based on

additional Disposable Incomeadditional Disposable Income Greater than zero but less than 1Greater than zero but less than 1 Also, marginal propensity to consume Also, marginal propensity to consume

and marginal propensity to save should and marginal propensity to save should add up to 1add up to 1


CONCEPTS (continuation)CONCEPTS (continuation) Savings Function (continuation)Savings Function (continuation)

S

YDYD

S

SO

GENERAL THEORY (CONT) CONCEPTS (continuation)CONCEPTS (continuation) Relation between Interest and Relation between Interest and

Interest Rate is negativeInterest Rate is negative Marginal Efficiency of CapitalMarginal Efficiency of Capital Opportunity cost of placing money Opportunity cost of placing money

into Investmentinto Investment

GENERAL THEORY (CONT) CONCEPTS (continuation)CONCEPTS (continuation) Relation between Interest and Relation between Interest and

Interest Rate (=return to investment)Interest Rate (=return to investment)

r

I

1

2

3

Divides those projects worth from those not worth it


CONCEPTSCONCEPTSAggregate DemandAggregate DemandAD = C + I + GAD = C + I + GC = consumptionC = consumptionI = InvestmentI = InvestmentG = Government ExpendituresG = Government Expenditures

GENERAL THEORY (CONT) CONCEPTSCONCEPTS

Aggregate SupplyAggregate Supply Keynes has aggregate supply adjusting to Keynes has aggregate supply adjusting to

aggregate demand so Hicks-Hansen use aggregate demand so Hicks-Hansen use the 45the 4500

line line

454500


CONCEPTS (Continuation)CONCEPTS (Continuation) Price of Bonds and InterestPrice of Bonds and Interest

Keynes recognized the concept of opportunity Keynes recognized the concept of opportunity cost as consequently concluded that interest rates cost as consequently concluded that interest rates and the price of bonds were inversely relatedand the price of bonds were inversely related

Based on the fact that as at high interest rates Based on the fact that as at high interest rates bonds become a “good deal”bonds become a “good deal”

At low interest rates, bonds become to expensive At low interest rates, bonds become to expensive and individuals would rather hold cash then and individuals would rather hold cash then bondsbonds


CONCEPTS (Continuation)CONCEPTS (Continuation) Money DemandMoney Demand

Individuals held money for:Individuals held money for:• To purchase goods To purchase goods (function of income)(function of income)

• For a rainy day For a rainy day (function of Income)(function of Income)

• Speculative purposes Speculative purposes (function of interest (function of interest rates)rates)


CONCEPTS (Continuation)CONCEPTS (Continuation) Liquidity TrapLiquidity Trap

In the case of holding money for In the case of holding money for speculative purposes. Bonds may be so speculative purposes. Bonds may be so high that speculators feel the price high that speculators feel the price must first go downmust first go down

Since Bonds an interest rates vary Since Bonds an interest rates vary inversely inversely


CONCEPTS (Continuation)CONCEPTS (Continuation) Liquidity Trap (Continuation)Liquidity Trap (Continuation)

Speculators will not purchase bonds Speculators will not purchase bonds and thus interest rates will now longer and thus interest rates will now longer decreasedecrease


CONCEPTS (Continuation)CONCEPTS (Continuation) Monetary PolicyMonetary Policy

Because of the “liquidity trap” it is Because of the “liquidity trap” it is possible that increase in money supply possible that increase in money supply that is intended to decrease the interest that is intended to decrease the interest rates will not do sorates will not do so

Monetary Policy

r

LS

Liquidity Trap

M0

P0

M2

P2

M1

P1 M3

P3


CONCEPTS (Continuation)CONCEPTS (Continuation) Fiscal PolicyFiscal Policy

Multiplier EffectMultiplier Effect• Assume that Income Increases by some Assume that Income Increases by some

amount amount YYDD

• From the Consumption function we know From the Consumption function we know Personal Consumption will increase by Personal Consumption will increase by C = b* C = b* YYDD where b is the marginal where b is the marginal propensity to consumepropensity to consume


CONCEPTS (Continuation)CONCEPTS (Continuation) Fiscal Policy (continuation)Fiscal Policy (continuation)

Multiplier Effect (continuation)Multiplier Effect (continuation)• Assume that Income Increases by some Assume that Income Increases by some

amount amount YYDD

• From the Consumption function we know From the Consumption function we know Personal Consumption will increase by Personal Consumption will increase by C = b* C = b* YYDD where b is the marginal where b is the marginal propensity to consumepropensity to consume



Multiplier Effect (continuation)Multiplier Effect (continuation)• Or Or C /C /YYD D = b = b• So that for the first new dollar in income the So that for the first new dollar in income the

new Cnew Cnewnew is now equal to the old C is now equal to the old Coldold + b. + b. However, that additional b expenditures However, that additional b expenditures become income to someone elsebecome income to someone else

• This other person now has the ability to spend This other person now has the ability to spend additional badditional b22



Multiplier Effect (continuation)Multiplier Effect (continuation)• But this additional consumption of bBut this additional consumption of b22

becomes additional income to someone becomes additional income to someone who now, with the same MPC will now who now, with the same MPC will now spend an additional bspend an additional b33

• So the next person spends now bSo the next person spends now b44 • And so on and onAnd so on and on



Multiplier Effect (continuation)Multiplier Effect (continuation)

• So the additional income generated So the additional income generated by an additional dollar of income by an additional dollar of income increases total consumption by increases total consumption by

• b + bb + b22 + b + b33 + b + b33 + b + b44 + b + b55 +……… +………



b + bb + b22 + b + b33 + b + b33 + b + b44 + b + b55 +……… +………However, because if the change comes from However, because if the change comes from

an increase in an autonomous expenditure, an increase in an autonomous expenditure, for instance government expenditures then for instance government expenditures then Aggregate income will increase by the dollar Aggregate income will increase by the dollar plus the infinite series b + bplus the infinite series b + b22 + b + b33 + b + b33 + b + b44 + + bb55 +……… +………

Or (1 + b + bOr (1 + b + b22 + b + b33 + b + b33 + b + b44 + b + b55 +………) +………)



Solving for the infinite series Solving for the infinite series (1 + 1*b + 1* b(1 + 1*b + 1* b22 + 1*b + 1*b33 + 1*b + 1*b33 + 1*b + 1*b44 + +

1*b1*b55 +………) +………)Is equal to 1/ ( 1 – b )Is equal to 1/ ( 1 – b )Consequently a one dollar increase in Consequently a one dollar increase in

Government expenditures will increase Government expenditures will increase Income by 1 * 1/( 1 – b )Income by 1 * 1/( 1 – b )



Solving for the infinite series Solving for the infinite series ( 1*b + 1* b( 1*b + 1* b22 + 1*b + 1*b33 + 1*b + 1*b33 + 1*b + 1*b44 + +

1*b1*b55 +………) +………)Let sLet snn = 1*b + 1* b = 1*b + 1* b22 + 1*b + 1*b33 + 1*b + 1*b33 + +

1*b1*b44 + 1*b + 1*b55 +…..+ 1*b +…..+ 1*bn-1n-1



Let sLet srr = 1 + 1*b + 1* b = 1 + 1*b + 1* b22 + 1*b + 1*b33 + 1*b + 1*b44

+ 1*b+ 1*b55 + 1*b + 1*b66 +…..+ 1*b +…..+ 1*br-1r-1

Or bsOr bsrr = b + 1* b = b + 1* b11+ 1*b+ 1*b22 + 1*b + 1*b33 + +

1*b1*b44 + 1*b + 1*b55 +…..+ 1*b +…..+ 1*brr

Or by subtracting the two we getOr by subtracting the two we get



( 1 – b)s( 1 – b)srr = 1 * (1 – b = 1 * (1 – brr))

ssrr = (1 – b = (1 – brr) / (1 – b)) / (1 – b)Since 0 < b < 1 then Since 0 < b < 1 then The limit of (1 – bThe limit of (1 – brr) as r increases to infinity ) as r increases to infinity

isis11



So thatSo thatssrr = 1 / (1 – b) = 1 / (1 – b)

Now Assume that the change comes from Now Assume that the change comes from a 100 million increases in Government a 100 million increases in Government expendituresexpenditures

GENERAL THEORY (CONT) CONCEPTS (Continuation)CONCEPTS (Continuation)

Fiscal Policy (continuation)Fiscal Policy (continuation) Thus Government expenditures increase by 100 Thus Government expenditures increase by 100

million andmillion and Consumption increases by 100 million timesConsumption increases by 100 million times

ssrr = 1 / (1 – b) = 1 / (1 – b)And if b=.75 then sAnd if b=.75 then srr = 4 = 4

So aggregate demand will increase by 400 million So aggregate demand will increase by 400 million dollars (100 million from government expenditures dollars (100 million from government expenditures and 300 from additional consumption)and 300 from additional consumption)

Fiscal Policy

C + I + GC+I+G

YD

YFYE

Fiscal Policy

A significant contribution of Keynes is clearly that A significant contribution of Keynes is clearly that an economy can be at equilibrium while not at full an economy can be at equilibrium while not at full employment employment

And that if the economy is 400 million from being And that if the economy is 400 million from being at full employment and MPC = .75 that all it at full employment and MPC = .75 that all it would take is an increase in autonomous would take is an increase in autonomous expenditure of 100 millionexpenditure of 100 million

Since we can not legislate increase autonomous Since we can not legislate increase autonomous Consumption or autonomous Investment then the Consumption or autonomous Investment then the only alternative is Government expendituresonly alternative is Government expenditures

Fiscal Policy

He was not particular either of the type of He was not particular either of the type of expenditure the government didexpenditure the government did For instance,For instance,

He has the example of hiring individuals one He has the example of hiring individuals one day to dig a hole and place bottles in that day to dig a hole and place bottles in that hole.hole.

The next day hire same or other individuals The next day hire same or other individuals to dig and bottles outto dig and bottles out

The next day bury them again, etc. The next day bury them again, etc.


He was the British He was the British representative in 1944 at representative in 1944 at Brenton Wood Conference that Brenton Wood Conference that set up the International set up the International Monetary Fund and the World Monetary Fund and the World Bank.Bank.

Documents

John Maynard Keynes Born: 5 June 1883 in Cambridge, Cambridge shire, England Died: 21 April 1946 in Firle, Sussex, England