LECTURE 12. ECONOMIC VIEWS OF J. KEYNS

1. Theory of effective demand

As we already know, since the 70s of the nineteenth century, the microeconomic approach has dominated economic theory. In the center of analysis is placed an economic entity (consumer or firm), which maximizes its benefits. It was assumed that economic entities operate in conditions of perfect competition, where the efficiency of the firm was identified with the efficiency of the economy as a whole. This approach implied a rational distribution of resources in the national economy and, in essence, did not allow for the possibility of a long-term imbalance in the economic system. These postulates were called into question by the English economist J. Keynes (1883-1946), whose name in economic theory is associated with a return to the analysis of macroeconomic problems. At the forefront, Keynes put the study of dependencies and proportions between the total national economic values: national income, savings, investment, aggregate demand - and saw the main task in achieving national economic proportions.

Keynes criticized Say's "law of markets", which was also shared by neoclassicists. Let me remind you that the essence of this law is that the supply automatically generates a corresponding demand. Since the goal of production, according to Say, is consumption (the producer sells his product in order to buy another, that is, each seller necessarily becomes a buyer), then in this situation the general overproduction of goods is impossible. In other words, any increase in output automatically generates an equivalent increase in expenditures and incomes, and in amounts capable of maintaining the economy in a state of full employment. This belief prevailed for many decades, and in the words of J. Galbraith, by the 30s of the twentieth century, the idea that production itself creates sufficient demand for itself was a holy truth in the field of economics.

Acceptance or non-acceptance by a person of Say's law was, in the words of the same Galbraith, a sign by which "economists differed from fools." The inconsistency of this law during the years of the "Great Depression" became obvious. In contrast to Say and the neoclassicists, who believed that the problem of demand (that is, the sale of a social product) is solved by itself, Keynes put it at the center of his research, made it the starting point of macroeconomic analysis. Keynes rightly pointed out that the classical doctrine assumes as an initial analysis an economy with the full use of factors of production, which are characterized by relative scarcity. Meanwhile, in reality (the depression of the 30s of the twentieth century), there was not so much a limitation as an overabundance of resources: mass unemployment, underutilized production capacities, idle capital.

The starting point of Keynes's theory is the belief that the dynamics of the production of national income and the level of employment are determined directly not by supply factors (the size of labor, capital, their productivity) but by the demand factors that ensure the realization of these resources. In Keynes' theory, they are called "effective demand" (the sum of consumer spending and investment). A significant part of his famous work "The General Theory of Employment of Interest and Money", published in 1936, Keynes just devoted to the analysis of the factors that determine the dynamics of personal consumption and investment.

According to Keynes, the increase in personal consumption is a stable function of income growth, the role of other factors is insignificant. With income growth, the marginal propensity to consume decreases, that is, as income grows, consumption growth slows down and this is the most important reason for the decrease in the average share of consumption during the upward phase of the economic cycle in the long run. Keynes associated this consumption dynamics with the so-called "basic psychological law" - a decrease in the share of consumption (namely, shares, the absolute size of consumption certainly grows), and, accordingly, an increase in the share of savings with income growth.

It follows from the “basic psychological law” that as income rises, the share of effective demand provided by personal consumption constantly falls and therefore the expanding volume of savings must be absorbed by the growing demand for investment. Keynes considered the size of investment to be the main factor of effective demand, and as a consequence, the growth of national income. But ensuring a normal investment size comes up against the problem of converting all savings into real investments. As for the representatives of the classical and neoclassical movements, they did not see any particular problem here, since they proceeded from the assumption that the act of saving simultaneously turns into an act of investment, that is, saving and investment are identical. Moreover, within the framework of the classical school, it was traditionally believed that a high level of savings is a condition for economic growth, since it is savings that are the source of capital accumulation. Since the time of A. Smith, the desire to save has been regarded as one of the most important virtues (among the virtues of the Protestant ethic are hard work, modesty, frugality), which should be maintained and developed. Keynes came to the conclusion that excessive savings is a factor impeding economic growth, in his figurative expression, “individual prudence threatens to turn into social madness” since excess savings is nothing more than an excess supply of goods, that is, a situation that threatens to turn into a general crisis of overproduction. Hence the logical conclusion followed that in order to maintain constant growth of national income, capital investments must increase, designed to absorb an ever-expanding volume of savings. It is the investment component of effective demand that plays a decisive role in determining the level of national income and employment.

The key equation of Keynesian theory can be considered the following equality:

GNP=C+I,

where GNP - gross national product;

С - consumer spending;

I - investments.

It would seem that there is no fundamental difference in the views of Keynes and representatives of the classical movement in economic theory. In both cases, investments are designed to absorb the amount of savings offered. But this is only at first glance. Representatives of the classical school, again since the time of A. Smith, automatically absorb savings into investments, that is, automatically achieve macroeconomic equilibrium. In the theory of J. Keynes, the level of savings is determined by the level of income, and the level of investment by completely different factors, and therefore the equality of savings and investments is more an accident than a pattern. According to Keynes, the real amount of investment depends on two quantities:

▪ expected return on investment or its marginal efficiency (return on the last invested unit of capital);

▪ interest rates.

The entrepreneur continues the investment process as long as the marginal efficiency of investment remains above the rate of interest. Thus, the existing rate of interest determines the lower limit of the profitability of future investments. The lower it is, the more lively the investment process, ceteris paribus, and vice versa. It is interesting to note that the neoclassicists believed that the rate of interest is determined by the point of intersection of the savings and investment curves (it was from this assumption that they derived the constant automatic equality of savings and investment). Keynes wrote that the interest itself determines the final amount of investment, and is not determined by them. Interest in Keynes's theory, as well as the propensity to invest, is a predominantly psychological phenomenon. The expected return on investment is very sensitive to pessimism, and the latter, according to Keynes, can cause deep economic depressions. As we can see, in Keynesian theory, investments are determined independently of the savings of economic entities.

Having shown that in a dynamically developing economy there is a tendency for savings to grow faster than investment, Keynes focused on the problem of stimulating investment. In his opinion, it is changes in the amount of desired investment expenditure that are the root cause of fluctuations in aggregate production and income and, being much less stable than consumer spending, investment plays a decisive role in the occurrence of economic downturns. Considering the increase in national income as a function of the increase in investment, Keynes turns to the multiplier mechanism. The mechanism of action of the multiplier was described in 1931, 5 years before the publication of Keynes’s work “The General Theory of Employment, Interest and Money” by the English economist R. Kahn. Kahn expressed the idea that all production costs, causing primary employment, give rise to additional purchasing power on the part of entrepreneurs and their workers, which becomes a source of new demand and secondary employment. But new expenses will make up only part of the additional income, so secondary employment will be less than primary, etc. There is a decreasing progression. In Kahn's theory, the multiplier is a coefficient showing the dependence of employment on the amount of initial investment; in turn, it depends on the share of income spent at each stage.

Unlike the employment multiplier, Keynes developed the idea of ​​the accumulation multiplier. In his theory, the accumulation multiplier is a coefficient showing how many times the increase in national income will increase as a result of initial investment. It is determined by an independent variable - the marginal propensity to consume (PSP), where M = 1 / (1 - PSP), or, what is the same, M = 1 / PSS, and the increase in national income is defined as the product of the multiplier and the increase in initial investment. If we assume that the PSP = 0,8, then newly made investments in the amount of, say, 1000 monetary units will cause an increase in national income by 5000 monetary units.

The value of the multiplier in a real economy is always greater than one, since the increase in additional investment in any industry gives rise not only to it, but also to industries related to it. And the creation of additional jobs in all these sectors will affect the increase in the effective demand of workers, and, accordingly, will create incentives for expanding the production of food and consumer goods. Thus, two interrelated problems are solved: ensuring economic growth and solving the problem of unemployment. According to Keynes, the state should provide initial investment in conditions of insufficient effective demand from consumers and the private sector of the economy, without neglecting indirect methods of stimulating investment.

2. Theory of employment and unemployment

As is known, in the neoclassical theory, employment depends on two factors: the marginal burden of labor (a factor that determines the supply of labor) and the marginal productivity of labor (a factor that determines the demand for labor). At the same time, the size of the demand for labor is determined by the marginal product produced by the last worker, the price of which is the fair price of this factor of production. From this followed the logical conclusion that the lower the real wages to which the workers agreed, the higher the level of employment in the national economy, and vice versa. Consequently, the level of employment in the hands of the workers themselves and their willingness to work for lower wages increases the growth of employment.

Keynes opposed this postulate, stating that the magnitude and change of employment do not depend on the behavior of workers. In other words, the willingness of workers to work for low wages is not a cure for unemployment. The level of employment (according to Keynes) is determined by the dynamics of effective demand - expected spending on consumption and expected capital investments. It is this, and not the supply of resources and the change in their relative prices, that determines the level of employment and national income.

According to Keynes, the fall in wages does not affect the capitalist economy directly, but through independent variables: the "marginal propensity to consume" and the "marginal efficiency of capital." It is in this statement that lies the reason why Keynes was opposed to wage cuts. In his opinion, the reduction in wages will lead not to an increase in employment, but to a redistribution of income in favor of entrepreneurs and rentiers.

And the decrease in consumer demand on the part of workers will not be compensated by an increase in demand from other groups of the population, since an increase in their income will be accompanied by a decrease in the marginal propensity to consume. It is no coincidence, therefore, that a more even distribution of income appears in Keynes as a factor in increasing the size of effective demand.

With regard to the impact of lowering wages on the growth of investment, then on this issue, Keynes does not agree with the representatives of the classical and neoclassical trends in political economy. Let me remind you that the latter believed that a decrease in wages would increase the marginal efficiency of capital, and thus a decrease in wages would be accompanied by an increase in investment. However, this statement may be valid if we consider the behavior of an individual firm. On the scale of the national economy, however, a decrease in wages will reduce the size of consumer demand, which will lead to a reduction in production and investment (since it is impossible to sell even the existing products), causing a further decrease in aggregate demand due to a decrease in wages and an increase in unemployment.

It is interesting to note that it is precisely by pushing some part of the economically active population into the ranks of the unemployed that equilibrium is restored in the system. Thus, in Keynes's theory, it is possible to achieve general equilibrium with underemployment! Neoclassical theory did not allow for such a possibility, believing that wage cuts would continue until the market absorbed the excess labor force. It is no coincidence that in neoclassical theory there were only two types of unemployment: voluntary and frictional. The first is formed in those cases when workers either do not want to work for a wage equal to the marginal product of labor, or estimate the burden of labor higher than the expected wage. The second (frictional) has as a reason the poor awareness of the workers about the supply of jobs, their unwillingness to change their qualifications, place of residence, etc. In both cases, the workers remain unemployed voluntarily, and unemployment arises due to the imperfection of the process of adapting people to changing market conditions. In other words, in the neoclassical model, the market system did not contain the possibility of long-term unemployment. Keynes refuted this thesis by proving that the possibility of long-term unemployment exists in the system itself. He, in addition to voluntary and frictional unemployment, also highlights the so-called involuntary unemployment. Keynes made a statement that even with a decrease in real wages, the employed do not quit their jobs, and the unemployed do not reduce the supply of labor. Thus, real wages depend on the demand for labor, but since it is limited, there are involuntary unemployed. In the thesis of involuntary unemployment, Keynes once again linked the volume of employment with the volume of aggregate demand.

As you can see, the classical and neoclassical theories allowed for a situation of temporary imbalance, when the supply of labor and goods is higher than the demand for them, but in their models, the solution to the problem of restoring the balance of supply and demand was to reduce prices and wages. In theoretical models, this happens instantly, but in a real economy, this takes many months, during which an increase in the unemployed and a decrease in the income of workers does not lead to any other result than a further decline in production. This gave Keynes reason to assert that monetary (nominal) wages are not involved either in the regulation of the labor market or in the process of achieving macroeconomic equilibrium. Keynes also noted that under the influence of trade unions and other social factors, money wages may not fall at all. The neoclassical model of restoring macroeconomic equilibrium in a monopolistic economy is especially far from reality, when the reduction in aggregate demand for products is not accompanied by a decrease in prices for them.

So, in Keynes's theory, a decrease in wages is a factor in reducing aggregate demand, including such a component as investment demand. Considering that in his model of economic development it is the size of effective demand that determines the level and growth rate of the gross national product, it is quite clear why Keynes advocated rigid wages and an economic policy aimed at achieving high employment in the national economy.

3. Price and inflation in the theory of J. Keynes

Since, according to Keynes's theory, the basis of economic growth is effective demand, the main element of economic policy is its stimulation. The main means is an active fiscal policy of the state, aimed at stimulating investment and maintaining a high level of consumer demand through government spending. The inevitable consequence of such a policy is a budget deficit and an increase in the money supply in the country's economy. In the classical direction, the consequence of the growth of the money supply is a proportional rise in product prices, that is, an adequate inflationary rise in prices. Keynes' main assertion on this issue boiled down to the fact that an increase in the money supply in circulation would lead to an inflationary rise in prices in the same proportion only under conditions of full employment. In conditions of part-time employment, the growth of the money supply will lead to an increase in the degree of use of resources. In other words, any increase in the money supply will be distributed between the increase in prices, the increase in money wages, and the increase in production and employment. And the farther away from the state of full employment the economy is, the more the increase in the money supply will affect the growth of production and employment, and not the growth of prices.

Budget deficits, money supply growth and inflation, according to Keynes, are quite an acceptable price for maintaining a high level of employment and a stable increase in the level of national income. However, absolute or true (in his terminology) inflation occurs only when there is an increase in effective demand at full employment. It should be noted that Keynes's work laid the foundations for cost-push inflation, that is, the rise in prices associated with an increase in money wages.

4. Economic program of J. Keynes

In Keynes' concept, economic factors are divided into independent and dependent. Among the independent factors, which he calls independent variables, he refers to: the propensity to consume, the marginal efficiency of capital and the rate of interest. They determine the size of effective demand. Dependent factors or dependent variables include: the volume of employment and national income. Keynes sees the task of state intervention in the influence on independent variables, and through their mediation - on employment and national income. In other words, the task of the state is to increase effective demand and reduce the severity of sales problems. As you remember, Keynes considered investments to be the decisive component of effective demand, giving them priority attention. His work recommends two main methods for increasing investment: fiscal and monetary policy.

The first involves active financing, lending to private entrepreneurs from the state budget. Keynes called this policy the "socialization of investment." In order to increase the amount of resources needed to increase private investment, the budget policy also provided for the organization of public procurement of goods and services. Also, to revive the economic situation, Keynes recommended an increase in government investment, which would play the role of an "ignition key" that triggers the multiplier mechanism. Since private investment in a depression is sharply reduced due to pessimistic views about the prospects for profit, the decision to stimulate investment should be taken by the state. At the same time, the main success criterion for the state budgetary stabilization policy, according to Keynes, is an increase in effective demand, even if the spending of money by the state will apparently be useless. Moreover, government spending on unproductive purposes is preferable, since it is not accompanied by an increase in the supply of goods, but nevertheless provides a multiplier effect.

Such a channel for pumping up effective demand as consumption is of a subordinate nature in Keynes’ practical recommendations. Keynes considered the main factor influencing the growth of the propensity to consume the organization of public works, as well as the consumption of civil servants, which practically coincides with the recommendations in the field of economic policy of T. Malthus. Repeatedly in his work, Keynes expressed the idea of ​​the advisability of reducing wealth inequality and redistributing part of income in favor of groups with the greatest propensity to consume. These groups include wage earners, especially those with low incomes. These recommendations should not come as a surprise, since according to Keynes’s “basic psychological law”, when income is low, the propensity to consume is higher, and therefore the effectiveness of government support for the population will be felt more strongly.

As far as monetary policy is concerned, it, according to Keynes, should consist in an all-round lowering of the interest rate. This will lower the lower limit on the efficiency of future investments and make them more attractive. Thus, the state must provide such an amount of money in circulation that would allow to lower the interest rate (the so-called cheap money policy.) Once again, I draw your attention to the fact that Keynes actually affirms the admissibility of inflation, believing that inflation is a lesser evil than unemployment. It can even be beneficial, as it lowers the preference for liquidity. However, purely monetary policy, Keynes pointed out, is insufficient in a deep recession, since it does not provide a proper restoration of confidence in the business environment. In addition, the effectiveness of monetary policy is limited by the fact that, beyond a certain threshold, the economy can find itself in the so-called "liquidity trap", in which pumping up the money supply practically does not reduce the rate of interest.

Keynes considered it necessary to reconsider the attitude to foreign economic policy. Let me remind you that for the classical school, the only possible course in foreign trade was free trade (free trade). Without denying its positive aspects, Keynes argued that if a country restricts the import of cheaper foreign goods in order to provide employment for "its" workers, even if the national industry is not efficient enough, then the country's actions should be recognized as economically feasible. How reminiscent of the arguments of the representatives of mercantilism in defense of the policy of protectionism!

Summing up the consideration of the economic views of John. Keynes, it should be noted that the essence of the "Keynesian revolution" was the rejection of a number of axioms generally accepted in the neoclassical school. These include:

▪ firstly, the thesis about the automatic establishment of supply and demand equilibrium;

▪ secondly, a view of national income as a constant value for a given economic potential of the country;

▪ thirdly, the belief about the neutral nature of money in relation to economic processes.

Keynes expressed his disagreement with all the above theses. Moreover, it was precisely the identification of the causes that determine the level of national income that was the starting point of his economic analysis. As for monetary, monetary factors, Keynes believed that they affect both changes in national income and the level of employment. Pointing out by representatives of the neoclassical that monetary factors, in particular an increase in the money supply with the aim of lowering the interest rate, have a positive effect on the economy only in the short term and ultimately lead only to an inflationary rise in prices, Keynes countered with the statement that "our life is also short-term."

Finishing the consideration of the economic views of John. Keynes, I want to once again draw attention to the fact that, unlike the representatives of the classical and neoclassical schools, who focused on the potential factors of economic growth that lie on the supply side (the quantity and quality of resources, the amount of fixed capital, technology and etc.), Keynes emphasized the factors of economic growth lying on the demand side, while destroying the idea that prevailed before him in economic science about the automatic achievement of equilibrium between aggregate demand and aggregate supply. In doing so, Keynes undermined faith in the internal restorative forces of the market mechanism and substantiated a theory that justified state intervention in economic processes.

A few representatives of the neo-liberal direction acted as successors of the traditions of classical political economy in the defense of the free market in the twentieth century.

Author: Agapova I. I.

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