Applications And Adaptations Of Keynesian Thought

Applications and Adaptations of Keynesian ThOUGHT

Jim Sanderson

Fall 2006Applications and Adaptations of Keynesian ThOUGHT

Tim Gunderson

Applied Managerial Economics

Fall 2006

Introduction

John Maynard Keynes' General Theory of Employment, Interest and Money was perhaps the leading tenet of modern capitalist economic thought in the twenty-first century. Ubiquitous in modern Western economies, reviled by Marxists and the opponents of big government alike, Keynes' theories have become a main pillar of macroeconomics and as a result, Keynesian economics has had a profound effect on monetary policy in the Western world.

This paper provides a brief overview of how Keynesian thought and economics have affected policy and become fundamental tenets of macroeconomics. I will present the formative events and applications of Keynes's theories in chronological order, starting at the end of World War I and finishing at the present day. I will discuss how Keynes' theories have been adapted to include more and more microeconomic insights as well as some of the criticisms aimed at his work

The Treaty of Versailles

Keynes rise to prominence began when he was selected to be a delegate at the Paris Peace Conference of 1918-1919. Keynes thought that economic limits placed on Germany by the Versailles Treaty were far too severe and predicted the disastrous ramifications of the Versailles Treaty in his influential book The Economic Consequences of the Peace which predicted the rise of Nazism:

Men will not always die quietly. For starvation, which brings to some lethargy and a helpless despair, drives other temperaments to the nervous instability of hysteria and to a mad despair. And these in their distress may overturn the remnants of organization, and submerge civilization itself in their attempts to satisfy desperately the overwhelming needs of the individual. This is the danger against which all our resources and courage and idealism must now co-operate.

Keynes argued that less severe reparations would allow the economies of Central Europe to modernize as well as loosen the air of imperialism that he felt was at the root of the conflict. He argued that the stiff penalties levied against Germany would actually prevent France, which had absorbed the brunt of Germany's aggression, from actually seeing any of it.

The Great Depression and

The General Theory

In 1936, Keynes published his defining opus, The General Theory of Employment, Interest and Money as a way of promoting government intervention via investment in large infrastructure projects as a way of getting England out of the Great Depression.

Briefly, the General Theory, as it is commonly referred to, has three key sections. The first, called The Propensity to Consume, introduces the concept of the "Multiplier Effect", which can be briefly defined as the degree which localized government spending encourages subsequent localized reinvestment by its beneficiaries. The second, The Inducement to Invest describes the power of using interest rates in monetary policy to regulate the economy. The third, Money - Wages and Prices establishes the modern concept of nominal wages and prices (referred to as money-wages and money-prices respectively), both of which include inflation and the current market conditions in their relative valuation. The crux of this section is the theory that gradually decreasing nominal wages in the face of rising unemployment will increase the real value of money and stimulate demand, which, in turn, will stimulate employment.

All of these sections together were used to support Keynes' central point, that " Governments cannot play no role... Governments are the largest spenders in an economy and they need to set the rules, knowing that they are a player... Given the economic clout, there are appropriate times for the government to put money into the economy, during low-lows, especially."(1)

The New Deal

Franklin D. Roosevelt was elected president during the height of the Depression. His only real running platform being solving the Depression and for a while, because of increased governmental public investment, agriculture programs, and, of course, repealing prohibition he was successful.

However, in 1938 the Depression deepened. Reluctantly, F.D.R. embraced the only new idea he hadn't yet tried, that of the bewildering British "mathematician." Yet not until the U.S. entered World War II did F.D.R. try Keynes' idea on a scale necessary to pull the nation out of the doldrums -- and Roosevelt, of course, had little choice. The big surprise was just how productive America could be when given the chance. Between 1939 and 1944 (the peak of wartime production), the nation's output almost doubled, and unemployment plummeted -- from more than 17% to just over 1%.(2)

Post World War II

"What in the world allowed so small and resource-poor a nation as Japan to develop to its present state? Naturally, the answer is partially owing to Japanese diligence. However, when all is said and done, I believe that Japan's success is directly linked to the generosity of the American Occupation policy."

- British Prime Minister Margaret Thatcher to a group of Japanese business men in 1989

After the second World War, the Allied Powers made a concerted effort not to repeat the debacle of the unrealistic reparations forced on Germany after World War I. Indeed, the Treaty of San Francisco does not include any payment of reparations to America by Japan and, in fact, had laid out the intent for American investors to improve the Japanese economy by improving the quality of its exports while protecting its internal economy.

West-Germany too was a major recipient of extensive U.S. investment as spelled out in the Marshal Plan, which was the United States government's plan for revitalizing the economies of Western Europe and pushing back the threat of communism. Although West-Germany has gone on to pay extensive reparations to Israel some fifty years after the fact, it was not required to pay the same extensive reparations as the previous World War. Indeed, West-Germany were only required to pay reparations to Russia which consisted of "10% of the industrial capacity of the western zones unnecessary for the German peace economy"(3).