The General Theory of Employment, Interest and Money

"It’s the most important book of the twentieth century. What he said in this book in 1936 was that all the economics that has thus far governed the world was but one instance, one special case. He says that the entirety of classical economics, which is basically dressed up today as neo-classical economics, is only one possible world. But what, he asks, if we find ourselves in a world that’s not like that? In the book Keynes refers to the notion of a non-Euclidean geometry – that you need to work in a world where parallel lines actually meet. His book is about a world in which parallel lines meet and argues that until then economists only had the geometry that said that they never do – and that that was useless. It’s a much, much bigger book than people give it credit for. It was reduced by Paul Samuelson and others in the 1950s down to sticky wages and counter cyclical demand management – that’s a bit like saying The Lord of the Rings is a book about people who are under five foot tall and have hairy feet. The General Theory is a series of arguments. For example, he asks why there was such high unemployment. The argument of the day was that there were jobs out there, the unemployed just had to move or accept the prevailing wage. What Keynes shows is that if everyone accepts the prevailing wage, i.e. cuts to the amount they are prepared to work for, that will lead to reduced consumption in the economy, and that ultimately will mean that the person employing them will have fewer customers coming through the door. So what will the employer do? He will end up laying off more people. So what is individually rational is collectively disastrous. In one simple paragraph, Keynes overturns 150 years of thought and shows how involuntary unemployment is possible. He then moves on to talk about the economy being more than the sum of its parts – genuine macroeconomics. Today, there’s a whole science called complexity theory – complex adaptive non-linear systems. Keynes didn’t use that language but that’s what he was describing. He was 80 years ahead of his time. What he figured out was that we don’t know what’s going to happen in the economy and that we shouldn’t go around nationalising things and intervening, all the things that were done in his name. What he talked about was the need for a robust policy that meant that if the economy goes into a big contraction and everyone’s individually rational decision leads to a worse outcome, then you do need the state either in the form of a central bank providing liquidity or its fiscal arm stimulating demand to make sure there’s enough income being generated so that the private sector can shed its debts. Once it’s done that, the state is meant to withdraw as the private sector recovers. The state is essentially an insurance policy to allow effective de-leveraging and to make the private sector work better to get over the deep paradox that what is individually rational can be collectively disastrous. This is an incredibly important book because it shows us that Adam Smith was only right in a special case. In relatively simple and complete markets with perfect competition, individual rationality will lead to collective superior utility. But in most of the world that we live in – this complex dynamic non-linear system – it doesn’t work like that at all, and Keynes worked that out in 1936."

"It is a difficult book, because it’s the first book that tries to figure this stuff out. You don’t teach Keynesian economics from Keynes anymore. Keynes was actually working on The General Theory of Employment, Interest and Money before the Great Depression , but, obviously, the Great Depression gave it urgency. It’s a first stab – it’s one hell of a first stab – but because it is a first stab, it’s got all the awkwardnesses that go with that. He goes off on tangents that seemed important to him at the time, but don’t seem so important now. It’s not an easy read. It’s a book to be read when you’re a practising economist with a fair bit of research of your own under your belt. Because then, as you read it, you can see the incredible process he’s going through, of freeing himself from the preconceptions of the economic analysis of his time. You can see him saying, “Hey, wait, maybe that’s not right. How can I think this through, how can I make this a story that actually fits the world I see around me?” There is stuff in there where you say, “What the hell is that about?” For example, there’s a whole discussion about the choice of units, which is, in fact, very boring. But having been through minor versions of that kind of process myself… the mechanics, the plumbing of your theory, is often critical. You work really hard to try to put that together, and Keynes is laying it out as he did it. It’s really breathtaking and inspirational. It’s implied. It’s clear from the book that you can have a problem of inadequate spending and that just printing more money, under some circumstances, does nothing. In that case you have to have the government come in and spend. Elsewhere, Keynes was more explicit about it, but you can deduce it from the framework of The General Theory . Once you understand the logic of the kind of slump we’re in, once you understand it’s very much the same kind of slump we were in in the 1930s, then the case for fiscal stimulus flows out of that analysis. That’s actually from my next book, his Essays in Persuasion , which are real time analyses, many of them written for popular magazines. Keynes was really expressing a hope, rather than making a prediction. He was saying I hope that we will eventually become like dentists, that it will be just a technical discipline. And probably that was one place where his wisdom failed him. Because the fact of the matter is there is too much interest at stake in economic policy. In the world in which we now live, there is no such thing as neutral advice or neutral expertise. The division is partly an intellectual division, which is overlaid with a political division. They mostly match up, but not totally. “In the world in which we now live, there is no such thing as neutral advice or neutral expertise” The idea of an activist government policy to fight recessions is controversial, and deeply opposed by certain factions, in part because they think it will hurt their interests directly and in part because they fear that it opens the door for an active role for government, for liberalism in general. Then you have the intellectual division, which, in a way, goes back to Hume. On one side there are the people who start with an axiomatic, “This is the way it must be” view of economics – it’s all about perfectly rational individuals interacting through perfect markets. In that view, there is no room for Keynesian economics, but of course there is also no room for the slumps like the one we’re in. Then there are people who say that maximising behaviour may be a useful strategic simplification, but if it doesn’t seem to fit the facts… We don’t use it where it doesn’t seem to work. That would be my position. So you have the division within the economics profession over epistemology, you could say, and then a division along political lines. Those two are matching up almost precisely right now. I think it’s stronger. We can’t do controlled experiments with economies. You can’t prove something the way you can prove something in physics. But we have a number of pretty clear cases. We have the Great Depression, which was ended by a very large fiscal stimulus, otherwise known as World War II . The 1930s is, in many ways, the best laboratory. You can see that when Mussolini did a military build-up, it expanded the Italian economy exactly as a Keynesian would have predicted. Of course, it’s not as clear-cut as one would like. It’s not as if you can find someone who is doing a fiscal expansion while holding everything else constant. Life doesn’t work that way. But compared to a lot of other things people believe in economics – about the efficiency of the markets, or what will happen if you raise taxes – it’s a lot better established. There are a lot of propositions in economics that are held with great firmness that actually have no clear historical evidence behind them. Fiscal policy is, if anything, actually a bit better grounded in the evidence."