John Maynard Keynes

While chapter 4 of this book discussed the emergence of the neoclassical school of economic thought, this chapter will examine the theory of John Maynard Keynes, who tried to understand the dramatic economic events of the 1930s by attempting to "escape" from that school's ideas. In the 1930s much of the world was in the throes of what has come to be known as the Great Depression. In the major capitalist countries of the world, the USA and the UK, the unemployment rate rose to 25 per cent in 1933 and above 15 per cent in 1932, respectively. The problem erupted with the New York stock market crash of October 1929, which was followed by widespread bank failures, declining levels of investment spending by firms, sharp reductions in output, income and employment, as well as wage and price deflation, resulting in much human misery. Although depressions and recessions were not unknown, such a deep economic downturn affecting so many people around the globe was unprecedented. It lasted, to varying degrees in different parts of the world, for almost a decade, and it was not until World War II that recovery occurred. Yet, most economists held on to neoclassical economic theories that took the view that the market for labor "clears" in the sense that supply and demand are brought to equality through wage variations, and that unemployment would not persist. To be sure, these theories could explain the existence of unemployment, but only in terms of the rigidity of wages due to, say, the existence of trade unions that prevented wages from falling. Such theories, however, seemed to be incompatible with the persistence of unemployment for a prolonged period, despite declining wages and prices. In his book The General Theory of Employment, Interest and Money (henceforth, the GT), written during the Depression and published in 1936, the British economist John Maynard Keynes developed what became the classic analysis of why capitalist economies can experience long bouts of involuntary unemployment and why this unemployment is not necessarily removed by automatic market forces. This analysis has been seen by many as the genesis of modern mainstream macroeconomics, which analyzes the economy as a whole, as a branch of economics separate from microeconomics, which analyzes particular markets and individual actors in the economy, such as firms and households.