Keynesian Business Cycle

Keynes and the Business Cycle, Keynesian Business Cycle

One of the most thought-provoking theories of the business cycle proposed in recent years is that of John Maynard Keynes (1883- ), one of the foremost contemporary English economists. In his book The General Theory of Employment Interest and Money (1936), he goes far beyond the bounds of the classical ideas of the business cycle, and frequently offers unorthodox ex­planations and proposals. He challenges the generally accepted view that the way to end depressions is to cut expenses, especially wages, and by so doing encourage full employment and revival. In individual plants a reduction of wages may make it possible to expand production and increase employment. A general wage cut, however, would simply reduce consumption and accentuate the depression. In Mr. Keynes' opinion, satisfactory business condi­tions depend upon mamtaining full employment. His argument, therefore, attempts to show why full employment is not achieved and why declining business activity appears as a consequence. The goal of the business man is profit. He operates his business at a level which will yield in his opinion the maximum return. In making his decision on this point he considers three variable factors: (1) the "propensity" of the population to consume; (2) the prospective return of new capital investment; and (3) the rate of interest.

In discussing the "propensity to consume," Keynes shows that as income increases, expenditures also increase, but not as fast as income. Hence there is always a surplus available as saving. But income and employment cannot rise except as a result of investment. Here arises the paradox. Investment cannot rise unless there is an increase in consumption, otherwise there is no demand for increased production. Nor is it possible to consume all that is produced if saving is to be accomplished.
However, business men will be inclined to invest in new pro­ductive enterprise if the returns to be expected are larger than the current rate of interest. A rise in the interest rate, he says, re­duces productive investment and curtails employment. A reduc­tion in the interest rate tends to have the reverse effect. Contrary to other economists, therefore, Keynes does not believe that a raising of the interest rate encourages saving and promotes invest­ment. Furthermore, the interest rate is not determined by the increases or decreases in demands for money, but is a matter of tradition. If it is to be helpful in controlling business activity, it must be controlled by public authority in the opposite direction to the suggestion of older economic theory. Rather than raising the interest rate to prevent over-investment, it is necessary to keep the interest rate low in order to encourage investment as a means of mamtaining full employment. A high interest rate, Keynes believes, would postpone investment and encourage hoard­ing. To cut wages would be to produce the most disastrous re­sults, for income would be redistributed in favor of property owners who save more than they consume. It is obvious that Mr. Keynes favors any plan which encourages both investment and consumption. For that reason he was one of the most ardent ad­vocates of large-scale public works, and the manipulation of in­terest rate and money policies as a road out of the recent de­pression. It is safe to say that the government programs adopted in England and America show definite evidence of Keynes' ideas. The complexity of economic life prevents any conclusive statement as to the effectiveness of these programs. That both England and America have left the depression far behind is cer­tain. Whether war, public works, managed currency, or some other plan was responsible, it is impossible at the present to say. We are still too close to the picture to see it in its entirety.

No one theory or explanation of business cycles meets with the general approval of a sufficient number of well-known economists to make it possible to identify it as the right or the correct ex­planation. Each economist, therefore, constructs his own theory, introducing various points of emphasis which suit his own pe­culiar tastes. There is no alternative, therefore, but to canvass each idea, compare it with other ideas on the same subject, and draw as reasonable a conclusion as possible. More definite judgments must wait for more careful analyses of the economic processes in­volved in the operation of the business cycle.