page_title: History of macroeconomic thought
section_title: Keynes's General Theory
hierarchical_section_title: History of macroeconomic thought / Keynes's General Theory
caption_attribution_description: English: Assistant Secretary, U.S. Treasury, Harry Dexter White (left) and John Maynard Keynes, honorary advisor to the U.K. Treasury at the inaugural meeting of the International Monetary Fund's Board of Governors in Savannah, Georgia, U.S., March 8, 1946. Français&#160;: John Maynard Keynes (à droite) et Harry Dexter White (à gauche) (1946) Русский: Джон Мейнард Кейнс (справа) и Гарри Декстер Уайт на Бреттон-Вудской конференции Deutsch: Harry Dexter White (links) und John Maynard Keynes beim Eröffnungstreffen des Gouverneursrates des Internationalen Währungsfonds in Savannah, Georgia, USA am 08. März 1946.
context_page_description: Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.
  The generation of economists that followed Keynes synthesized his theory with neoclassical microeconomics to form the neoclassical synthesis. Although Keynesian theory originally omitted an explanation of price levels and inflation, later Keynesians adopted the Phillips curve to model price-level changes. Some Keynesians opposed the synthesis method of combining Keynes's theory with an equilibrium system and advocated disequilibrium models instead.
context_section_description: Modern macroeconomics can be said to have begun with Keynes and the publication of his book The General Theory of Employment, Interest and Money in 1936. Keynes expanded on the concept of liquidity preferences and built a general theory of how the economy worked. Keynes's theory was brought together both monetary and real economic factors for the first time, explained unemployment, and suggested policy achieving economic stability.
  Keynes contended that economic output is positively correlated with money velocity. He explained the relationship via changing liquidity preferences: people increase their money holdings during times of economic difficulty by reducing their spending, which further slows the economy. This paradox of thrift claimed that individual attempts to survive a downturn only worsen it. When the demand for money increases, money velocity slows. A slowdown in economic activities means markets might not clear, leaving excess goods to waste and capacity to idle. Turning the quantity theory on its head, Keynes argued that market changes shift quantities rather than prices. Keynes replaced the assumption of stable velocity with one of a fixed price-level. If spending falls and prices do not, the surplus of goods reduces the need for workers and increases unemployment.
  Classical economists had difficulty explaining involuntary unemployment and recessions because they applied Say's Law to the labor market and expected that all those willing to work at the prevailing wage would be employed. In Keynes's model, employment and output are driven by aggregate demand, the sum of consumption and investment. Since consumption remains stable, most fluctuations in aggregate demand stem from investment, which is driven by many factors including expectations, "animal spirits", and interest rates. Keynes argued that fiscal policy could compensate for this volatility. During downturns, government could increase spending to purchase excess goods and employ idle labor. Moreover, a multiplier effect increases the effect of this direct spending since newly employed workers would spend their income, which would percolate through the economy, while firms would invest to respond to this increase in demand.
  Keynes's prescription for strong public investment had ties to his interest in uncertainty. Keynes had given a unique perspective on statistical inference in A Treatise on Probability, written in 1921, years before his major economic works. Keynes thought strong public investment and fiscal policy would counter the negative impacts the uncertainty of economic fluctuations can have on the economy. While Keynes's successors paid little attention to the probabilistic parts of his work, uncertainty may have played a central part in the investment and liquidity-preference aspects of General Theory.
  The exact meaning of Keynes's work has been long debated. Even the interpretation of Keynes's policy prescription for unemployment, one of the more explicit parts of General Theory, has been the subject of debates. Economists and scholars debate whether Keynes intended his advice to be a major policy shift to address a serious problem or a moderately conservative solution to deal with a minor issue.
caption: Keynes (right) with Harry Dexter White, assistant secretary of the U.S. Treasury, at a 1946 International Monetary Fund meeting
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