The General Theory of Employment, Interest and Money

Lore & Background

The General Theory is a sustained attack on the classical economics orthodoxy of its time. Keynes denied that an economy would automatically adapt to provide full employment even in equilibrium, and believed that the volatile and ungovernable psychology of markets would lead to periodic booms and crises. The central argument is that the level of employment is determined not by the price of labour, as in classical economics, but by the level of aggregate demand. If the total demand for goods at full employment is less than the total output, then the economy has to contract until equality is achieved. Keynes's theory is based on the interaction between demands for saving, investment, and liquidity. Saving and investment are necessarily equal, but different factors influence decisions concerning them. The desire to save is mostly a function of income: the wealthier people are, the more wealth they will seek to put aside. The profitability of investment is determined by the relation between the return available to capital and the interest rate. The economy needs to find its way to an equilibrium in which no more money is being saved than will be invested, and this can be accomplished by contraction of income and a consequent reduction in the level of employment. Keynes accepted the classical relation between wages and the marginal productivity of labour, but proposed a 'second postulate of classical economics' asserting that the wage is equal to the marginal disutility of labour. He argued that the postulates of the classical theory are applicable to a special case only and not to the general case, and that its teaching is misleading and disastrous if applied to the facts of experience.

Reader's Guide

Its significance lies in challenging the classical economic orthodoxy that full employment is the natural result of competitive markets in equilibrium. Keynes argued that the level of employment is determined by aggregate demand, not by the price of labour, and that market psychology leads to periodic booms and crises. The book introduced key concepts such as the consumption function, the principle of effective demand, liquidity preference, and gave new prominence to the multiplier and the marginal efficiency of capital. Its policy implications were interpreted as providing theoretical support for government spending, budgetary deficits, monetary intervention, and counter-cyclical policies. The work is pervaded with an air of mistrust for the rationality of free-market decision-making. The first chapter, only half a page long, emphasizes the prefix 'general' to contrast with classical theory, which Keynes argued applies only to a special case. The book's legacy includes the 'Keynesian Revolution' in economic thought and policy.

Did You Know?

• The first chapter of The General Theory is only half a page long.
• The book introduced the concepts of the consumption function, the principle of effective demand, and liquidity preference.
• Keynes denied that full employment was the natural result of competitive markets in equilibrium.