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Needed in the context of the renewed popularity of Keynes's ideas: An analysis of his errors
Abstract
This paper provides a detailed exposition of Keynes's theory of why depressions occur in a market economy, doing so by allowing Keynes himself to describe his theory, for which the article draws mainly from The General Theory of Employment, Interest, and Money. The basic reason Keynes gave for why depressions occur is that there is too much saving and too little consumption and investment. After explaining his theory of depressions, the article proceeds to show the major errors Keynes commits. These errors include believing that falling wage rates lead to decreased spending and a lower rate of profit, believing more investment leads to a lower rate of profit, equating gross values with net values, and equating saving with hoarding. This paper is relevant to current events in which governments around the globe have used various Keynesianinspired "stimulus packages" in an attempt to help economies recover from the financial crisis and recession of 2008.
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Every year thousands of introductory economics students are made to accept as valid one of Keynes's lasting inversions of classical economics, namely the proposition that saving may be a private virtue, but is a public vice. According to Keynes, a community that seeks to increase its rate of saving would end up impoverishing itself and actually saving less, but the community that increases its consumption at the expense of saving would end up being richer and saving more. This proposition, frequently stated in macroeconomics textbooks as the "paradox of thrift," arises mainly from Keynes's definition of saving to include the hoarding of cash, contrary to the classical definition and language of the marketplace, but has received little recognition or criticism as such.' Rather than emphasizing Keynes's misrepresentation of the classical theory of income determination and growth in which hoarding constitutes a reduction in saving, most critics have pointed out only that saving may take other forms besides hoarding.2 Thus, several reviewers of the General Theory [22], in which Keynes fully develops the argument, criticized it mainly for having assigned too much importance to the hoarding of cash, e.g., Pigou [37], Robertson [40], Viner [51], and Hawtrey [11]. Some modern textbook writers employ the loanable-funds view of savings to show the lim
Following Keynes's attribution of the assumption of full employment to the classics in the General Theory (1936), it has become standard practice particularly in macroeconomics textbooks to identify classical economics' with that assumption. Among the intermediate-level texts that repeat the attribution are Abel and Bernanke [1, 426], Baily and Friedman [6, 443-44], Dornbusch and Fischer [14, 200-201], Froyen [17, 55], Galbraith and Darity [18, 44-45], Gordon [19, 165], McElroy [45, 41-51], and Sachs and Larrain [62, 55].2 Case and Fair [10, 349-50], Colander [12, 211], Samuelson and Nordhaus [63, 277], and Slavin [65, 219-20] are among introductory-level texts that state the same claim. However, devising appropriate policies to raise the standard of living, especially for the poor, and also increase employment opportunities for a growing population were the principal focus of the classical economists. See, for example, Smith [66, 1:359-60, 372, 2:208], Ricardo [58, 1:386-97], Malthus [40, 231-40, 351-60], and Mill [46, 2:356-58]. Writing in the tradition of the classics, Alfred Marshall also was equally concerned about the fate of the poor and the need to identify policies that would promote economic growth and their welfare.3 Indeed, Keynes recalls Marshall's own explanation of his transition from mathematics to economics as being influenced by his visits to "the poorest quarters of several cities and [having] walked one street after another, looking at the faces of the poorest people" on his vacations.4 Pigou [53] also firmly denies having employed the full employment assumption as Keynes alleges. Indeed such an assumption would also be inconsistent with the title of Pigou's 1933 book, The Theory of Unemployment. On the other hand, Keynes's efforts to contrast classical arguments with his own charac
Keynes's multiplier story invites acceptance by building on the fact that people typically consume only a fraction of their income and that such purchases are incomes for sellers. By misrepresenting the classical definition of saving and the meaning of Say's Law, Keynes laid the grounds for extolling the virtues of consumption spending as determining income and employment growth. But the mythology of the multiplier story becomes clear when we ask, "From where do people find the means to purchase consumption goods, other than production?" The inadequacies of several earlier criticisms stem from their failure to focus on this fundamental point. Copyright 2001 The American Journal of Economics and Sociology.