 Hi, this is Gerald Friedman, Department of Economics, University of Massachusetts in Amherst. And today we're here to talk about Keynes, Jean-Mainid Keynes of Cambridge, England, adviser to the British Treasury, author of The Economic Consequences of the Peace, Economic Consequences of Mr. Churchill and, in 1935, the General Theory of Employment, Interest and Money. I think it's safe to say that he is the most important economist of the twentieth century. He also is one of the most interesting, while arrogant, witty, argumentative, sometimes nasty. He also was a very romantic figure, married to a Russian ballerina, lover of many people of all various elks. And he died young, which is often a prerequisite for being a romantic hero. He died in 1946 shortly after trying to sway the U.S. to a more open-minded approach to post-war economic settlements. The U.S. did all right as these things go. The Bretton Woods Accords set up institutions that were a lot better than what was done after World War I. But there is no question, going into these negotiations, Keynes, who wanted a much larger international monetary fund, wanted a much more liberal approach towards balance of trade, balance of payments deficits, wanted the U.S. to put a lot more money into what became the Marshall Plan. Keynes was playing with a very bad hand, and the U.S. didn't do what he wanted, which is probably too bad. The world would have been a lot better if we had listened to Keynes. But for now, Keynes wrote his most important book, The General Theory, Drawing the Great Depression. And in it, as he makes clear not only in that, but also in his essays and persuasion, Keynes was a wonderful writer, by the way. That's a great asset. So was Milton Friedman, very clear, good writing, fun to read. You can read them out loud. Keynes was trying to formulate a theory behind the empirical observations of the Great Depression, which had actually started much, much earlier in Britain. Britain never really recovered from World War I, and it certainly never recovered from the decision in 1926, which Keynes described in the economic consequences of Mr. Churchill, the decision in 1926 to go back to the gold standard at the pre-war rate of exchange of the pound for gold. That was a decision that left Britain with an overvalued currency and a chronic balance of trade deficit, chronic on high unemployment. So what we in the United States experienced beginning in 1929, Britain experienced long before. Britain never had full employment in the 1920s. Instead they had a prolonged period of high unemployment, seeming equilibrium. So when Keynes looked at the world of the 1930s, he was looking at it through the vision of what happened in Britain in the 20s, which was a long period of unemployment, with no tendency towards full employment. Keynes was a great classical economist. He knew the orthodox theory. He understood it, but he looked at what happened to Britain in the 20s and what happened throughout the world in the 30s, and wait a second, the classical theory says law doesn't work. And that's where he had his most brilliant insight in the general theory, which agree or disagree, is a fundamentally different approach to economics. He said that demand on the aggregate level, you're not talking about individuals, but you talk about demand for the whole economy, it is fundamentally separate from supply. In fact, it's prior to supply. People do not make things because they want to consume. They consume, and then that determines what they're going to make. Robinson Cruser doesn't make a canoe because he wants to consume a canoe. Somebody buys a canoe, gives him an order to make a canoe, and he then makes the canoe. It's demand that comes first. And there's no mechanism in the aggregate economy for supply to be brought in line with demand, sorry, for demand to be brought in line with full employment supply. Supply will follow demand, but there's no reason why demand should ever be at the level that will provide for full employment. That is the basic idea in Cades, and here's how it works. There are two key points. The first is the multiplier. What determines the aggregate level of demand in the economy, the amount that people demand depends on some exogenous decision by people to buy things, which we'll call investment. People out there decide they're going to invest. So they start out with $100, let's say they buy $100 worth of investment goods, they buy it from Dan, Dan has this $100, what does he do with $100? Well Dan spends it. In fact, Dan spends $99 of that $100, and he puts $1 in the bank because Dan's young, he has a lot of needs, he doesn't have much money, so he spends most of his money. He spends those $99, buying stuff from other people like himself who put $1 in the bank. So the $99 is spent, becomes $98, the next round becomes $97. You keep on going until all the money is in the bank. There's $100 in the bank and $1,000 worth of consumption. That is the economy. They start out with a certain level of external spending and that gets siphoned off through this multiplier process until all of that initial spending has been saved. So the savings equals the investment and the level of output is set at $1,000. If Dan saved $50 out of the $100, then he would get the $100, spend $50, the next person just like him would take the $50, spend $25, the next person would spend $12.50 and you would end up with just $200 of output. The level of output depends on the amount of initial spending investment and the marginal propensity to consume. And that's it. How many people get jobs? Well, if there's a very high marginal propensity to consume, like Dan's $99 out of the $100, then a lot of people will have jobs. If there's a low marginal propensity to consume, like $50 out of the $100, very few people have jobs and there'll be a lower level of output. And here's the second key point to Keynes. There's nothing here that equilibrates the level of demand with the potential of the economy. You could have 1,000 people out there, 100 of them at work because there's a very low marginal propensity to consume or very little investment and that'll be it. The level of demand does not change because there's more unemployment out there. If wages go down, that's not going to create more employment because that will just reduce the amount that people demand. There'll be less wages, less consumption. There's nothing in Keynes that guarantees full employment. What there is in Keynes is the potential for, as he described in the economic consequences of Mr. Churchill, as he found in Britain in the 1920s, that you can have long periods of unemployment. This by the way is what we saw in Japan in the 1990s is what we're seeing in the United States today. People associate, this is my last point on this, people associate Keynes with the depression of the 1930s. That's a big mistake. His theory was not written for the 30s. It was written for the 1920s. A long period of equilibrium, high unemployment. Okay, we're going to talk next time about animal spirits. Thank you and have a good day. Bye bye.