Keynes Seminar 11 February 2009 Geoff Tily Government Economic Service Keynes, Policy and The General Theory © PKSG 2009

Keynes, Policy and The General Theory

Structure 1. Monetary policy backdrop: the gold standard 2. Public expenditure: history 3. Theory 4. Outcome 5. Implications 6. Further reading

1. Monetary policy backdrop: the gold standard

If we restore the gold standard, are we to return also to the pre-war conceptions of bank rate, allowing the tides of gold to play what tricks they like with the internal price level, and abandoning the attempt to moderate the disastrous influence of the credit cycle on the stability of prices and employment? In truth, the gold standard is already a barbarous relic. A Tract on Monetary Reform, 1923, pp The Gold Standard,

Keyness Project: Indeed it is difficult not to be impressed by the consistency of his main strategic objectives: the full employment of resources; the achievement of balance of payments for all countries by methods that would not be inconsistent with full employment; as a means to this, a system of exchange rates that would combine the short-term virtues of fixity and predictability with the long- term virtues of flexibility; and, as a means to full employment, low interest rates. Keyness obituary in the Economic Journal (Keyness obituary in the Economic Journal, Robinson 1947, p. 45)

The confusion lay in the futile attempt to ignore the existence of bank money and consequently the inter-relationships of money and bank credit, and to make representative money behave exactly as though it were commodity money. (p. 15) A Treatise on Money, 1930 The failure of theory

Outcome: unemployment rates

Bank rate,

Post-gold policies, 1932 February, first rate cut to 5% from 6% February, first rate cut to 5% from 6% April, Exchange Equalisation Account instigated April, Exchange Equalisation Account instigated June, conversion operation announced, embargo on overseas loans and final rate cut to 2 % June, conversion operation announced, embargo on overseas loans and final rate cut to 2 %

Action on other rates: quantitative easing

Outcome? unemployment rates Off Gold, September 1931 Off Gold, April 1933

2. Public Expenditure: History

Consistent themes Spending multiplying itself Spending multiplying itself Spending paying for itself Spending paying for itself Necessity of the use of (cheap) credit Necessity of the use of (cheap) credit Leakages Leakages Solvable by geometric progression Solvable by geometric progression

Chronology (1) March 1929, Liberal Manifesto March 1929, Liberal ManifestoLiberal ManifestoLiberal Manifesto May 1929, Can Lloyd George Do It? May 1929, Can Lloyd George Do It?Can Lloyd George Do ItCan Lloyd George Do It 30 May 1929, General Election 30 May 1929, General ElectionGeneral ElectionGeneral Election [October 1929, Wall Street Crash] [October 1929, Wall Street Crash] 5 November 1929, CX appoints Macmillan Committee on Finance and Industry 5 November 1929, CX appoints Macmillan Committee on Finance and Industry 22 January 1930, PM announces Economic Advisory Council 22 January 1930, PM announces Economic Advisory Council February & March 1930, Keyness five sessions at Committee, explores Treasury view February & March 1930, Keyness five sessions at Committee, explores Treasury viewTreasury viewTreasury view

… we are ready with schemes of work which we can put immediately into operation …. These plans will not add one penny to national or local taxation. taxation

Chronology (1) March 1929, Liberal Manifesto March 1929, Liberal ManifestoLiberal ManifestoLiberal Manifesto May 1929, Can Lloyd George Do It? May 1929, Can Lloyd George Do It?Can Lloyd George Do ItCan Lloyd George Do It 30 May 1929, General Election 30 May 1929, General ElectionGeneral ElectionGeneral Election [October 1929, Wall Street Crash] [October 1929, Wall Street Crash] 5 November 1929, CX appoints Macmillan Committee on Finance and Industry 5 November 1929, CX appoints Macmillan Committee on Finance and Industry 22 January 1930, PM announces Economic Advisory Council 22 January 1930, PM announces Economic Advisory Council February & March 1930, Keyness five sessions at Committee, explores Treasury view February & March 1930, Keyness five sessions at Committee, explores Treasury viewTreasury viewTreasury view

That a demand for a suit of clothes implies a demand for cloth; that a demand for cloth implies a demand for yarns and tops, and so for wool; that the services of farmers, merchants, engineers, miners, transport workers, clerks are all involved – this is the ABC of economic science. (CW IX, pp ) ABC

Chronology (1) March 1929, Liberal Manifesto March 1929, Liberal ManifestoLiberal ManifestoLiberal Manifesto May 1929, Can Lloyd George Do It? May 1929, Can Lloyd George Do It?Can Lloyd George Do ItCan Lloyd George Do It 30 May 1929, General Election 30 May 1929, General ElectionGeneral ElectionGeneral Election [October 1929, Wall Street Crash] [October 1929, Wall Street Crash] 5 November 1929, CX appoints Macmillan Committee on Finance and Industry 5 November 1929, CX appoints Macmillan Committee on Finance and Industry 22 January 1930, PM announces Economic Advisory Council 22 January 1930, PM announces Economic Advisory Council February & March 1930, Keyness five sessions at Committee, explores Treasury view February & March 1930, Keyness five sessions at Committee, explores Treasury viewTreasury viewTreasury view

Ramsey MacDonald Prime Minister

Philip Snowden Chancellor Chancellor

Chronology (1) March 1929, Liberal Manifesto March 1929, Liberal ManifestoLiberal ManifestoLiberal Manifesto May 1929, Can Lloyd George Do It? May 1929, Can Lloyd George Do It?Can Lloyd George Do ItCan Lloyd George Do It 30 May 1929, General Election 30 May 1929, General ElectionGeneral ElectionGeneral Election [October 1929, Wall Street Crash] [October 1929, Wall Street Crash] 5 November 1929, CX appoints Macmillan Committee on Finance and Industry 5 November 1929, CX appoints Macmillan Committee on Finance and Industry 22 January 1930, PM announces Economic Advisory Council 22 January 1930, PM announces Economic Advisory Council February & March 1930, Keyness five sessions at Committee, explores Treasury view February & March 1930, Keyness five sessions at Committee, explores Treasury viewTreasury viewTreasury view

Sir Richard V. N. Hopkins Permanent Secretary

HMT view (1) … the decision taken by the Government at the end of 1925 to restrict grants for relief schemes was based mainly on the view that, the supply of capital in the country being limited, it was undesirable to divert any appreciable proportion of this supply from normal trade channels. (British Government to ILO, 1927, cited in Kahn 1931)

HMT view (2) It is the orthodox Treasury dogma, steadfastly held, that whatever might be the political or social advantages, very little additional employment and no permanent additional employment, can, in fact, as a general rule, be created by State borrowing and State expenditure. (CW IX, pp. 115) expenditure

Chronology (2) September 1930, Richard Kahn circulates primitive analysis of multiplier to EAC sub- Committee, the Committee of Economists September 1930, Richard Kahn circulates primitive analysis of multiplier to EAC sub- Committee, the Committee of Economists October 1930, A Treatise on Money published October 1930, A Treatise on Money published March 1931, Proposals for a Revenue Tariff March 1931, Proposals for a Revenue Tariff May 1931, Macmillan Report published May 1931, Macmillan Report published June 1931, Kahns article published in the Economic Journal June 1931, Kahns article published in the Economic Journal Economic Journal Economic Journal July 1931 European banking crisis July 1931 European banking crisis 31 July 1931, May Committee Report published 31 July 1931, May Committee Report published 24 August, National Government formed under MacDonald and elected in November 24 August, National Government formed under MacDonald and elected in NovemberNovember

It is important, we are told, not to overlook the beneficial repercussions that will result from the expenditure of the newly-employed men's wages. But little is done to evaluate these repercussions in concrete terms. The main purpose, though not the only purpose, of this article is to outline the means by which this gap could be filled, … It is, however, important to realise that the intelligent co-operation of the banking system is being taken for granted. Cost of investment = saving on dole + increase in imports + increase in unspent profits. (Mr Meades relation)Mr Meades

Chronology (2) September 1930, Richard Kahn circulates primitive analysis of multiplier to EAC sub- Committee, the Committee of Economists September 1930, Richard Kahn circulates primitive analysis of multiplier to EAC sub- Committee, the Committee of Economists October 1930, A Treatise on Money published October 1930, A Treatise on Money published March 1931, Proposals for a Revenue Tariff March 1931, Proposals for a Revenue Tariff May 1931, Macmillan Report published May 1931, Macmillan Report published June 1931, Kahns article published in the Economic Journal June 1931, Kahns article published in the Economic Journal Economic Journal Economic Journal July 1931 European banking crisis July 1931 European banking crisis 31 July 1931, May Committee Report published 31 July 1931, May Committee Report published 24 August, National Government formed under MacDonald and elected in November 24 August, National Government formed under MacDonald and elected in NovemberNovember

Neville Chamberlain Chancellor Chancellor

Chronology (3) 21 September 1931, off gold 21 September 1931, off gold 1932 Budget, EEA etc 1932 Budget, EEA etc Follow up in EJ, Warming and Kahn (June 1932) and also Giblin in Australia Follow up in EJ, Warming and Kahn (June 1932) and also Giblin in AustraliaKahn 17 October 1932, signatory to letter supporting public works in The Times 17 October 1932, signatory to letter supporting public works in The Times 4 March 1933, FDR takes office 4 March 1933, FDR takes office March 1933, The Means to Prosperity March 1933, The Means to ProsperityThe Means to ProsperityThe Means to Prosperity 20 April 1933, US off gold 20 April 1933, US off gold June & July 1933, World Economic Conference June & July 1933, World Economic Conference 31 December 1933, Keyness open letter 31 December 1933, Keyness open letterletter

… savings are always and necessarily equal to investment: that is a mere truism, … Whatever the level of investment, funds are always available to pay for it..

Chronology (3) 21 September 1931, off gold 21 September 1931, off gold 1932 Budget, EEA etc 1932 Budget, EEA etc Follow up in EJ, Warming and Kahn (June 1932) and also Giblin in Australia Follow up in EJ, Warming and Kahn (June 1932) and also Giblin in AustraliaKahn 17 October 1932, signatory to letter supporting public works in The Times 17 October 1932, signatory to letter supporting public works in The Times 4 March 1933, FDR takes office 4 March 1933, FDR takes office March 1933, The Means to Prosperity March 1933, The Means to ProsperityThe Means to ProsperityThe Means to Prosperity 20 April 1933, US off gold 20 April 1933, US off gold June & July 1933, World Economic Conference June & July 1933, World Economic Conference 31 December 1933, Keyness open letter 31 December 1933, Keyness open letterletter

… to create wealth will increase the national income and that a large proportion of any increase in the national income will accrue to an Exchequer, amongst whose largest outgoings is the payment of incomes to those who are unemployed and whose receipts are a proportion of the incomes of those who are occupied. (CW IX, p. 338).

Chronology (3) 21 September 1931, off gold 21 September 1931, off gold 1932 Budget, EEA etc 1932 Budget, EEA etc Follow up in EJ, Warming and Kahn (June 1932) and also Giblin in Australia Follow up in EJ, Warming and Kahn (June 1932) and also Giblin in AustraliaKahn 17 October 1932, signatory to letter supporting public works in The Times 17 October 1932, signatory to letter supporting public works in The Times 4 March 1933, FDR takes office 4 March 1933, FDR takes office March 1933, The Means to Prosperity March 1933, The Means to ProsperityThe Means to ProsperityThe Means to Prosperity 20 April 1933, US off gold 20 April 1933, US off gold June & July 1933, World Economic Conference June & July 1933, World Economic Conference 31 December 1933, Keyness open letter 31 December 1933, Keyness open letterletter

Dear Mr President, You have made yourself the trustee for those in every country who seek to mend the evils of our condition by reasoned experiment within the framework of the existing social system. … In the field of domestic policy, I put in the forefront, for the reasons given above, a large volume of loan expenditure under government auspices. … Your obedient servant, J. M. KEYNES (New York Times, 31 December 1933, CW IX, pp )

3. Theory Multiplier, prices, financing, saving, government borrowing, trade and estimation

No. C Y … I know for certain that the multiplier is not always 2 It should not be difficult to compile a chart of the marginal propensity to consume at each stage of a trade cycle from the statistics (if they were available) of aggregate income and aggregate investment at successive dates.

Multiplier in the GT (1) Law of consumption: Law of consumption: The fundamental psychological law, upon which we are entitled to depend with great confidence both a priori from our knowledge of human nature and from the detailed facts of experience, is that men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income. (CW VII, p. 96)

Multiplier in the GT (2) Derived via MPC and NA identity (in closed economy) Derived via MPC and NA identity (in closed economy) C / Y = c, where 0 < c < 1 C / Y = c, where 0 < c < 1 Y = C + I Y = C + I Y = 1 I Y = 1 I 1 - c 1 - c Note equivalence to summing sequence: Note equivalence to summing sequence: 1 + c + c 2 + … = 1 / (1 – c)

Keynes on prices (Ch20, §IV,V): Hence, in general, supply price will increase as output from a given equipment is increased. Thus increasing output will be associated with rising prices, apart from any change in the wage-unit. It is probable that the general level of prices will not rise very much as output increases, so long as there are available efficient unemployed resources of every type. But as soon as output has increased sufficiently to begin to reach the bottlenecks, there is likely to be a sharp rise in the prices of certain commodities. When a further increase in the quantity of effective demand produces no further increase in output and entirely spends itself on an increase in the cost-unit fully proportionate to the increase in effective demand, we have reached a condition which might be appropriately designated as one of true inflation.

Financing of spending New money: banks to create credit New money: banks to create credit Do so at very low interest Do so at very low interest Created savings can then flow into bonds, which repays banks Created savings can then flow into bonds, which repays banks +ΔM-ΔM +ΔB liabilities

Saving: crowding out Because income increases, eventually saving is generated to exactly same extent of original expenditure, i.e. no crowding out Because income increases, eventually saving is generated to exactly same extent of original expenditure, i.e. no crowding out Keynes worked through the NA algebra: Keynes worked through the NA algebra: Process analysis Process analysis Process analysis Process analysis Really, its a monetary phenomenon Really, its a monetary phenomenonphenomenon

Or process analysis C C C r (1-C) C2C2 spend save C –C 2 = C (1-C) (1-C)(1+C+C 2+ … = (1-C) / (1-C) = 1 1

Saving: crowding out Because income increases, eventually saving is generated to exactly same extent of original expenditure, i.e. no crowding out Because income increases, eventually saving is generated to exactly same extent of original expenditure, i.e. no crowding out Keynes worked through the NA algebra: Keynes worked through the NA algebra: Process analysis Process analysis Process analysis Process analysis Really, its a monetary phenomenon Really, its a monetary phenomenonphenomenon

Government finances Gain of tax on multiplied income (income, CT and VAT) Gain of tax on multiplied income (income, CT and VAT) –Eg if average rate of tax = 50%, multiplier =2 Saving on dole Saving on dole

Trade Leakage to overseas Leakage to overseas Amended formula Y = 1 I Y = 1 I 1 – c + m 1 – c + m NB savings still created, but overseas. BoP arithmetic has them returning NB savings still created, but overseas. BoP arithmetic has them returning Remain to be convinced that this leakage is greatly more significant than in Keyness time Remain to be convinced that this leakage is greatly more significant than in Keyness time

Other implications No account taken of beneficial outcomes outside the original multiplier process as confidence restored and firms cashflow recovers No account taken of beneficial outcomes outside the original multiplier process as confidence restored and firms cashflow recovers

Estimating the multiplier No official statistics in 1930 No official statistics in 1930 Colin Clarks figures, National Income , published in 1932 Colin Clarks figures, National Income , published in 1932 Kahn: 2 Kahn: 2 MTP: 2, but safer 1 ½, even safer 1 1/3 MTP: 2, but safer 1 ½, even safer 1 1/3 [in the US] the multiplier seems to have been less than 3 and probably fairly stable in the neighbourhood of 2.5. This suggests a marginal propensity to consume not exceeding 60 to 70 per cent. – a figure quite plausible for the boom, but surprisingly, and, in my judgment, improbably low for the slump (GT, p. 128). [in the US] the multiplier seems to have been less than 3 and probably fairly stable in the neighbourhood of 2.5. This suggests a marginal propensity to consume not exceeding 60 to 70 per cent. – a figure quite plausible for the boom, but surprisingly, and, in my judgment, improbably low for the slump (GT, p. 128). For as and for as (Colin Clarks estimates) For as and for as (Colin Clarks estimates)

Marginal propensities

Multiplier

Obamas multipliers The job impact of the American recovery and reinvestment plan The job impact of the American recovery and reinvestment plan FT 23/1 FT 23/1 Christina Romer, chairman of the CEA, estimates a multiplier of 1.5 Barro with partial crowding out the multiplier will be a lot less than one Rogoff Academic economists are far more uncertain about the impact of the fiscal stimulus than Wall Street … The range of estimates is very wide. But given the situation were in it is certainly worth trying

Marginal propensities, US

Multiplier, US

4. Outcome

UK GDP(E)

Real outcomes

Debt, % GDP

Action on other rates: quantitative easing

FDR spending Eg Works Progress Administration, Eg Works Progress Administration, –644,000 miles of roads, –122,760 bridges, –38,800 schools, –2,300,000 public toilets, –8,000 swimming pools, etc Peter Fearnon estimates that between January 1933 and December 1940 $21.1 billion was spent on public relief and federal works programmes Peter Fearnon estimates that between January 1933 and December 1940 $21.1 billion was spent on public relief and federal works programmes 3 per cent of total GDP over the same period 3 per cent of total GDP over the same period – today: $420 billion a year in the US; £42 billion in UK

US GDP(E)

5. Closing remarks

Implications of Keynes Charles Kindleberger, The World in Depression, : Charles Kindleberger, The World in Depression, : "A nation can finance anything it can produce."

Taking London as our example, we should demolish the majority of the existing buildings on the south bank of the river from County Hall to Greenwich, and lay out these districts as the most magnificent, the most commodious and healthy working-class quarter in the world. The space is at present so ill used that an equal or larger population could be housed in modern comfort on half the area or less, leaving the rest of it to be devoted to parks, squares and playgrounds, with lakes, pleasure gardens and boulevards, and every delight which skill and fancy can devise. Why should not all London be the equal of St Jamess Park and its surroundings? The river front might become one of the sights of the world with a range of terraces and buildings rising from the river. The schools of South London should have the dignity of Universities with courts, colonnades and fountains, libraries, galleries, dining-halls, cinemas and theatres for their own use. Into this scheme should be introduced the utmost variety. All our architects and engineers and artists should have the opportunity to embody the various imagination, not of peevish, stunted and disillusioned beings, but of peaceful and satisfied spirits who belong to a renaissance. (Keynes,The Listener, August 1936)

Thanks to Graham Turner of GFC economics, and author of the Credit Crunch. Dated 6 January.