A work by the British economist John Maynard Keynes of King’s College, Cambridge, which founded Keynesian macroeconomics, an analytical framework in which public and private spending decisions affect output and employment.
John Maynard Keynes’s The General Theory of Employment, Interest, and Money analyzed the determination of aggregate output and employment. Written during the Great Depression, the General Theory argued that governments could use expansionary fiscal and monetary policy, stimulating aggregate demand, to reduce unemployment and increase national income. Keynes denied that market forces would automatically restore full employment in a monetary economy after demand shocks in the absence of active government stabilization policy. Keynes took a leading role in the Bretton Woods monetary settlement that established the International Monetary Fund and the World Bank at the end of World War II, and Keynesian ideas shaped macroeconomic policymaking in the industrial countries for a quarter-century after the war. In the Bretton Woods negotiations and in his “Notes on Mercantilism” in the General Theory, Keynes held that maintaining the autonomous ability of national policies to stabilize employment is more important than the unrestricted international movement of goods and funds.
John Maynard Keynes took a leading role in the Bretton Woods monetary settlement that established the International Monetary Fund and the World Bank at the end of World War II. Keynesian ideas shaped macroeconomic policymaking in the industrial countries for a quarter-century after the war. (AP/Wide World Photos)
In the 1920s, Keynes had pioneered analysis of the forward market for foreign exchange and had warned that Britain’s 1925 return to the gold standard at an overvalued exchange rate would necessitate domestic deflation and unemployment. At the beginning of the Great Depression, Keynes advocated a protective tariff as a politically acceptable substitute for devaluation, dropping his tariff proposal in 1931 when Britain left the gold standard and allowed the pound to depreciate against other currencies. The analysis of the General Theory dealt formally only with a closed economy. Keynesian macroeconomics was extended to open economies by Keynes’s associate James Meade and, most influentially, by Robert Mundell and J. Marcus Fleming. The Mundell-Fleming or IS-LM-BP (where IS is the investment-saving equilibrium curve for the goods market, LM is the liquidity-money equilibrium curve for the money market, and BP the balance-of-payment equilibrium curve for the foreign exchange market) model is an open-economy extension of the interpretation of Keynes’s General Theory presented in John Hicks’s IS-LM diagram.
This framework for analyzing the simultaneous determination of aggregate income, interest rates, and exchange rates continues to be widely used. Post-Keynesian economists criticize the IS-LM-BP framework for neglecting Keynes’s insight that private investment is volatile because of limited knowledge of the future. In contrast, New Classical economists claim that Keynes underestimated private-sector stability and that government attempts at stabilization cause instability and inflation.
Robert W. Dimand
See also: Economic Consequences of the Peace, The; Great Depression; Keynes, John Maynard.
Clarke, P. The Keynesian Revolution in the Making, 1924–36. Oxford: Clarendon, 1988.
Dimand, R.W. The Origins of the Keynesian Revolution. Stanford: Stanford University Press, 1988.
Harcourt, G.C., and P.A. Riach, eds. A “Second Edition” of the General Theory. New York: Routledge, 1997.
Moggridge, D.E., and E.A.G. Robinson, eds. Collected Writings of John Maynard Keynes. New York: Cambridge University Press for the Royal Economic Society, 1971–1989.