Cambridge is perhaps the most beautiful university in the world. Every year hundreds of thousands of tourists meander through medieval courts, punt on the River Cam, and snap photographs, as students play cricket and croquet on lush lawns. Sometimes the students put down their cricket bats to play practical jokes on the visitors. A few years ago, some merry sons of Cambridge painted a papier-mâché ball to look like a heavy concrete ornament found on one of the many bridges spanning the Cam. As a boat filled with Japanese tourists streamed by, the boys pushed the ball off the bridge and screamed. The tourists shrieked and leaped overboard—cameras in hands. Aside from terrorized tourists, Cambridge can be idyllic. Fellows and students donned in gowns still stroll into sixteenth-century halls to dine beneath portraits of Henry VIII, Elizabeth I, and alumni such as Newton, Darwin, and Wordsworth.
Here it was that Cockcroft ran through the streets hugging passersby and shouting, “We’ve split the atom! We’ve split the atom!” Here it was that Watson and Crick revealed the secret of life in their DNA model.
No one embodied the Cambridge spirit of culture, fun, and public duty so much as Maynard Keynes. No one was more brilliant or charming. No economist in his century influenced politicians or the course of economics more. Bertrand Russell, one of Britain’s most distinguished philosophers, announced that Keynes had “the sharpest and clearest” intellect he had ever known: “When I argued with him, I felt that I took my life in my hands, and I seldom emerged without feeling something of a fool.”1 One feels sorry for Charles Rye Fay, a classmate of Keynes’s. The first freshman Fay met upon arriving at Cambridge was Keynes, and poor Fay thought that all his classmates would be just as superior to him. He later reflected that the first person he met at college turned out to be the smartest he would meet during his entire life. Incidentally, Keynes was smart enough to know that he was smart. Few accused him of modesty. In fact, Keynes did not return Fay’s admiration, later writing that his friend was unfit as a traveling companion: “He is too ugly. Ugliness of face, hands, body, clothes and manners are not, I find, completely overbalanced by cheerfulness, a good heart, and an average intelligence.”2
Despite his origins in the secluded paradise of Cambridge, Keynes and his ideas ranged throughout the world. If Ronald Reagan wore an Adam Smith necktie, every president from Franklin D. Roosevelt to Richard Nixon could have slipped on a Keynes cravat, especially Kennedy and Johnson. Ironically, after Nixon announced, “We are all Keynesians now,” Keynes’s influence began to wane. Milton Friedman, the fiercest critic of Keynesian economics, admitted that “in one sense, we are all Keynesians now; in another, no one is a Keynesian any longer.”3 During the 1980s and 1990s, Keynes’s allure began to fade. Robert Lucas, the Rational Expectations pioneer we will discuss in chapter 12, said that the Keynes name began to elicit whispers and giggles at economist gatherings. And yet when the stock market and economy tumbled into a banking crisis in 2008 (and a coronavirus panic in 2020), whose name came back into vogue? Lucas admitted, “Well, I guess everyone is a Keynesian in a foxhole.”4
What does it mean to be a Keynesian? Two basic propositions will suffice here: (1) the private economy may not reach full employment; (2) government spending can spur the economy into filling the gap. Every time a politician ardently advocates priming the pump, government programs to get the country moving again, or slashing taxes to boost consumption, he exalts Keynes.
Keynes was not concerned solely with employment, though. His Collected Writings number more than two dozen volumes and span many subjects, including currency questions, trade restrictions, rebuilding after the world wars, and graceful essays on such figures as Einstein and Newton. The distinguished Oxford historian Hugh Trevor-Roper names Keynes as among the major contributors to historical method.
Keynes was born in 1883 into a Puritanical Victorian home. John Neville Keynes, his father, was a well-known logician, economist, and Cambridge University registrar, whose mind impressed Alfred Marshall, but whose nerves had always required soothing. Like many students in any era, Neville’s anxiety showed up on exam days, and he would complain about headaches, toothaches, and chest pains. While his son would learn to walk with kings and princes, Neville would rather stroll among the stacks of the library and pursue calming hobbies like chess and stamp collecting. While his son would, with sneaky glee, toss around words like “sodomy” and “catamites,” Neville resisted Ibsen’s plays because he was offended that Nora would desert her husband and children in A Doll’s House.5 The daughter of a minister, Maynard’s charming mother, Florence Ada, was taller and psychologically sturdier than her husband. She later served as mayor of Cambridge, and kept their marriage strong for sixty-seven years. Neville’s family had an ample cushion of money, and so they could afford to indulge in theater-going, library-building, and other high-minded pursuits of the Victorians. The marriage started with a sort of bang, however, because Maynard was conceived not long after their honeymoon, in June 1883.
An aunt had explained to young Maynard that “‘Keynes’ rhymed with ‘brains.’” Although Keynes was fond of his parents, he spent much of his life escaping from their moral and philosophical influences. Keynes liked to have fun and cared little for the Puritan attitudes embodied in Sir James Stephen, grandfather of his friend Virginia Woolf, who reputedly once smoked a cigar and found it so pleasurable that he never smoked again. Still, Keynes felt quite comfortable as a member of the high intellectual bourgeoisie. In a pun on the British expression “wet” (meaning “weak political devotion”), Lenin referred to him as a “bourgeois of the highest water,” while Keynes joked that when the communist revolution came, he would be found beside the bourgeois banner.
At Eton, he amassed numerous prizes for mathematics, and performed well in the theater and humbly on the cricket pitch. Entering King’s College, Cambridge, he flourished even more boldly. More important, he developed friendships and liaisons, both intellectual and physical, with other highbrows and was invited to join the university’s most select and secretive society, the Apostles. The society included eminent older members, or “angels,” such as Russell, G. E. Moore, and Alfred North Whitehead, as well as Keynes’s peers, many of whom would later achieve fame in literature and the arts, such as Lytton Strachey, E. M. Forster, and Leonard Woolf. The Apostles threw themselves into the radical philosophy of morality that Moore spelled out in Principia Ethica and agreed with him that “goodness” could not be prescribed, written in stone on Mosaic tablets, or beaten into a child by the hickory stick of a schoolmarm. Instead, goodness was an “intuition,” a claim that seemed to liberate the Apostles. Generally, the Apostles discussed three topics: philosophy, themselves, and aesthetics. Not that they were particularly pleasing aesthetically. Most, including Keynes, lacked what Virginia Woolf called “physical splendour.” The most blistering commentary on Keynes’s looks comes from an assistant master at Eton, who described him as “distinctly ugly at first sight, with lips projecting and seeming to push up the well-formed nose and strong brows in slightly simian fashion.”6 Friends at Eton had called him “Snout.” As Keynes grew to a stooping height of six feet, six inches, he grew into his pseudo-simian face, though he remained convinced of his ugliness. It did not help when Virginia Woolf went beyond the primate species and said that Keynes resembled “a gorged seal” and later a “queer swollen eel.” These descriptions seem gross and grossly unfair. A 1931 video shows him looking quite human, with an accent and bearing that Henry Higgins would approve of.7
The Apostles bred an ugly arrogance, and Keynes himself had many ways to look down on his inferiors. Not only did the Apostles consider themselves far superior to the masses; they thought they soared above all of Cambridge and Oxford. “I get the feeling that most of the rest never see anything at all—too stupid or too wicked,” Keynes wrote to Strachey.8 Still, no one can deny that the Apostles were a formidable group who often engaged in sparkling conversation. Here, as well as in the Cambridge Union Society, Keynes learned to be the consummate debater and raconteur, who later surpassed colleagues, competitors, and politicians in seminars and summits.
Many of the Apostles, including Keynes, later emerged as the Bloomsbury Group, whose anti-Victorian, bohemian attitudes powerfully affected the development of British culture. In addition to his achievements in economics, Keynes would spend almost as much time collecting books, founding the Cambridge Arts Theatre, and serving as a trustee for the National Gallery, buyer for the Contemporary Arts Society, and chairman of the trustees of the Royal Opera House. A report of his theater activities shows a deep concern for microeconomics: he “was fascinated by statistics of bar-profits, and programme money, and matinee ices, and cups of coffee.”9 As an academic, arts patron, finance manager, and government officer, he seemed to be everywhere. Over the years, he would have a finger, a foot, and every other appendage in every camp, from beagling with landed lords to buggering with itinerant actors. In today’s more specialized academic world, one might seriously ask whether Keynes would choose economics, given his dilettantism.
Keynes did not come to Cambridge to study economics but mathematics. Though he performed satisfactorily, he struggled. “I am saddening my brain, destroying my intellect, souring my disposition,” he wrote to a friend.10 After passing his mathematics exam, he read his first economics book, Marshall’s Principles of Economics. Keynes began writing papers for Marshall, who scribbled encouraging words in the margins. In the greatest understatement since Smith started writing a book to “pass away the time,” Keynes wrote about economics: “I think I am rather good at it.” He added, “I want to manage a railway or organise a Trust, or at least swindle the investing public.” A few days later he reported, “Marshall is continually pestering me to turn professional Economist. . . . Do you think there is anything in it? I doubt it.”11
Keynes’s studies with Marshall lasted only eight weeks. Nor did he take a degree in economics. He proved rather good at on-the-job training, however.
In 1905 Keynes began studying hard for the Civil Service Examination. As he reviewed mathematics, philosophy, psychology, et al., his prejudices again emerged. After reading a book by a non-Cambridge philosopher, he lamented, “What a home of diseased thought Oxford is.” Keynes came in second of 104 candidates. Ironically, economics and mathematics were his worst subjects! “Real knowledge seems an absolute bar to success,” he reported. About economics, Keynes decided that the examiners did not know enough. He would teach them.12
Since the first-place candidate snatched a job at the Treasury, in 1906 Keynes grabbed the second-best position, at the India Office in London. He never made it to India. His first task was to ship ten young bulls to Bombay. Keynes quickly became bored silly, or more accurately, bored flippant, reporting to Strachey that he was working on the annual report on the moral and material progress of India and planned a “special feature” in “this year’s edition . . . an illustrated appendix on Sodomy.”13
Keynes returned to King’s College, Cambridge, repelled by tedium and attracted by Marshall’s offer of a lectureship. As an economics teacher, Keynes leaned on one of the few texts he had actually read, Marshall’s. In the early years his economics did not venture far beyond Marshall and the classical tradition. As he read more, though, his reputation for insight and lucidity grew, resulting in an appointment as co-editor of the influential Economic Journal. Keynes held this post until 1945 and established a sterling reputation for careful editing and good humor. Once he told a foreign contributor that while “exempli gratia” may be abbreviated “e.g.,” he could not abbreviate “for instance” as “f.i.” Two years later, in 1913, he published Indian Currency and Finance, one of the few fruits of his India Office years. Joseph Schumpeter called it the “best English work on the gold exchange standard.”14 Of course, Schumpeter, who sometimes seemed envious of Keynes, may have been insulting English economists as much as complimenting the book.
World War I brought Keynes back to government in the Treasury Department. The war posed a test to the Bloomsbury Group and their aloof, iconoclastic, and apatriotic persuasions. Almost all the male members, including Keynes, claimed exemption from military service as conscientious objectors. As usual, Lytton Strachey injected humor into the serious matter. Though he stated that all physically fit intellectuals should be prepared to defend the shores of England, he added one proviso: no intellectuals are physically fit. Sometime later, Strachey made his proudest contribution to the war effort: he knitted a navy-blue wool scarf for the neck of a sailor he desired. Finally, when Strachey was haled before the war tribunal to test his conscientious-objector status, officials asked the classic question: What would you do if you saw a German officer attempting to rape your sister? Strachey paused. “I would attempt to interpose my body between them,” he said, winking.15
After the war, Keynes represented the Treasury at the Paris Peace Conference. Again he grew disgusted with government, but not because of boredom. Keynes witnessed Woodrow Wilson being bamboozled by British prime minister Lloyd George and the Frenchman Georges Clemenceau into squeezing a defeated Germany beyond reason and beyond her ability to rebound, except in frightening belligerency. Keynes came close to predicting another world war. Unable to endure the diplomatic nightmare he was watching, he resigned and quickly penned The Economic Consequences of the Peace, one of the most acid polemics of his time, judged even by Bloomsbury standards. He was perhaps inspired by his friend Strachey’s brutal takedown of societal paragons in his bestselling 1918 work, Eminent Victorians, in which Strachey even poked at Florence Nightingale, the founder of modern nursing. In his Versailles postmortem, Keynes said that President Wilson’s reputation had the world and Keynes in awe: He noted how the crowd pressed around the president’s carriage, trying to catch a glimpse of this man of destiny who would bring healing. Instead, Wilson appeared like a Presbyterian minister with “no plan, no scheme, no constructive ideas whatever . . . his mind was too slow.”16 When visiting Washington, D.C., which he called “very oriental,” Keynes changed metaphors and described Wilson as “an invisible sultan spending most of his time in his harem,” by which Keynes surely meant seclusion, not the arms of wives and concubines.17 Clemenceau seldom spoke at Versailles, Keynes reported, but then “a sudden outburst of words, often followed by a fit of deep coughing from the chest produced their impression rather by force and surprise, rather than by persuasion.” The Germans were a sad lot with drawn, dejected faces, and were led by a small, noble-visaged man who bore a high collar and the gleaming eyes of “an honorable animal in pain.” This was Carl Melchior, a lawyer for the once-powerful Warburg Bank, representing vanquished Germany. The negotiations were tetchy and treacherous. One day, Melchior and Keynes snuck away from the rage and the bank ledgers and stepped into a small room. Keynes was quivering with excitement and fear, for breaking ranks and protocol. Each begged the other to see the honesty and humanity in the other. How did these two men end up in a room, the result of a gunshot in Sarajevo, mustard gas in trenches, and twenty million dead? “I begged him to believe that I, at least, at that moment was sincere. He was as much moved as I was. . . . In a sort of way I was in love with him.”18 Along with searing portraits of the world’s leaders, Keynes carefully argued to the French and Americans that Germany could not afford the reparations demanded of her. He ominously warned, “If we aim at the impoverishment of Central Europe, vengeance, I dare say, will not limp. Nothing can then delay for very long the forces of Reaction . . . before which the horrors of the later German war will fade into nothing, and which will destroy, whoever is victor, the civilisation.”19 Book sales soared, breaking records in England and the United States, and so did Keynes’s reputation and ego. In a parodic poem, one magazine commented on “The Candour of Keynes”: “Still we feel . . . That possibly some of the Ultimate Things / May even be hidden from Fellows of King’s.”20
Not much was hidden from Keynes. In the next decade he continued to teach, edit, write, advise governments, and serve as chairman of a life insurance company. He corresponded with the most prominent politicians, academics, and artists of his time. In 1925, he married Lydia Lopokova, a Russian ballerina who had danced with Nijinsky and had headlined Diaghilev’s traveling troupe. She was known for her lively style, louche manners, and memorable malapropisms. She once told a fellow dancer that he danced like a cantaloupe. She meant antelope. It turned out that she had learned English in the Catskill Mountains of New York. At a British embassy reception in Washington on the evening of Franklin Roosevelt’s reelection, she kept turning to others and asking, “Do you like Rosie?”21 Lydia puzzled and troubled Maynard’s Bloomsbury friends, who wondered what a world-class intellect could see in a middling dancer whose brain seemed to pirouette more dizzily than her legs. Besides, she was female, and Maynard had seemed to be spending more time with young men. He even paid for his brilliant friend Ludwig Wittgenstein to visit them for six days during their honeymoon in Sussex, during which time Wittgenstein acted like, well, Wittgenstein. Lydia comments brightly, “What a beautiful tree!” The fiendishly fey philosopher replies, “What do you mean?” Lydia cries. No matter, Keynes and Lydia stuck together through the honeymoon and twenty years beyond until his death in 1946. At the wedding, his friends bet on whether Lydia would get pregnant soon, and Keynes’s friend Clive Bell, an art critic and the brother-in-law of Virginia Woolf, took the long side of the bet, saying, “Maynard is too fast on the trigger.”22 In the end, Maynard and Lydia did not raise children but instead raised money for the opera, ballet, theater, and other artistic causes across Britain.
Luck and a good measure of skill aided Keynes as he earned a fortune trading stocks and commodities. He not only spoke the King’s English, but he was also fluent in rubber, cotton, tin, and gold.23 Perhaps because he was secure in his intellect and so well connected among those whom sociologist C. Wright Mills would call the “power elite,” Keynes took big chances in his portfolio and, when he felt bullish, borrowed from banks to buy more shares than his cash on hand would permit. He would sit in his bed each morning, sift through the newspapers, take phone calls from brokers, and then place his orders. Though he went nearly bankrupt in the late 1920s and late 1930s, when he died in 1946 he left behind a solid portfolio worth £400,000 (about $20 million in today’s dollars), in addition to a prescient art collection featuring coveted works by Picasso and Braque. He frequented auctions and once accompanied the head of the National Gallery on a clandestine trip to Paris. To disguise his deep pockets from other bidders, the gallery chief shaved his mustache and donned spectacles. On another trip, Keynes reported, “I’ve got a Cezanne in my suitcase” and then added that because it was too heavy, he had to temporarily leave it in a “ditch, behind the gate.”24 His collection, including the work retrieved from the ditch, is worth about $100 million today and was donated to Cambridge’s Fitzwilliam Museum. Some critics challenge economists to “put up or shut up”—that is, if they know about money, why aren’t they rich? If economists were judged by this test, Keynes would rank second only to David Ricardo. Too many economists tie for last place to mention any others.
In economics, Keynes focused mostly on monetary policy, writing his Tract on Monetary Reform in 1923, followed by a two-volume Treatise on Money in 1930. The Treatise tied together much of Keynes’s earlier work on investment with new insights on the connection between savings and investment. But despite the comprehensive nature of the Treatise, 1930 brought challenges to economics so perplexing that he could no longer rest on his published work and enchanting charm. Though Keynes’s luck seemed never to run dry, the world’s luck did, and nations were awash in the debt and despair of the Great Depression.
Recall the scary Malthusian scenario, with the world seemingly splitting, leaving victims scrambling for survival. Once upon a time not far removed and in a place familiar to us, it nearly happened. From 1929 to 1933 in the United States, the invisible hand of the free market slapped prosperity in the face. Unemployment rocketed from about 3 to 25 percent, and national income plummeted by half. Residential construction stopped. Many lost their homes and businesses. The stock market crash of 1929, with brokers jumping to their deaths, became both symbol and cause of further economic decline. The Roaring Twenties sputtered to a halt, leaving income in 1933 lower than that in 1922. Workers scrambled for the few jobs available. Soup kitchens sprang up. And psychological depression accompanied economic depression.
The popular song lyricist Yip Harburg, who would later promise a brighter place for Judy Garland in the song “Over the Rainbow,” echoed the frustration and despondency of the Depression in his classic “Brother, Can You Spare a Dime?” The song chronicles the generations that labored to help carve a prosperous civilization from the American wilderness. Yet now the singer who helped build a railroad that raced “against time” has no job. Can one beg with pride and dignity? Yes. For he has not lost his job because of any personal failure. An economy run awry has robbed him.
Economic historians have long debated the cause of the Great Depression, but there is no simple answer. The more important question is, what transformed a recession into a nightmare? The United States had lived through dips and drops before, but never so severe. Most economists stress a coincidence of bad events: investment opportunities dried up after accelerating in the 1920s; consumers decided to decrease spending and repay loans; nations panicked into protectionism; and the Federal Reserve system responded with tighter, not looser, policies.25
When Ronald Reagan battled President Carter in 1980, he wittily defined some economic terms: “A recession is when your neighbor loses his job. A depression is when you lose your job. And recovery is when Jimmy Carter loses his job.”
Maynard Keynes might agree, but with a slight change in the last definition. Recovery from the Great Depression comes when old fuddy-duddies in the British Treasury (and the American government) lose their jobs. To Keynes, the old men of the Treasury were drunk on the old wine of the classical economists, which to his taste had turned to vinegar. Keynes blasted the Treasury view, which prescribed patience and promised recovery in the long run. What is the point of having such a government? “In the long run we are all dead,” he wrote in his Tract on Monetary Reform.
In truth, the Treasury men were not simply bound by inertia and old age. They did have some smart, young theorists to back them. The chair of the London School of Economics, Lionel Robbins, had visited Vienna a number of times and had begun to embrace the views of the so-called Austrian school of economics, led by Ludwig von Mises and his student Friedrich von Hayek. Robbins found Hayek’s views electrifying and exotic, compared with the Marshallian analysis that dominated in England. He offered the thirty-two-year-old Hayek a position in London, and together the duo set out to battle Keynes. Even though Hayek was awed by Keynes’s brainpower and bewitching voice, he was stunned by Keynes’s ignorance of non-English economics and European history. In an interview in the late 1970s, Hayek recalled that Keynes “knew nothing but Marshallian economics. . . . He hated the nineteenth century and, therefore, knew little about it.” According to Hayek, Keynes was enamored with his own theories and “had contempt for most other economists.”26 In Prices and Production (1931), Hayek lays out his own business-cycle theory, which contends that central banks spark downturns because they first spark a boom. By pushing interest rates lower than the “natural rate” (a term from Knut Wicksell) in the Roaring Twenties, the central bank mistakenly spurred businesses to borrow too much and to overspeculate on too-risky ideas. The economy raced on an amphetamine high and then crashed. Future Nobel laureate Ronald Coase heard Hayek’s first London lectures and called his effect “magical.” But what to do about the Depression? Keynes and Hayek amicably toasted each other at dinners, while exchanging friendly missives and bitter reviews of each other’s work. Keynes could be a vicious debater and called Hayek’s work “frightful muddles” that “end in bedlam.” Regardless of insults, the two men offered radically different prescriptions. Keynes said that the government should jump into the breach and throw more money at workers and businesses. Hayek and Robbins advised waiting for the excesses to unwind and for prices to readjust. Herbert Hoover would later call this the “liquidationist” method, while Milton Friedman would deem the London axis a dismal and dark view that did the world “a great deal of harm.”27 The Cambridge-versus-London wrestling match took place on the blackboard, in journals, and in newspapers. On October 17, 1932, Keynes and his supporters signed a letter to London’s Times making their case, and two days later Robbins and Hayek rebutted. In a time of crisis, however, “do nothing” was not an attractive policy. With jobless numbers soaring and British exports collapsing by 50 percent, Robbins and Hayek retreated from the fight. They each bore wounds for a long time. More than forty years later, Robbins admitted, “I was on the wrong side,” and fifty years later Hayek remarked, “The moment there is any sign that the income stream may actually shrink, I should . . . try everything in my power to prevent it from dwindling.”28 After the battles with Keynes and after World War II, Hayek turned more toward political and legal philosophy, producing striking and enduring works like The Road to Serfdom and The Constitution of Liberty. Though he died in 1992, Hayek might be considered the grandfather of cryptocurrencies, for he advocated nongovernment money long before the first Bitcoin, and even before the first Internet connections were flipped on.29 While King George VI would grant Keynes the title of baron and place him in the House of Lords, Hayek would receive the Presidential Medal of Freedom from George H. W. Bush.
Back in the 1930s, Keynes knew that writing letters to editors would not win the day. He justified the advice he gave to politicians in his 1936 masterpiece, The General Theory of Employment, Interest and Money, which smashes the Treasury view and presents a new framework for macroeconomic analysis. As Keynes predicted in the preface, conventional economists would fluctuate “between a belief that I am quite wrong and a belief that I am saying nothing new.” Paul Samuelson, whose introductory economics text has taught Keynesian economics to generations, cleverly summed up the ambiguity of The General Theory: “It is a badly written book, poorly organized; any layman who, beguiled by the author’s previous reputation, bought the book was cheated of his five shillings. . . . It is arrogant, bad-tempered, polemical and not overly-generous in its acknowledgments. It abounds in mares’ nests and confusions. . . . In short, it is a work of genius.”30
Keynes begins by mercilessly attacking his predecessors and Cambridge colleagues (especially A. C. Pigou), sometimes directly, sometimes through caricatures. During the prosperous years before the Depression, Pigou used to confidently say, “It is all in Marshall,” as if few questions in economics remained to be solved. (Despite his shy manner, Pigou did devise many original ideas, and in recent years he is making a comeback. In the following chapter we shall see how his model helps explain the economic rebound from the Great Recession of 2008.) Unlike Keynes, Pigou disliked discussions of economic controversies once he had put down the chalk and left the classroom. Keynes’s friend Ludwig Wittgenstein was even less accessible. After class he ran off to movies, preferably those starring Carmen Miranda, who was famous for dancing with tropical fruit on her head and singing the “Chiquita Banana Song.” Whether Wittgenstein found a deeper meaning in this rite, we do not know.
The General Theory tries to settle some scores with Hayek, likening him to Ibsen’s “wild duck,” who dives to the bottom of a mucky lake and gets tangled up.31 Harry Johnson described well Keynes’s sarcastic, terroristic intellectual strikes in The General Theory: “It posits a nameless horde of faceless orthodox nincompoops, among whom a few recognizable faces can be discerned, and proceeds to ridicule a travesty of their published, presumed, or imputed views.”32 The most nincompoopish belief was in Say’s Law, which Malthus had attacked a century before. Recall from an earlier chapter that Say’s Law states that producing goods generates enough income to workers and suppliers for all the goods to be purchased. Therefore, no general gluts can take place. People have enough money to buy everything that has been produced. (Of course, a merchant may produce too much of a particular product. But this would not be a general glut. The price would fall to eliminate the particular surplus.) If one believes in Say’s Law, however, one must not believe in long-term unemployment and great depressions. Only a schizophrenic could believe in both. And even Keynes would not accuse his colleagues of schizophrenia. He gave them the benefit of the doubt and called them stupid.
The nincompoops ignored an important leak in the smooth, cyclical flow from producers to consumers to producers and so on. What happens when households save? As they build up their bank accounts, won’t merchants find themselves staring at piles of unsold goods? Keynes thought so. The nincompoops had an answer. Was it right? Keynes thought not. He argued against two prime propositions:
1. According to the classicists, households consume part of their income and save the remainder. If consumers decide to save more, demand for goods and services slips, but this is offset because merchants simply invest more. Why would merchants invest more? When people save, they do not usually stuff bills under their mattresses. They put money in the bank. The banks lend the money to merchants. Now, if people bring more savings to the bank, the bank will lower the price it charges borrowers, which is the interest rate. And if the bank lowers the interest rate, merchants will borrow more for investment because more projects will appear profitable compared with the cost of borrowing. Thus, whenever consumers boost their savings and reduce their consumption, merchants will be induced to boost their investment. A flexible interest rate will, in Marshallian splendor, tie investment and savings together. We might say that consumers provide the supply of savings (which rises as interest rates rise, because saving becomes more attractive), while merchants provide a demand for those savings (which falls as interest rates rise).
If a recession seems imminent because people cut back on their purchases and instead raise savings, the model predicts that interest rates will fall, which inspires merchants to spend more on investment, which puts money in people’s pockets and sustains the flow.
2. Flexible wages and prices buttress Say’s Law. Suppose that all merchants limp. They cannot walk to the bank as fast as consumers do when the consumers raise their savings. Thus, merchants cannot invest quickly enough to make up for the decreased consumption. A slight recession may result. But wages and prices would fall in response to a fall in demand for goods and services. As wages fell, unemployed workers would be rehired. As prices fell, surplus goods would be sold. The recession would be over quickly.
An art aficionado, Keynes refused to admit that the neat, logical, classical picture belonged to the realism school. It might be vaguely reminiscent of the truth in an impressionistic way. But the world was not so pretty, especially in 1936.
Keynes launched a two-pronged attack on the classical school. First, he denied the automatic link between savings and investment. Households and businesses save and invest for completely different reasons. A family may save from habit or for a particular purpose such as old age or for an automobile. Businesses may change their investment plans based on politics, confidence, technology, foreign exchange rates, or who wins the World Series. To expect interest rates to bring harmony is silly. If household savings exceed business investment, gluts will emerge, and bosses will fire employees, leading to even less consumption. During 1997 and 1998, Japanese households cut back their spending even though the central bank slashed short-term interest rates to just 0.5 percent. As income falls, savings may drop enough to equal investment, but not necessarily at full employment.
Second, Keynes scoffed at fluid, flexible wages and prices. When politicians prophesy that prices will float to their correct levels, they sound like magicians chanting prophecies that “abra will rise, cadabra will fall.” Monopolies and union contracts surely impede adjustment. During a recession, real wages should fall, according to classical theory. But workers usually refuse to accept lower nominal wages, Keynes thought.
In a recession, Keynes argued, businesses slash investment. Yes, savings eventually equal investment. But why? Not because investment rises (as the classicists say), but because laid-off employees cannot afford to save. Further, because wages and prices take a long time to adjust, prolonged recessions or depressions are possible.
Sure enough, savings did equal investment in the early 1930s. There was none of either. The classical show was over.
It was time for a new show. The spotlight would shine on aggregate demand. The marquee would read “Depressions Occur When Total Demand for Goods and Services Is Less Than Total Income.” (A large marquee would be needed, but remember that during depressions, vacancies rise.) Through his analysis, Keynes warns of inadequate demand for goods and services by households and businesses. If they do not purchase enough, merchants will fire workers and slash output. This is Keynes’s capsule description of a depression.
Let’s build the simple Keynesian model step by step, discussing first households and then businesses. Since more products are bought by households, households are the most important component of overall demand. What determines how much households spend? Although family size, tastes, and expectations are significant, Keynes appoints income the chief determinant. If income rises, people will buy more. If income falls, they will buy less. This seems logical. In fact, Keynes assumes that each time a person gets an extra dollar, he will spend most of that dollar and save the rest. Keynes calls the spent part the marginal propensity to consume. Say a dollar falls from heaven into your pocket. You buy a candy bar for 80 cents and put the rest in the bank. Your marginal propensity to consume is 0.80 (algebraically, the change in consumption divided by the change in income). Your marginal propensity to save is 0.20.
Businesses also buy goods and services. By investing in equipment and inventories, they form the other substantial part of aggregate demand. What does investment depend on? Keynes thought investment was much more volatile than household consumption. Expectations, interest rates, confidence, weather, and politics could all distort investment plans. In the simplest Keynesian model, we assume that so many factors count that businessmen do not change their investment plans in response to short-run changes in incomes. (Recall that households do change their consumption in the short run.)
What does this model mean? To have a healthy economy with full employment, households must consume enough and businesses must invest enough that sales of goods equal the amount produced. If people consumed all their income (MPC = 1), Say’s Law would produce full employment. But since people save, business investment must make up for the savings. If it does not, output exceeds sales, inventories build, and employers lay off employees. The problem is deficient demand for goods and services. The culprit in a recession is savings.
Several years before The General Theory, Keynes urged citizens to spend more. In a Redbook magazine article, “Can America Spend Its Way into Recovery?,” Keynes proclaimed: “Why, obviously!” Few listened. Nor did they hear when he wrote in The Listener:
When anyone cuts down expenditure, whether as an individual or a town council or a Government Department, next morning someone for sure finds that his income has been cut off, and that is not the end of the story. The fellow who wakes up to find that his income is reduced or that he is thrown out of work . . . is compelled in his turn to cut down his expenditure, whether he wants to or not. . . . Once the rot has started, it is most difficult to stop.33
Whereas past critics of capitalism eagerly pointed a bony, prosecutorial finger at evil robber barons and sordid profiteers, Keynes calmly claims that well-intentioned savers, including harmless old ladies, inflict more harm than any wicked industrialist.
The harm, or “rot,” compounds itself, though. This is the remarkable Keynesian multiplier (actually borrowed from his colleague Richard Kahn). The point of the multiplier is that any change in spending by one person starts a snowball effect, and the ultimate change in national spending far surpasses the initial change.
Let’s say that Maynard Inc. decides to raise investment by $100 by building a new men’s room. Total spending rises by $100. But Maynard Inc. has to pay plumbers, architects, and interior decorators. What do they do with the money when they come home from work? They spend some and save the rest. The part they spend may go to grocers, video game sellers, and Girl Scouts for cookies. These recipients now have more income, part of which they spend. The chain reaction continues. Although the initial injection was only $100, total income may rise by $300. If so, the multiplier is 3.
Keynes provides a simple formula to calculate the multiplier. Since he exalts consumption, it’s not surprising that the key is the marginal propensity to consume:
Multiplier = 1/[1−MPC] or 1/MPS
The higher the degree of consumption, the higher the multiplier. The chain reaction moves more quickly if recipients spend more money. Again, saving slows the process.
Startling conclusions follow. First, small drops in investment, perhaps due to depressing weather or despondent corporate officers, may severely pressure the economy as a whole. If people save one-third of their additional income, the multiplier is 3. Therefore, if business cuts investment by $50 million, national income plummets by $150 million! Business pessimism is a self-fulfilling prophecy! Dreary dreams become suicidal nightmares. No wonder presidents and vice presidents spend so much time cheerleading. Even Dwight Eisenhower, whose reticence provoked some to call the White House the “tomb of the well-known soldier,” begged the public to buy during the 1958 recession. Buy what? “Anything!” In 1982, Ronald Reagan’s advisers labeled a dip in the economy a “growth recession.” They claimed that the economy slowed while preparing to soar ahead. Critics mocked by calling Reagan’s pet dog a “growth horse.” In the 1991 recession, President George H. W. Bush tried to inspire shoppers by going to a mall and buying socks. Because Bush was mocked for his efforts, his successors have been more cautious about public displays of shopping during downturns, with presidents Obama and Trump preferring to show good cheer and poise by swinging golf clubs.
The startling implications of Keynes’s advice are not all bad, though. In fact, some are nearly magical. If deficient demand incites recessions, the antidote must be to arouse more spending. Further, if we know the MPC, we know the multiplier. Therefore, we can inject spending into the economy, which will multiply throughout and cure the recession by filling the original gap between output and sales.
Who is “we”? The government. Nothing prevents the private sector from flowing into dire straits and foundering at sea, while laborers thrown overboard are tempest-tossed. But the national government can either cut taxes or spend money directly to save the ship. If deficient demand brings a recession gap of $12 billion, and the MPC is two-thirds, the multiplier equals 3. Thus, a $4 billion government spending program should spur the economy into closing the gap.34
In fact, Keynes estimated the United States’ multiplier at about 2.5 and advocated massive public spending programs in letters to President Roosevelt as well as in magazines. In a 1933 letter he advised “a large volume of loan expenditure under government auspices. It is beyond my province to choose particular objects of expenditure. But preference should be given to those which can be made to mature quickly, on a large scale, as, for example . . . railroads. The object is to start the ball rolling.”35
Keynes knew that economists and politicians would attack his activist fiscal policy. British and U.S. Treasury officials cherished a balanced budget, and if the governments followed Keynes, deficits would emerge. So what? responded Keynes. During recessions, balanced budgets are stupid, for there are two sides to a budget: tax revenues and outlays. Since in recessions incomes fall, governments collect less in taxes. If the government is obsessed by a balanced budget, it must either cut spending or raise taxes. But each of these squeezes the economy further by the multiplier process! Over the course of the business cycle, budgets should be balanced, Keynes urged. During prosperity, people pay more money in taxes, and budget surpluses should result. But during recessions, the government should allow deficits. The dunces at the treasuries took a long time to understand this.
Throughout his presidency Ronald Reagan vigorously pressed for a constitutional amendment requiring a balanced budget, despite $200 billion deficits at the time. Reagan toiled to force spending reductions, not raise taxes. Most economists, remembering Keynes’s advice, objected to the proposal, to the extent the law would have required balanced budgets during downturns. By 1997, though, a public backlash against spendthrift politicians combined with a surging economy produced a balanced budget without a constitutional amendment. (Further discussion of this will come with the Public Choice critique of Keynes.)
Keynes also knew he would face philosophical opposition. After all, more government means less freedom, the laissez-faire tradition taught. But Keynes, who ridiculed Marx and mocked his friends who were fooled by Stalin, thought he was trying to save capitalism, not bury it.
I defend [the enlargement of government] . . . both as the only practicable means of avoiding the destruction of existing economic firms in their entirety and as the condition of the successful functioning of individual initiative. . . . For if effective demand is deficient, not only is the public scandal of wasted resources intolerable, but the individual enterpriser who seeks to bring these resources into action is operating with the odds loaded against him.36
Sometimes it’s important to put principle aside and do what’s right. Keynes often responded wryly to philosophical objections:
If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again . . . there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.37
Although government spending under Roosevelt never reached Keynes’s suggested levels or the worst fears of Keynes’s critics, from the 1936 publication of The General Theory to the Nixon years, Keynes’s influence grew. Paul Samuelson recalled that the “General Theory caught most economists under the age of 35 with the unexpected virulence of a disease first attacking and decimating an isolated tribe of South Sea islanders. Economists beyond 50 turned out to be quite immune from the ailment.”38
Harvard University, under the influence of Professor Alvin Hansen’s popular seminar on Keynes, became the principal American outpost for Keynesians, educating such eminent economists as Samuelson, James Tobin, and Robert Solow. During the Kennedy and Johnson administrations, the Council of Economic Advisers became an outpost for Cambridge, Massachusetts, Keynesians, as well as prominent participants from Yale and the University of Minnesota. These economists, along with their European counterparts, developed Keynesian economics, adding rigor where Keynes left intuition and insight.
With Keynesian economics in their grasp, politicians could blaspheme the invisible hand and battle the business cycle. When the economy slowed, they could boost federal spending or cut taxes, leading to temporary deficits until the economy rebounded. If demand rose too quickly, outpacing the supply of goods and therefore pressuring prices upward, they could raise taxes or cut federal spending to rein in demand. A neat symmetry. If it were not apparently true, it would be deemed magic. Confidence in fiscal control grew. Politicians gleefully passed the Employment Act of 1946, which boldly went where no measure had gone before, declaring Congress’s responsibility to “promote maximum employment, production, and purchasing power.”
The Keynesian star shone most brilliantly in 1964, when Kennedy-Johnson advisers perceived a sluggish economy and confidently prescribed a shot of economic adrenaline. Estimating a recessionary gap of about $30 billion and a multiplier of 2.3, they cut personal and business taxes by about $13 billion. No discretionary economic policy ever worked better. All the vital signs responded vigorously. Higher demand propelled output, creating jobs for thousands. It appeared that economics had finally shaken off Carlyle’s insulting tag, the “dismal science.”
In the 1970s, though, when Keynesian policies seemed to falter, Carlyle’s affront haunted, and the multiplier hobbled. In 1973, the Arab oil embargo targeting the United States, the U.K., Canada, Japan, and other countries sparked “stagflation,” raging inflation simultaneous with a stagnant job market. The crisis confounded Keynes’s model, because it was designed to fight just one of those opposing foes. In the next chapter and in chapter 12, we will take a closer look at the intellectual forces that seemed to dethrone Keynes.
Despite the setbacks for Keynes’s paradigm, even today every political leader knows that when the economy and job market begin to sniff the fumes and fire of a deep recession, they can turn to a “break the glass” emergency plan that still has Keynes’s name on it. For example, during the financial meltdown of 2008, President George W. Bush, who was as anti-Keynesian as any president in his lifetime, mailed out $600 paper checks to every American adult and $300 to every child. When the Great Cessation struck in 2020, President Trump and Congress sent $1,200 checks to adults and $500 to children. The Great Cessation does present a different case, however. Unlike a typical recession sparked by excess risk-taking, bloated inventories, and central-bank miscalculations, the coronavirus suddenly forced healthy businesses to shutter. Immediately prior to the viral invasion, the U.S. economy looked solid, with tame inflation, lean inventories, and unemployment rates near record lows. The stimulus checks were not intended, in Keynesian style, to stir up dispirited consumers; they were intended to help people pay their bills and offset the sheer inability to earn money in a shutdown.
Discretionary fiscal policy depends on the wisdom of politicians. Since few sleep soundly while relying on such a scarce resource, the economy has been equipped with automatic tools to dampen the swings in the business cycle. Automatic stabilizers such as progressive taxes and unemployment insurance counteract downturns and inflationary accelerations. If the economy slows down and income begins to fall, people automatically move into lower tax brackets. When workers are laid off, unemployment insurance permits them to maintain spending. When they are rehired, the payments stop. These stabilizers act counter-cyclically, dampening volatility. They thereby stabilize national sleep patterns also.
Maynard Keynes suspected that the volatility of investment would eventually lead to even more government influence over the level of national investment, if not the kind. In murky passages he spoke sometimes of “socialisation of investment”; at other times he praised the structure of the status quo. No wonder he gained a reputation for economic duplicity. In some of his writings, almost every word was ambiguous. His associates told many stories about his rather tidal positions. One joke reported that “when a Royal commission solicits opinions from five economists, they get six answers—two from Mr. Keynes.” If Harry Truman begged for a one-handed economist, he certainly didn’t want Keynes, who was an octopus on policy matters.
But the reputation is somewhat unfair. Keynes probably wrote and spoke more words to more audiences than any other economist. Since situations differ, prescriptions should. Keynes once said that economists should be practically minded, like dentists. How many would rush into the chair of a dentist who always drilled the same tooth regardless of the patient? Whenever dentists slip or slice accidentally, they calmly say the one word that is supposed to heal all oral wounds: “rinse.” There is no “rinse” in macroeconomics (although Schumpeter thought that a recession acted like a good cold shower and ultimately invigorated an economy through new ideas and risks taken by entrepreneurs). When teased about his fickle reputation, Keynes responded, “When my information changes, I alter my conclusions. What do you do, sir?”
Still, fickleness may be a symptom of sloppiness. All economists know that time is a scarce resource. Keynes probably devoted a lower proportion of his time to economic theory than almost anyone else in this book. On the other hand, he probably got the highest return on investment. He often preferred attending the theater to reading another economist’s theoretical work. Given the success of his Cambridge Arts Theatre and the aridity of most academics, we can’t blame him. Apparently, Keynes did not look to economic theory for the same intellectual enrichment and fascination he found in practical applications and in other disciplines. Given these proclivities, he probably sacrificed a more integrated, consistent analytical framework.
As fickle as critics found Keynes, so Keynes found the stock market. Chapter 12 of The General Theory, “The State of Long Term Expectation,” is important for two reasons: first, Keynes explains why the hope of mathematical precision in economics is folly; second, he describes the innate volatility of investment. Keynes stressed that much investment is incited by “animal spirits,” irrational forces impelling entrepreneurs and speculators forward. But these forces are not consistent:
A conventional valuation which is established as the outcome of the mass psychology of a large number of ignorant individuals is liable to change violently as the result of a sudden fluctuation of opinion. . . . The market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning and yet in a sense legitimate where no solid base exists for a reasonable calculation.39
Keynes cleverly speculates that the way to make money in the stock market is not to be the best corporate analyst, but to be the best at guessing what others think is good. With an ingenious metaphor, Keynes likens professional investment to
those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so each competitor has to pick not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view.40
The passage recalls Woody Allen’s line about cheating on his metaphysics examination by looking into the soul of the student sitting next to him. Keynes managed a great deal of money for his own family and for King’s College. Ironically, he learned that he was better at investing in a bottom-up way—assessing individual companies—rather than making broad predictions about which way the overall economy would lurch next. In other words, Keynes was not so Keynesian in his personal portfolio, and it served him well: “I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes.”41
From this, Keynes does not deduce reason to despair about macroeconomics, just cause for uncustomary modesty in economics:
We should not conclude . . . that everything depends on waves of irrational psychology. On the contrary, the state of long-term expectation is often steady. . . . We are merely reminding ourselves that human decisions affecting the future, whether personal or political or economic, cannot depend on strict mathematical expectation, since the basis for making such calculations does not exist; and that it is our innate urge to activity which makes the wheels go round, our rational selves choosing between the alternatives as best we are able, calculating where we can, but often falling back for our motive on whim or sentiment or chance.42
By the time World War II struck, Keynes was tired and often sickly. He had been diagnosed with a lingering infection of the heart valves, and the organ was stressed by the burden of powering his exceedingly large frame and excessively demanding calendar. One night in 1942, though, he found himself sleeping on a rooftop with Hayek. After dropping bombs on London, the Luftwaffe launched the Baedeker Blitz, attacking smaller cities, villages, and cultural landmarks. Since Cambridge was a suspected target, the university asked faculty to defend its buildings against the expected fires. Civil defense forces learned from the London bombings that if they could sweep incendiary devices off rooftops, the explosives would do less damage at the ground level. One night it was Keynes’s turn to man the rooftop of King’s College Chapel, completed by Henry VIII in 1515. Hayek had been visiting his old rival, and so Keynes directed Hayek to climb with him, past the gargoyles to the limestone parapets of the rooftop, where the two men gazed at the black sky, searching for the menacing glow of incoming bombers. The planes never showed up. But all night long, the economists held their brooms and, no doubt, held forth on the future of the free world.
After the war, Keynes soldiered on, counseling the Treasury and crisscrossing the Atlantic by rickety airplane and heaving troopship, trying to persuade U.S. government officials to loosen their lending terms to the U.K. When the war ended, he helped lead frustrating, endless negotiations in the United States, only to be greeted in the House of Lords by starry-eyed aristocrats who accused him of surrendering to the Yanks.
In the midst of the war in 1942, King George VI had named him to the House of Lords and given him a title, Baron of Tilton. Some days later Keynes stood in his Tilton garden before a nonflowering fig tree and (alluding to the New Testament) punned, “Barren fig tree. Baron Keynes.” In that rare moment he was wrong about his lack of progeny. Keynes, who died of heart failure in the arms of Lydia and his mother in April 1946, would have been thrilled to see his ideas triumph—but not too surprised. Against the Marxists and with the religionists, Keynes fervently held that the truth shall make you free. Having spent much of his life advising governments, he witnessed the power of mind. He passionately affirmed this in the famous final passage of The General Theory:
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. . . . But, soon or late, it is ideas, not vested interests which are dangerous for good or evil.43
The Public Choice school now battles Keynes’s contention, warning that special interests effectively capture and hold good ideas and good policy hostage.
Despite his famous “long run” quip, Keynes thought quite hard about the future. In a graceful 1930 essay reminiscent of Mill, “Economic Possibilities for Our Grandchildren,” Keynes shined his crystal ball.44 The news was good, he said, Malthus was wrong. In the next hundred years, man could solve the raison d’être of economics: scarcity. Because each generation stands on the shoulders of its parents, perfecting their achievements and living their dreams, our grandchildren and great-grandchildren might climb high enough to satisfy all their material desires, including luxuries. The streets might soon be paved with gold. After all, despite bumps along the business cycle and wretched wars, the Western economies had swiftly ascended for two hundred years.
More striking, as human existence grows more gentle, human hearts may soften. Keynes claimed that we needed the self-interested homo economicus to evolve economically. Having satiated material desires, humans may heighten their desire for kindness and affection.
We may not live happily ever after, however. With cupboards full and new cars shined, what would we do? Keynes asked. Today, retirees often yearn for work and complain of tedium. What if the whole world retired? How many Paul McCartney and Mick Jagger “final tours” would it take to entertain an entirely pensioned population? Existential angst might pervade a sated world. Often joy comes in striving for goals, not achieving them.
Perhaps this explains Keynes the dilettante, Keynes the art collector/investor/benefactor/curator. Maybe he diversified his portfolio of activities just in case he was too good at economics and brought us too close to heaven. He wanted something to do just in case he made it through the long run.