the Keynes meme

Interest in Keynes' ideas has understandably increased since the last year's great banking bailout and recession. At least, the opinion pieces in the Guardian seem to mainly involve Keynesianism and the "liberal left". Because Keynes' system is fairly complicated, I thought it would be worth restating what it entails, as far as I understand it. This could then be a sort of resource for amateur criticism of the theoretical basis of the Keynesian proposals put forward by playwrights, journalists and celebrity cooks, in the pages of the Guardian.



"N" (investments) represents the value of capital investments to be made from the reserve fund of non-circulating money

"S" (savings) represents the value of money diverted from consumption into the reserve fund of non-circulating money

"MEC" marginal efficiency of capital, i.e. rate of profit on additional capital.

Money wages are fixed in the short run. It is hypothesised that workers will be able to effectively resist cuts in money wages. Because there is involuntary unemployment, it is further hypothesised that an increase in the workforce will not cause money wages to rise. In the terminology of economics, the labour supply is perfectly elastic, within the relevant range, at the prevailing money wage.

"MEC" represents the marginal efficiency of capital. It describes the expected return on capital added to existing capital. The Keynesian "problem" occurs when the graph of MEC is downward sloping. That is, each £100 added to the stock of capital is expected to return a lower percentage of its value each year as profit. Keynes explains this phenomenon as resulting from technical diseconomies of scale. Each additional worker set to work produces output of less value than the last.

Competition between capitalists is assumed to coerce them into setting production where their costs, including normal profits, coincide with their income. Put another way, capitalists increase or decrease production until the industry supply curve, representing their costs, including normal profits, coincides with the industry demand curve, representing their income.

The short run supply curve, representing industry costs, can be taken to be fairly similar to the supply curve for labour, because industry as a whole need only put to work extra labour to increase production. The industry supply curve will have a tendency to rise, however, as production increases, because labour is considered to work with decreasing efficiency. Industry will respond to an increase in demand by expanding production, with a less marked increase in prices. Similarly, industry will respond to a decrease in demand by reducing output, with a less marked decrease in prices.

The economy will only be stable if the sum of money output to the consumers, in the form of wages and profits, exactly equals the money input into industry, in the form of consumption spending and investment. This is the basis of the problem of oversaving. If money is saved from the incomes generated by industry , with no commensurate injection of money from elsewhere, then demand in the goods market will have effectively fallen. Capitalists cannot simply devalue their products, as they cannot devalue their costs, and will be forced into the expedient of reducing production.

"Saving", for Keynes, means the same thing as "hoarding", for Marx. That is, it is either the saving of banknotes, in a shoebox or whatever, or the banks' reserve on bank saving: the percentage of deposits the banks can't relend. Keynes' saving schedule represents net savings: while some people may be saving others may be dissaving. Money is considered to be saved for the usefulness of possessing a liquid asset, entitling the holder to unspecified future production. Keynes assumes that saving increases as national income increases, but that the percentage of income saved also increases as national income increases. At low levels of national income, Keynes expects net dissaving. The money saved might be thought of as accumulating, in a sort of fund of virtual wealth that isn't used as entitlements to current production. Obviously, the money remains in individual private ownership rather than collective ownership. The money saved neither circulates nor yields interest.

"Investment" represents the sum of money spent on additions to the capital stock from the fund of non-circulating money. The amount of money diverted into capital expenditure depends on the rate of interest. If the rate of interest is relatively high a relatively large amount of money will be spent on additional capital. If the interest rate is relatively low, a relatively small amount will be spent.

"Savings" represents money withdrawn from expenditure. "Investment" represents money added to expenditure. If savings exceeds investments, demand will be insufficient and capitalists will be obliged to reduce output. As production is reduced the interest rate increases. Investment, consequently increases, while savings falls. When parity is achieved between savings and investments the economy becomes stable at a lower level of output. Similarly, if investments exceeds savings, the demand is excessive and production expands. The expansion of production reduces the interest rate, until savings once again equals investments.

Hence, Keynes theorises an economic system in which production stalls below full employment, but which is self stabilising with regard to various sorts of shock. The stable level of output and the stable interest rate can be derived, theoretically, from the propensities of saving and investment and the marginal efficiency of capital.