The General Theory of Employment, Interest, and Money

Indeed it [the economy] seems capable of remaining in a chronic condition of sub-normal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse

I suspect John Maynard Keynes’ “General Theory” was to the 1930s what Thomas Piketty’s “Capital in the Twenty-First Century” was to the 2010s – much discussed, mostly unread. I never made it further than the introduction to Piketty’s tome, but I have finished the 80-odd pages of the General Theory collected in The Essential Keynes.

The General Theory of Employment J.m. Keynes First Edition Rare

The book is why we use the word Keynesian today. It changed the course of economics and politics in the 20th century. The world would be unimaginable without it. When Keynes concluded the book with these now famous words, I wonder if he realised he was talking about himself:

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.

His technical discussions about liquidity preferences, the marginal propensity to consume, sticky wages, or the marginal efficiency of capital are explained in textbooks far better than I ever could. Instead I’m going to focus on some big ideas still relevant to today:

Breadlines aren’t inevitable

His central insight was that an economy could indefinitely operate below full employment – that involuntary unemployment and breadlines could stay around indefinitely. If this strikes you as obvious, you have Keynes to thank. He wrote at a time when most economists thought the economy always settled at full employment – if there were breadlines, it was because people liked bread.

The attitude seems absurd and callous today, but it was common sense then. In the middle of the Great Depression, President Herbert Hoover refused to act against rising unemployment. When asked why so many unemployed men were selling apples on street corners, he replied: “Many people have left their jobs for the more profitable one of selling apples.”

How Apples Became a Weapon Against the Great Depression - HISTORY

Keynes thought the problem was often a lack of investment. Keeping people employed requires a combination of investment and consumption. Factories can employ people because they sell products to people (consumption), and/or investors loan them money to make products to sell to people (investment). When there is insufficient investment, employment will be lower than it could be. Breadlines were not inevitable, nor did they represent an unusually high demand for bread, they were a technical problem, with a technical fix.

Keynes also emphasized what a precious thing it was to have everyone in work. Today, we think of “normal” as a healthy economy with full employment. We reserve “abnormal” for big crises or recessions, when things go wrong. Keynes inverted this, he thought that a healthy economy with full employment was a “rare and shortlived occurrence.” Societies had to work hard to maintain a healthy economy – there was nothing inevitable about it.


Keynes thought that investment was lower and more unstable than it needed be, because our expectations about the future were so fickle. Investment depends, in part, on how people feel. Keynes, whose first work was a philosophical treatise on probability (with blog favorite Bertrand Russell), thought human life was governed by deep uncertainty. We create stability with stories about what the future will be like. Sometimes these stories rest on analysis and calculations, other times stories rest on the simple fact that everyone believes them. Unfortunately, stories about the future are often incorrect. Being wrong makes people pessimistic, and if investors feel pessimistic, they expect lower returns, and when they expect lower returns, they invest less, and when they invest less, there is less employment. All of this may occur without any actual changes to the fundamentals. Think about Gamestop.

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 around, 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

An important corollary to this is the idea that just because people can, does not mean they will. Low interest rates and lots of savings are powerful incentives for people to invest money, but they do not guarantee people will invest. Uncertainty about the future means people often choose to sit and wait:

For whilst the weakening of credit is sufficient to bring about a collapse, its strengthening, though a necessary condition of recovery, is not a sufficient condition

A brief aside: China and Investment

If investment is prone to shortfalls, then economies are vulnerable to the extent that they rely on investment to drive growth, as opposed to consumption. Since any level of employment is supported by some combination of consumption and investment, for example a 50:50 split, as employment (and output) grows, an increasing amount of investment will be required. At $100 of output, $50 of investment. At $1000, $500, at $10^10, $10^5 and so on. If the split between consumption and investment does not change, it is conceivable that a country runs out of worthwhile new investment opportunities before it uses up spare investment funds. To counter this, countries need to increase the percentage of income that people consume, say shifting the balance to 80:20. This is pattern is visible when you look at development:

China struggles with this problem today. For decades, growth has been driven by state-directed investment, but there are only so many railways, ports, and new apartment blocks an economy can productively absorb at once. The government needs to increase how much people consume out of their income. Unfortunately, high inequality means the majority of the population has little disposable income – the rich only spend a small proportion of their total income. A limited social safety net means what little they do have is often saved rather than consumed. Switching to a more consumption-heavy growth strategy is easier said than done. Years of investment have enriched parts of society and industry who have no interest in redistributing their wealth across society.

It’s a serious challenge for China, and if you’re interested in learning more, I recommend following Michael Pettis.

Contingency and change

Keynes shows a deep appreciation for the fact that observations are often contingent or conditioned on other, invisible, factors. If I failed to notice I was sitting in a silent carriage, I would be incorrect to assume only introverted people used trains. Individual and collective behavior is often the product of the rules, customs, culture, and organizations that surround us, not some intrinsic factor.

This allowed Keynes to, for example, look at investment behavior, and explain it in terms of changes in patterns of ownership, the regulation of certain markets, and the availability of different financial instruments – as opposed to some inherent behavioral characteristic of the investor. That is not to say he thought everything was contingent, but he showed an appreciation for it’s importance.

It also allowed him to move beyond describing what is, to imagining what could be:

But we must not conclude that the mean position thus determined by ‘natural’ tendencies, namely, by those tendencies which are likely to persist, failing measures expressly designed to correct hem, is, therefore, established by laws of necessity. The unimpeded rule of the above conditions is a fact of observation concerned the world as it is or has been, and not a necessary principle which cannot be changed.

The state, the private sector, and economy

“Keynesian” means different things, to different people, at different times. In the 1940s and 50s economists in the US suspected of being Keynesian were accused of being communists. In 1971, Richard Nixon said “we are all Keynesian now.” Today, it means supporting government spending in a recession. Keynes was more nuanced.

Keynes saw a role for government beyond just providing unemployment benefits and occasional stimulus packages. He was skeptical that private investment decisions would lead to socially advantageous outcomes. Left completely in private hands, investment would tend to be below the level required for full employment, leading to a persistent state of under-employment. He thought the state should manage the level of investment in the economy to ensure full employment. This need to socialise investment led to his famous passages calling for the “euthanasia of the rentier:”

The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment today is ‘to beat the gun’ … to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow….

There is no clear evidence from experience that the investment policy which is socially advantageous coincides with that which is most profitable.

Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital.

At the same time Keynes was no revolutionary. The euthanasia of the rentier was going to be “nothing sudden, merely a gradual but prolonged continuance of what we have seen recently in Great Britain, and will need no revolution.” He wanted government to maintain full employment, precisely to avoid the mass social upheaval and revolutionary unrest he had seen in Germany or Russia. As long as a sufficient level of investment and consumption was ensured in the aggregate, Keynes thought private actors and markets should determine how it was employed:

When 9,000,000 men are employed out of 10,000,000 willing and able to work, there is no evidence that the labour of these 9,000,000 is misdirected. The complaint against the present system is not that these 9,000,000 men out to be employed on different tasks, but that tasks should be available for the remaining 1,000,000

His hesitation over revolutionary socialism stemmed from his liberalism. Keynes valued creativity and individuality; his friends were poets, philosophers, and artists, not accountants. His economics was a way to build a world where that would be protected and encouraged. Soviet homogeneity threatened this vision as much as mass unemployment.

But, above all, individualism, if it can be purged of its defects and its abuses, is the best safeguard of personal liberty in the sense that, compared with any other system, it greatly widens the field for the exercise of personal choice. It is also the best safeguard of the variety of life… For this variety preserves the traditions which embody the most secure and successful choices of former generations; it colours the present with the diversification of its fancy; and, being the handmaid of experiment as well as of tradition and of fancy, it is the most powerful instrument to better the future.

This is my favorite Keynes (one I’ve discussed before). Economics served a vision of the good life. It was not an exercise in discovering some “natural” state, some special truth about economic behaviour. It was a tool for society to use, and he was wise enough to see that people were not selling apples for pleasure or profit. It was the job of economics to create a prosperous society where creativity and individuality could flourish. It was, and remains, an inspiring vision.

If you’d like to read more about The General Theory, Keynes, and its influence on economics but don’t feel up to the full tome, I recommend these two short pieces (here and here) by Paul Krugman.

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Bond market vigilantes

Government bond holders were the playground bullies of the 80s and 90s. They would threaten governments and central banks with bond sales to get what they wanted – usually fiscal discipline and lower inflation. Bond vigilantes – a self-appointed nickname – was presumably a way to sound more like Batman and less like thugs. Like everyone who picks their own nickname, they had high opinions of themselves:

“Bond Investors Are The Economy’s Bond Vigilantes.” I concluded: “So if the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.”

The guy who coined the name in 1983

These threats worked because selling government bonds causes their price to fall, and the yield – the interest rate – to rise. A government bond is just an IOU from the state, so higher interest rates make it more expensive for governments to borrow. Higher interest rates in government bond markets also usually increase interest rates elsewhere in the economy, slowing down growth. Governments, especially smaller, fiscally precarious ones, had reason to be afraid.

Their reputation was cemented when Bill Clinton’s campaign strategist James Carville said: “I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.”

Quantitative easing mostly killed off the bond vigilantes. Central banks have bought trillions in government bonds since the GFC, making the threat of a bond vigilante sell-off mute. Sell all you want, the central bank will hoover it up.

Or did it? The deluge of fiscal and monetary stimulus, vaccines, and the beginnings of a recovery have some worried about inflation – a concern I’ve discussed previously. Bond holders hate inflation because it erodes the value of their (usually) fixed coupon payment. Because they hate inflation, bond holders tend to be wary of government spending. A world where governments are planning trillions of new spending has the vigilantes reaching their capes and masks. The FT reports:

It’s probably premature. Bond yields have slumped again after reaching record highs last week. The Reserve Bank of Australia brought forward bond purchases in response to yields rising. It’s hard to fight a central bank.

Bond vigilantes bring together history, macroeconomics, markets, and superheroes in a neat bundle. I recommend further reading:

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No end in sight for the debate over inflation

The debate over the Biden’s administrations proposed stimulus I discussed a few weeks ago is still going. If you wanted to keep up to date, here are some useful links:

The debate still hinges around three technical questions:

  • How large is the output gap? This is the gap between what an economy can theoretically produce, and what it is producing today. Think of the gap as representing idle factories or unemployed workers. The larger the gap, the more stimulus can be applied before you hit ‘supply limits,’ and cause inflation.
  • How effective will the stimulus be? Stimulus does not automatically create the demand which fills the output gap. Instead of buying a new TV, people might save the money they receive, or use it to pay down debts. Those who are concerned expect most of the stimulus to be spent, those who are more sanguine, the opposite.
  • How will inflation behave if it arrives? Both camps agree there is likely to be some inflation, but they disagree over how it will evolve. Those in favour of the stimulus as it stands expect inflation to steadily increase, perhaps even to 2% or 3%. They see this as a good thing, given inflation has been below target for almost a decade. There is little risk of it getting out of control because the Fed can always raise rates in the last instance.

    Pessimists are concerned that if inflation starts growing, it could quickly get out of control. Instead of growing to 2% or 3% and stabilising, expectations might change, causing inflation to continue higher. If the Fed has to react by rapidly raising rates, it could have negative consequences for the financial sector and the wider economy.

This says nothing about the politics around the stimulus. Biden does not want to run the risk of delivering an underpowered stimulus as Obama did after the GFC.

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What do jobless men do all day?

From a new study in the AEI by Nicholas Eberstadt and Evan Abramsky: “What do prime-age ‘NILF’ men do all day?” (thanks to Marginal Revolution)

Some excerpts:





A few quick thoughts:

We don’t know why these men are not in the labour force. Does an absence of paid work/income support cause screen time and anomie, or is there a third (and fourth and fifth) factor at work here.

Is this the way things are or the way things must be? Where the paper sees anomie and alienation naturally following from the absence of work, I see it as contingent. We live in a society which extols paid work and demonises the unemployed. Should we be surprised that those who inhabit such a stigmatised rung of society are not a garden bed for the flowering of the human spirit?

A towering infrastructure of education, encouragement, and coercion has been required for people to accept that they must organise their identity and time around the eight hours a day, forty hours a week, they spend in contractual labour. Were we to reach a point where that became economically superfluous, we would need to develop a new infrastructure to encourage and educate people to live as they chose.

Why should we police what people do with their own time? I know many professionals who spend their weekends wedged between a bottle and a baggie who will tell you that the working poor must be kept in place lest they do the same. If you believe in human freedom and human creative potential, you should want to limit unnecessary restrictions on it. When the economy reaches a point where it becomes unnecessary to compel the population into paid work each day, we should cease to do so for the same reason we no longer compel people to serve in the armed forces. If they choose to drink all day, and despite fair and accessible options otherwise, that is truly what they wish to do, I have no issue with it. Freedom-loving conservatives quickly become paternalistic statists at the prospect of more leisure for the masses.

The moralisation of work: We are constantly told about the dignity of labour, usually by those who work for high pay in air conditioned offices. I fail to see what is dignified about being compelled to spend the majority of your day doing something you would rather not, in conditions you would prefer be different, with people you sometimes dislike. I can say it no better than Bertrand Russell: “The morality of work is the morality of slaves, and the modern world has no need of slavery.”

The only reason to compel paid labour is that our collective economic prosperity requires it; the health of the tribe requires that we devote some portion of our time to the modern equivalent of hunting deer or harvesting wheat. Should a day arrive where robots can take our place in the fields, we should consign paid work to the dustbin of history as fast as we possibly can.

Competing visions of the future: Arguments in the vein of, “if we give people X (a good thing), they’ll just do Y (a bad thing), because they’re too uneducated / lazy / ignorant / selfish / unprepared, have been deployed against every social reform from the right-to-vote to the 8-hour work week. Those who use them are pessimistic about human potential, or our ability to realise it. I remain an optimist in both respects. I aspire to a world where people’s decisions about how they spend their time, and exercise their creative energy were not overly constrained by the need to feed, cloth, and house themselves. A world where that is possible will take some building, but as Oscar Wilde said, a map of the world which does not include Utopia is not worth glancing at.

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Central banks, climate change, and firing an AK-47 underwater (wonkish)

Barry Eichengreen has written a piece for Project Syndicate on how central banks can help tackle climate change and inequality.

The standard argument is that central banks do not possess the tools to combat these issues, and even if they did, doing so would call their independence into question, undermining their ability to fight inflation. Barry disagrees. He argues central banks have a swathe of regulatory tools that could be deployed, and this fact creates a moral responsibility to act given the existential nature of these issues.

As I read it, Eichengreen’s climate change proposal does not go beyond what most central banks have already expressed willingness to do: create a strict and consistent framework for disclosing climate risk, and then use that information when assessing risk in the financial sector. For example, banks who hold lots of assets with climate risk might have higher capital requirements, the same as if they hold lots of junk bonds or dodgy mortgages. There is no mention of using the balance sheet, or differentiating between the collateral a central bank accepts (as I discussed the other day).

His deeper point, that there is no shortage of tools for central banks to tackle important policy issues, is an important one.

Central banks often claim they do no possess the appropriate tools for tackling inequality or climate change. Look, they’ll say, interest rate changes take years to filter through the economy, and besides, the effects are too broad; it’s like trying to hit a target 500 meters away, with a shotgun, underwater.

An AK-47 – close enough

This is a bit disingenuous. The experience of the GFC and COVID-19 has shown that tools can be invented to fit our needs; swap lines, the paycheck protection program, the Main Street lending program, the multiple variations of quantitative easing. Central bankers may well be the only innovators in the world who do not post about their new creations on LinkedIn.

Even the boring old interest rate can be incredibly flexible, as Eric Lonergan’s proposal for dual (and discerning) interest rates shows.

The real problem is not so much a lack of tools, but the risk of becoming politicized (I’m going to write a whole post on politicization, because it is more nuanced than it first appears). That’s a legitimate concern, and one we should seriously discuss.

Economics is about optimization under conditions of scarcity, so any such discussion should be guided by the trade-offs associated with independence. What policy tools would be available were maintaining independence no longer a concern? What would the costs and benefits of any alternative arrangement be?

Please do read the whole thing.

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Is Green Quantitative Easing on the horizon?

Many forces are pushing central banks to change how they operate: low inflation; hesitant fiscal policy; climate change; anemic growth; financial instability. Low inflation claimed the first scalp, when it led the Federal Reserve to switch to an average inflation targeting regime. Climate change may be the next.

The FT reports that:

This is a big deal, even if it might sound like gibberish at first.

Right now, to stimulate the economy, central banks print money (it’s slightly more complicated) to buy government and corporate bonds from the private sector. The idea is that this lowers bond yields, which lowers interest rates, and moves money into other parts of the economy. In theory, interest rates for governments and corporations fall, and lending should increase to businesses and consumers, stimulating the economy. This is Quantitative Easing.

Today, central banks do this without taking the environment into account. A corporate bond from Shell is the same as a corporate bond Vestas (they make wind turbines). For several years now, people have been saying that central banks should use Quantitative Easing in an environmentally conscious way. This mean that, when it buys a corporate bond from Shell, it should acknowledge that Shell is a polluter. When it buys a corporate bond from Vestas, it should acknowledge that Vestas is not a polluter. It could do so by charging a premium for example.

This has been fiercely resisted to date. The fact that the head of the French central bank, who has a seat on the ECB’s Governing Council, is in favour, speaks to how much the consensus is changing.

Please do read the whole thing

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