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Keynesian theory, as variously interpreted by the Keynesians, dominated mainstream economic thought from the publication of The General Theory of Employment, Interest and Money (1936) [1] until the early 1970's. Keynesian theory created the foundations of a new approach to economics and profoundly altered government's involvement in the economy.


John Maynard Keynes (1883-1946)

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 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. Keynes, 1936.

John Maynard Keynes [2] reputedly made one of the most important contributions for the science of Economics. His classic book, The General Theory of Employment, Interest and Money (1936) [1], Keynes's famous treatise, revolutionized both economics and the political science, bringing what is generally regarded as the most influential social science treatise of the 20th century. This single book permanently changed the way the world looked at the economy and the role of government in society.

After a brief period in the British civil service, Keynes returned to his alma mater, Cambridge, in 1909 where he published Indian Currency and Finance [3], considered to be the best book in English about the gold standard and his A Treatise on Probability [4] (1921), which dismantled the classical theory of probability, launching what has since become known as the "logical-relationist" theory of probability.

In 1930 Keynes published his first major work on economics, the heavy two-volume A Treatise on Money [5] which set out his Wicksellian Theory [6] theory of the credit cycle. In it, the rudiments of a liquidity preference theory of interest are laid out. Friedrich von Hayek [7], the laissez-faire advocate, reviewed the Treatise [5] so harshly that Keynes decided to ask Sraffa [8] to review Hayek's own competing work and condemn it, no less harshly. The Keynes-Hayek conflict initiated a battle in the Cambridge-L.S.E. [9] whose effects continue to the present day.

In the General Theory [1] Keynes developed a theory that could explain the determination of aggregate output - and as a consequence, employment. He explained how the determining factor to be aggregate demand. Among the revolutionary concepts initiated by Keynes was the concept of a demand-determined equilibrium wherein unemployment is possible, the ineffectiveness of price flexibility to cure unemployment, a unique theory of money based on "liquidity preference", the introduction of radical uncertainty and expectations, the marginal efficiency of investment schedule breaking Say's Law (and thus reversing the savings-investment causation), the possibility of using government fiscal and monetary policy to help eliminate recessions and control economic booms. Indeed, with this book, he almost single-handedly constructed the fundamental relationships and ideas behind what became known as "macroeconomics".

The General Theory [1] set up the The Keynesian Revolution [10] which split the economics world in two generations: the young lining up behind Keynes; the old rallying to condemn it. John Maynard Keynes responded to his critics -- Jacob Viner [11], Dennis Robertson [12] and Bertil Ohlin [13] -- in a series of 1937 articles, which expanded upon his theory. A densely-written and difficult book, it was followed up immediately by elucidatory publications by the members of the Keynes's Circus [14], such as Joan Robinson [15], and young economists such as Roy Harrod [16] and Abba Lerner [17].

Of particular importance was the 1937 article by John Hicks [18] which introduced the Hicks-Hansen IS-LM Model [19] of Keynes's theory that launched the "Neoclassical-Keynesian Synthesis" [20], which became the World's mainstream form of macroeconomics in the post-war era until the early 1970s.

Joan Robinson and the Cambridge Keynesians

"Cambridge Keynesians" refer to the unique group of British economists inspired by John Maynard Keynes's General Theory in a more "fundamentalist" way than the American Neo-Keynesians [21].

Their origin stems from the Keynes's Circus [14] at Cambridge -- Joan Robinson, Richard Kahn, Piero Sraffa, Austin Robinson and James Meade. Although it followed upon Joan Robinson's original queries about capital aggregation (1954, 1956), Piero Sraffa [8] "capital critique" set the radical "counter-revolutionary" tone of the Cambridge Capital Controversy that ensued with the American Neo-Keynesians [21].

The Robinson-Kaldor growth theory and the Cambridge Capital Controversy galvanized a new generation of "Cambridge Keynesians" -- such as Luigi Pasinetti, Piero Garegnani, John Eatwell, Geoff Harcourt -- to initiate the "Neo-Ricardian" [22] research program, an attempt at an explicit marriage of Keynesian theory of effective demand and the Ricardian theory of value. In the course of their confrontation with Neo-Keynesian Synthesis, the Cambridge Keynesians found sympathizers in the American Post Keynesian school [23].

Franco Modigliani, James Tobin and the Neo-Keynesian Synthesis

The "Neoclassical-Keynesian Synthesis" [20] refers to the "Keynesian Revolution" [10], as interpreted by group of American economists in the early post-war period, which was centered in the Hicks-Hansen IS-LM Model [19] first introduced by John Hicks (1937) [18] and then expanded upon by Franco Modigliani (1944)[24].

However the IS-LM model was unable to obtain the Keynesian result of an "unemployment equilibrium". The model tended to yield the Neoclassical result of "full employment". To explain the results of this system of equations, the Neo-Keynesians [25] appealed to rigid money wages, interest-inelastic investment demand, income-inelastic money demand or some other imperfection to this system. Thus it became a "synthesis" of Neoclassical and Keynesian theory.

Later on the money demand function was derived from utility-maximization by William J. Baumol (1952) [26] and James Tobin (1956, 1958) [27] and the Neo-Keynesians added the Phillips Curve [28] (Phillips, [29] 1958; Lipsey, [30] 1960) to account for inflation. The international sector was incorporated into an extended IS-LM system known as the Mundell-Fleming model [31]

The "Neoclassical-Keynesian Synthesis" was wildly successful and dominated macroeconomics in the post-war period. For a long time, the Neo-Keynesian system was synonymous with the "Keynesian Revolution".

The Neo-Keynesian system came under attack in the late 1960s and early 1970s by Axel Leijonhufvud (1968) [32]. However, the Neo-Keynesian system only came into serious trouble in the early 1970s, when a sustained bout of inflation and unemployment in the OECD countries, which became known as "stagflation", could not be explained by their models. Milton Friedman [33], the leader of the Monetarist School [34], proposed a "natural rate of unemployment hypothesis" [35] that did seem consistent with the OECD experience. This natural rate hypothesis formed the basis of a "New Classical" [36] macroeconomic theory, which has risen since the 1970s to replace Neo-Keynesianism [25] as the new macroeconomic orthodoxy.

Abba Lerner and the American Post-Keynesians

The principal concern of Post Keynesians is to have a more complex and realistic aggregate supply and demand framework that includes mark-up pricing, the trend to monopoly, the workings of endogenous money and credit, circular and cumulative causation, and a pragmatic guide to policy. The workings of uncertainty lead to an unstable capitalistic system that requires the making of agreements and accords to promote stability. At the global level, it requires a fairer distribution of power such that the onus is on nations with trade surpluses to adjust their policies. More than anything, Post Keynesians eschew the quantity theory of money, since money and credit are seen to affect output and employment in both the short and long term. Indeed, like the institutionalists and Marxists, they see the capitalist economy as a monetary system of production, where money and creative financing are essential aspects of its functioning. [37]

Abba P. Lerner [17] was born in Russia, raised on the London East End and worked as a machinist, a capmaker, a Hebrew teacher, a Rabbinical student before enrolling in 1929 at the London School of Economics [38] to which he was attracted by L.S.E.'s Fabian [39] associations.

Lerner moved to the United States in 1937 where he taught at over a half-dozen universities, including the New School for Social Research [40]. Lerner became of of the most important American Post Keynesians [41], along with Evsey Domar, Sidney Weintraub, Paul Davidson, Alfred S. Eichner, Hyman P. Minsky, Alain Barrère, Josef Steindl, Edward J. Nell and Athanasios Asimakopulos [42], the William Dow Professor of Political Economy in the Department of Economics at McGill University (Montreal), among others.

In 1934, Lerner wrote paper laying out the full Pareto-optimality conditions in a general equilibrium production economy, introducing the Paretian rule for efficiency, i.e. "that price equal marginal cost", P=MC .

His magnum opus,The Economics of Control: Principles of Welfare Economics (1944) [43] synthesises his work on trade, welfare, socialism and Keynesian theory .

Lerner discovered the factor price equalization theorem [44] (1947), but never published it. It was rediscovered in 1948 by Paul Samuelson and published in 1952.

Lerner was the first to recognize the importance of accounting for inflation in Neo-Keynesian theory and laid out his analysis in a remarkable series of articles and books (1944, 1947, 1949, 1951, 1972). In particular, he introduced the concept of "seller's inflation", a form of cost-push inflation which was to become central to Sidney Weintraub and Post Keynesian economics. In his analysis of inflation, Lerner was quite ahead of his time: he recognized the possibility of "stagflation", the unemployment-inflation trade-off of the "Phillips Curve" [28], what he called "high full employment" (a predecessor of the Friedman's NARU - natural rate of unemployment [45] [46], the differential effects of expected and unexpected inflation and the theory of implicit contracts long before any of these concepts were discussed elsewhere.

Robert Clower, Axel Leijonhufvud and Disequilibrium Keynesianism

On an scholarly study On Keynesian economics and the economics of Keynes : a study in monetary theory [47] (1968) Leijonhufvud [32] (1968) differentiated between "Keynesian Economics" (Hicks-Samuelson type of synthesis) and "Economics of Keynes" (the work of J.M. Keynes) and essentially demonstrated that the two had little in common. He joined Clower [48] in calling for a dynamic, "microfounded" formulation of Keynesian theory which explained underemployment equilibrium rather than merely referring to it as an imperfection. In particular, Leijonhufvud relies on differing speeds of quantity and price adjustments to create the coordination failures which yield protracted unemployment.

His later work in the 1970s and 1980s still mirrored this quest. In the 1990s, Clower and Leijonhufvud identified the fast-growing evolutionary theory and computational economics as moving in the right direction and founded a fledgling school, "Post Walrasian" [49], intent on harnessing macroeconomics to it.

Joseph E. Stiglitz and the New Keynesians

Joseph E. Stiglitz [50] is one of the most important leaders of the New Keynesians [51]. In 2001 he shared the The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2001 [52] a.k.a., imprecisely, Nobel in Economics with George A. Akerlof and A. Michael Spence "for their analyses of markets with asymmetric information". His career began at Yale, where he became a tenured professor at the age of 27. Stiglitz has also been a faculty member at Princeton, Oxford and Stanford universities. At the age of 29, he became a Fellow of the Econometric Society and is a member of the National Academy of Science. Stiglitz is also the recipient of the prestigious John Bates Clark Medal, awarded every two years to the American economist under the age of 40 who has made the most significant contributions to the subject.

Stiglitz has also become influential in the making and evaluation of economic policy in the last decade. He served on President Clinton's Council of Economic Advisers – first as a member and later as chairman with cabinet rank. He was later named chief economist of the World Bank. Since January 2000, Stiglitz has been a visiting professor at Columbia's Graduate School of Business and Department of Economics in the Graduate School of Arts and Sciences.

Noting that many of the major political debates over the past two decades have centered around one key issue: "the efficiency of the market economy", and the appropriate relationship between the market and the government, and based on his lifelong experiences, Stilglitz became to question [53] the argument of Adam Smith (1776) that free markets led to efficient outcomes, "as if by an invisible hand", which has played a central role in these debates: it suggested that we could, by and large, rely on markets without government intervention. There was, at best, a limited role for government.

However his childhood told him otherwise. When he began the study of economics over forty years ago, Stiglitz was struck by the incongruity between the models that he was taught and the world that he had seen growing up, in Gary Indiana, a city whose rise and fall paralleled the rise and fall of the industrial economy. Founded in 1906 by U.S. Steel, and named after its Chairman of the Board, by the end of the century it had declined to but a shadow of its former self. But even in its heyday, it was marred by poverty, periodic unemployment, and massive racial discrimination. Yet the theories that Stiglitz was taught paid little attention to poverty, said that all markets "cleared" ­ including the labor market, so unemployment must be nothing more than a "phantasm", and that the profit motive ensured that there could not be economic discrimination. The central theorems argued that the economy was Pareto efficient and that, in some sense,­ he had been living in the best of all possible worlds. It seemed to Stiglitz that he should be striving to create a different world. As a graduate student, he set out to try to create models with assumptions ­ and conclusions ­ closer to those that accorded with the real world he saw, with all of its imperfections.

Stiglitz's contributions to economics

Stiglitz helped create a new branch of economics, "The Economics of Information" exploring the consequences of information asymmetries and pioneering such concepts as adverse selection and moral hazard, which have now become standard tools not only of theorists, but of policy analysts. He has made major contributions to macro-economics and monetary theory, to development economics and trade theory, to public and corporate finance, to the theories of industrial organization and rural organization, and to the theories of welfare economics and of income and wealth distribution. In the 1980s, he helped revive interest in the economics of R&D. [54]

His work has helped explain the circumstances in which markets do not work well, and how selective government intervention can improve their performance.[55]

For Stiglitz there is no such a thing as Adam Smith's "invisible hand": "Adam Smith's invisible hand - the idea that free markets lead to efficiency as if guided by unseen forces - is invisible, at least in part, because it is not there". [56]

For more information, see: Joseph E. Stiglitz.

The Mandarins

From the very beginning of time, economists have served government and influenced policy-making. Many of the earliest economists, such as the Mercantilists, were precisely government civil servants writing on the affairs of their nation.

The golden age for the "Mandarin" economist was doubtlessly the post-war period. Perhaps the most critical event in the government-economist relationship was the publication of John Maynard Keynes's General Theory in 1936. The Keynesian Revolution found a theoretical role for interventionist, discretionary government policy in the economy.


  1. 1.0 1.1 1.2 1.3 KEYNES, John Maynard. The General Theory of Employment, Interest and Money (1936)
  2. John Maynard Keynes
  3. KEYNES, John Maynard. Indian Currency and Finance. London: MacMillan & Co., Ltd., 1913
  4. KEYNES, John Maynard. A Treatise on Probability. London: Macmillan & Co. Ltd., 1921.
  5. 5.0 5.1 KEYNES, John Maynard. A Treatise on Money. New York: Harcourt, Brace and Co.; 1st American edition; 1930
  6. Wicksellian Theory of the Credit Cycle
  7. Friedrich von Hayek
  8. 8.0 8.1 Piero Sraffa
  9. Cambridge-L.S.E.
  10. 10.0 10.1 The Keynesian Revolution
  11. Jacob Viner
  12. Dennis Robertson
  13. Bertil Ohlin
  14. 14.0 14.1 Keynes's Circus
  15. Joan Robinson
  16. Roy Harrod
  17. 17.0 17.1 Abba Lerner
  18. 18.0 18.1 John Hicks
  19. 19.0 19.1 The Hicks-Hansen IS-LM Model
  20. 20.0 20.1 "The Neoclassical-Keynesian Synthesis"
  21. 21.0 21.1 American Neo-Keynesians
  22. "Neo-Ricardian"
  23. American Post Keynesian school
  24. Franco Modigliani (1944)
  25. 25.0 25.1 The Neoclassical-Keynesian Synthesis ("Neo-Keynesians")
  26. William J. Baumol (1952)
  27. James Tobin (1956, 1958)
  28. 28.0 28.1 Phillips Curve
  29. Alban William Phillips, 1914-1975
  30. Richard G. Lipsey, 1928-
  31. Robert A. Mundell, 1962
  32. 32.0 32.1 Axel Leijonhufvud
  33. Milton Friedman (1968)
  34. Monetarist School
  35. The Inflation Acceleration Controversy
  36. New Classical Macroeconomics
  37. O'HARA, Phillip Anthony. The Revival of Political Economy and its Main Protagonists: 1960s to the Present. History of Economics Review pp. 140-151
  38. London School of Economics and Political Science
  39. Fabian Socialists
  40. New School for Social Research
  41. American Post-Keynesians
  42. Athanasios Asimakopulos
  43. LERNER, Abba. The Economics of Control: Principles of Welfare Economics. New York: MacMillan, 1960. First published in 1944
  44. Factor Price Equalization Theorem
  45. NARU - natural rate of unemployment
  46. BRATSIOTIS, George Bratsiotis (University of Manchester), MARTIN, Christopher (Brunel University) and PANAGIOTIDIS, Theo. (Loughborough University) Monetary Policy and the Natural Rate of Unemployment, September 2003.
  47. LEIJOHNUFVUD, Axel. On Keynesian economics and the economics of Keynes : a study in monetary theory. New York: Oxford University Press, 1968.
  48. Clower
  49. "Post Walrasian"
  50. Joseph Stiglitz
  51. "New Keynesians"
  52. The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2001
  53. STIGLITZ, Joseph E. Information And The Change In The Paradigm Of Economics.(Prize Lecture, December 8, 2001). New York: Columbia Business School, Columbia University, 2001.
  54. GALEGATI, Mauro et al.Worrying trends in econophysics
  55. STIGLITS, Joseph E. More Instruments and Broader Goals: Moving Towards The Post Washington Consensus. World Institute for Development Economic Research - WIDER; The United Nations University: 1998 WIDER Annual Lecture.
  56. STIGLITZ, Joseph E. There is no invisible hand. London: The Guardian Comment, December 20, 2002.
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