Question

Explain how Keynes in his General Theory of Employment, Interest and Money, connects the what happens in the monetary economy to the real economy to explain how a capitalist economy can end up in a state of unemployment in equilibrium. How did this lead him to the policy prescriptions he proposed to bring capitalist economies out of the Great Depression?

Answer 1

• Before Keynesian revolution, all economists used to recommend no government interference in economic activities. They used to argue that government participation in economic activities leads to sub-optimal outcomes.
• But great depression of 1929, proved that classical policies cannot deal with recession effectively.
• Great depression was triggered by the fall in aggregate effective demand. Private sector was not ready to take up any investment activities for fear of losing investments. It further deepens the recession. In such situation, Keynes suggested that government must come forward to increase aggregate effective demand.
• Thus, government made expenditure to push up economic activities. Keynes proved that how monetary policy becomes ineffective due to liquidity trap.
• Fiscal policy was widely recommended by the Keynes to deal with recession.
• Thus, keynes and great depression changed the role of state fundamentally. Eventually, capitalism was saved by state.