A.K. Dasgupta published Epochs of Economic Theory in 1985. It quickly became a classic.

Its major theme was that the development of dominant theories in economics reflected the historical events of the epochs with which they were associated. Dasgupta identified three epochs: classical including Marx, marginalist (he objected to the use of neoclassical to describe the second epoch) and Keynesian.

It may be argued that Keynes had to rationally reconstruct the system which he (inappropriately) named classical until Pigou’s 1933 book on the theory of unemploy­ment provided him with a detailed and comprehensive example of what he had in mind. (Ambrosi (2003) makes the definitive case for this reading.) Finally, it is argued that because of the particular ways in which Keynes’s thought developed, his system, though still relevant and applicable (the “tract for our times” most convincingly arguing this is Taylor (2010)) nevertheless may be set out even more appropriately and relevantly within the approach of Michal Kalecki.

Kalecki’s own development drew on the classical political economists and Marx’s schemes of reproduction.

So the emphasis in this entry is on, first, Keynes’s contributions and approach and, secondly, on the most appropriate and promising ways forward. The alternative approaches under the rubric of Keynesianism which ruled the roost from Hicks 1937 on are only mentioned in passing.

Keynes came to economics with a background in mathematics and philosophy. He always regarded economics as a moral science. The development of his own philo­sophical ideas constituted an integral and essential part of the way he thought economics should be done and of his own revolutionary contributions to economic theory. Three aspects stand out. First, he argued that in a subject like economics, a whole spectrum of languages applies, running all the way from intuition and poetry through lawyer-like arguments (weight) to formal logic and mathematics. All have roles to play, depending upon what issues, or what aspects of issues, are being analysed.

Secondly, there is his emphasis that the whole may be more than the sum of the parts, a vital ingredient of his leading insight in the analysis in The General Theory and other of

his writings of the processes at work in the economy as a whole. Much modern macro­economics is done in terms of one representative agent models which by their nature preclude Keynes’s insight and especially the implications of the fallacy of composition.

Thirdly, there is his stress, also to be found in Marshall, that sensible, and sometimes not so sensible, people have to make important decisions in environments of inescapable fundamental uncertainty and so must develop behaviour and act in ways which are not implied by the assumption of homo economicus at work in all situations.

So what was the system that Keynes was brought up on? Marshall only produced one fully finished volume of the, at least three, volumes he thought should make up a comprehensive principles of economics: volume 1, theories of the formation of relative equilibrium prices and quantities in market, short and long periods in mainly competi­tive situations; volume 2, theories of the determination of the general price level and the roles of monetary and financial variables and institutions; and volume 3, economic history based around the theme of economic progress. (Keynes himself said he would spend his eighth decade on economic history.) Marshall did leave in various places his views on money, finance and related matters, international trade and capital flows, as well as his unsatisfactory volume, Money, Credit and Commerce (1923) published in his old age. From these sources, Keynes constituted what he was to call the classical system.

In the simplest outline, there was, first, a strict dichotomy between the real and the monetary so that the formation of relative prices and quantities in firms, industries and the economy as a whole could be analysed without there being any analytical role for money (other than as a ticket) and finance. Especially was this so for the analysis of long- period competitive prices and quantities, what Richard Kahn was later to call “the real business” of Marshall’s Principles, Kahn (1929 [1989], xxviii). Money was essentially a veil, that is, had no impact on real economic activity. A corollary of this view was that in a competitive environment there was a tendency for prices and quantities to become such that all markets cleared, including those for the services of all classes of labour and capital goods. This implied in turn at least the long-period existence of Say’s law.

Accumulation was seen as the transformation of delayed consumption today into more consumption tomorrow through saving, a psychological choice at the margin, by what we now call agents but were then regarded as people, and investment (accumula­tion) by business people who transformed flows of consumption foregone today through investment in capital goods into higher flows of consumption in the future. The flows of each were equalized when their respective rates of swapping at the margin, one sub­jective, the other technical, matched each other and the nominal rate of interest. Irving Fisher became the principal expositor of this view which is still the dominant account of the accumulation process of the mainstream today. It lies behind the commonly held view that saving determines investment, especially at the level of the world economy, rather than the Keynesian view that investment leads and saving follows. The classic ref­erence is Feldstein and Horioka (1980), but see also for a critique which contains James Meade’s counterattack, Dalziel and Harcourt (1997) and Harcourt (2001).

The establishment of the Say’s law position of the economy as a whole was the vital link to the analysis of the general price level by the quantity theory of money. If we state it in its Fisherian form, MV ? PT, where M is the quantity of money, V is the velocity of circulation, P is the general price level and T is the total number of transactions in the period concerned, we see immediately how its principal long-period proposition is obtained. With M determined by the monetary authorities, V by historical, social and institutional factors, and T corresponding to the Say’s law level of transactions, the value of P is the only unknown to be endogenously determined. The identity becomes an equa­tion and P is proportional to M via P = ^mT^v.

Short-term fluctuations around such levels were part of the various theories of the trade and credit cycle and role of monetary policy and the nominal rate of interest in them. Basically, though, the natural rate of interest ruled the roost and the nominal rate had to be consistent with it in order to avoid cumulative processes of inflation and defla­tion. (Wicksell was the pioneer here.)

This was Keynes’s basic structure in both the Tract (1923) and A Treatise on Money (1930). He made modifications and extensions - in the Tract putting emphasis on the role of monetary policy in the short run in order to attack inflation and deflation, leaving the long run to the dead; in A Treatise on Money, he developed within a quantity theory framework theories of sectorial as well as the overall price level - his “fundamental equa­tions”. He also analysed the banana plantation parable which cried out for the concept of the multiplier to rid the analysis of ad hocery and provide a reason for why the cumu­lative downturns in prices, quantities and employment would come to an end endog­enously (1930 [CW 1973 V]: 158-60). However, Keynes was still betwixt and between, providing, as Joan Robinson later pointed out, “a new theory of the long-period analysis of output” without realizing it (Robinson 1933 [1951], I: 56, original emphasis).

When Keynes published The General Theory in February 1936, and his major responses to his critics in 1937 (see CW 1973 XIV: 109-23), together with the essential addition to his new system of the finance motive (see CW 1973 XIV: 215-23), the key components of his revolution were brought together.

First, he rejected the dichotomy between the real and the monetary, insisting that monetary matters be integrated in the analysis right from the start. In particular, he argued that the nominal rate of interest ruled the roost in both the short and the long period, and that his version of the natural rate - the marginal efficiency of capital or, as it should have been, the marginal efficiency of investment - had to measure up to it rather than the other way around as in the old system. The rate of interest in turn was the outcome of the interaction between the demand for and the supply of money.

Secondly, investment led and saving had to follow, even at full employment. The components of aggregate demand resulting from the decisions of business people con­cerning production, accumulation and employment in the light of their expected sales for their products drove the system along. In the absence of government intervention, and given the state of long-term expectations, the ultimate constraint on investment became the cost and availability of finance. Meade and Keynes have left us succinct statements that bring all this altogether. “Keynes’s intellectual revolution was to shift economists from thinking normally in terms of a model of reality in which a dog called savings wagged his tail labeled investment to thinking in terms of a model in which a dog called investment wagged his tail labeled savings” (Meade 1975: 82, original emphases). “The investment market can become congested through shortage of cash. It can never become congested through shortage of saving... the most fundamental of my conclusions” (CW 1973 XIV: 222).

Thirdly, the emphasis on the short period as worthy of study in its own right began with the Tract, was given credence by Richard Kahn for the firm and the industry in his 1929 dissertation for King’s, “The economics of the short period”, and came into its own for the economy as a whole in The General Theory itself. (This is not an uncontroversial view, of course, for it is not accepted by Eatwell, Garegnani and Milgate, for example, nor, I suspect, by the joint editor of this Handbook, Heinz Kurz.) Disposable income becomes a dominant determinant of both consumption expenditure and saving. The multiplier, first worked out in Cambridge by Kahn and Meade using the apparatus of A Treatise on Money, is the means by which a change in desired investment is equalized with desired saving, and aggregate demand and aggregate supply are equalized at the point of effective demand (Kahn 1931). The periodic flow of saving is regarded as a residual though the forms in which present saving and past savings are held result from conscious economic decision making.

The major determinants of investment and consumption spending are such that there is no presumption that even on average they will be at levels which ensure the full employment of labour and normal capacity working of the existing stock of capital goods. That is, sustained levels of involuntary unemployment become probable possibili­ties as does over full employment, especially in war time.

Finally, because Say’s law was refuted by Keynes’s arguments, the quantity theory no longer provided a theory of the general price level even in the long period. Keynes himself replaced it in The General Theory by adapting Marshall’s theory of short-period competitive pricing at the firm and industry level to the economy as a whole. The general price level now reflects the short-period aggregate marginal cost of producing overall national output. While Keynes put in provisos about the modifications that would be needed if imperfect competition prevailed in goods and factor markets, in order to get his main point across, he did not stress this. For his particular purposes, market structures, and their impact on price formation, were of secondary importance in that they did not affect his main qualitative conclusions.

Keynes was happy in 1939 to accept Dunlop’s, Tarshis’s and Kalecki’s overthrow of the expected regularities that would be found if his theory of the general price level was dominant. He did not think it changed the essence of his argument and it made it easier politically to advocate expansion by government expenditure and tax cuts in periods of recession, because the impetus to inflation associated with higher marginal costs and therefore prices would not necessarily occur (see Keynes 1939 [CW 1973 VII]: 394-412). However, when, at the beginning of World War II, he explicitly extended his analysis to analyse full and overfull employment in “How to pay for the war” (1940 [CW 1972 IX]: 367-439), his concept of an inflationary gap drew on his theory of overall pricing in The General Theory. Whether market structures are or are not crucial is still being debated (see, for example, Marris 1997; Shapiro 1997). It is significant that Kalecki in his review article of The General Theory (Kalecki 1936; Targetti and Kinda-Hass 1982) did not believe that they were, and illustrated why.

The post-war arguments that Keynes’s system had a fixed price system are certainly not supported by Keynes’s own contributions, nor is the argument that Keynes-type results depend upon assuming a given money wage. Moreover, Keynes did not accept that stable, dependable long-run relationships were a feature of economies which could be relied on when making policy decisions so that the argument that the Phillips curve could be regarded as an integral part of his system, that it provided a missing link, is foreign to his methodology (see Harcourt 2000; 2001).

In The General Theory Keynes put little emphasis on the open economy aspects of his new theory and the role of international capital movements. However, in his wartime writings and papers prepared for the creation of the post-war international institutions, Keynes set out the conceptual bases of the open economy macroeconomics which has been developed in the post-war period (see Vines 2003 and below).

In Keynes’s discussion of the determinants of investment expenditure, the impact of the demand for money and finance, the workings of stock exchanges, and the dominant importance of analysing decision making under uncertainty are brought together. This provides a sounder base on which to erect explanations of the recent financial crisis and its impact on the real economy than any of the approaches developed by mainstream economists in the past 40 years and more. As we noted, the most incisive statement of this view point is Lance Taylor’s “tract for our times”, appropriately entitled Maynard’s Revenge (2010), see also Joe Stiglitz’s Freefall (2010).

Keynes never insisted on the adoption of the particular detailed ways he put these strands all together, only that they all be considered and that his theory not be regarded as an alternative way of stating the loanable funds theory of the rate of interest. This was primarily because the loanable funds theory was dominated by the interplay of flows and largely ignored the role of stocks in the determination of the role of interest. It is, moreo­ver, linked excessively to the forces of productivity and thrift which dominated Keynes’s definition of classical theory and was what he objected to in it.

Keynes’s analysis of and criticisms of the workings of the stock exchange are as fresh today as when he wrote chapter 12 of The General Theory, probably his own favourite chapter. There, he identified first the stock exchange’s role in “enterprise” - the bringing together and gathering up of new saving, a flow, and the rearrangement of old savings (a stock), in directing funds towards the holding of financial assets, the prices of which were meant to reflect the expected profitability of newly established and long established physical assets of firms, the shares and debentures of which were quoted on the stock exchange. Keynes pointed out that if “speculation” was only a bubble on the pool of “enterprise”, the stock exchange would be a socially valuable institution, doing the tasks described above tolerably well. But if the roles were reversed, so that “speculation” was dominant, the stock exchange then more resembled a casino and did a very poor job in trying to fulfil its tradition and proper role.

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of the country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism... not surprising, if the best brains of Wall Street have been... directed towards a different object. (Keynes 1936 [CW 1973 VII]: 159)

These considerations also apply to business people making decisions concerning accumulation in an uncertain environment. Keynes in The General Theory had an unsat­isfactory, in details, theory of aggregate investment flows in Chapter 11, in which the marginal efficiency of capital (investment) and the rate of interest match off against each other, with the rate of interest dominating. However, he clearly thought that what he called the “animal spirits” of business people and the cost and availability of finance and credit were dominant for most periods in determining the desired level of accumulation. He argued that conventions - regarding the future as akin to the present and past unless there were very good reasons for expecting otherwise, for example - dominated deci­sion making and allowed actions to occur, usually at levels which would not match full employment voluntary saving. In so arguing, he was anticipating the themes of Nicholas Kaldor’s greatest theoretical article, “Speculation and economic stability” (1939). Kaldor analysed markets where stocks dominated flows and expectations about future events and other people’s behaviour dominated the usual fundamentals in markets in determining prices. With this was associated a most important Kaldorian and Keynesian insight, the importance of established norms set by expert market makers for the attainment of stability in individual markets and economic systems as a whole. In their absence, speculative activity feeds on itself in a cumulative process of destabilization.

Keynes always remained a Marshallian in method, even in his most radical theory of shifting equilibrium (Keynes 1936 [CW 1973 VII]: 293-4), on which the basis of the post­Keynesian theory of distribution and growth in the post-war period (for example, Joan Robinson’s 1956 The Accumulation of Capital), was erected. Keynes’s approach was recursive and he recognized mutual determination; but because of his keen sense of the different lengths of actual time that components of interrelated processes needed to work themselves out, he was wary of suggesting simultaneous determination. Keynes also never developed (nor would he probably have accepted) the theory of cumulative causa­tion which comes from Adam Smith through Allyn Young (1928) and then Kaldor and Myrdal in the post-war period. The theory rejects the traditional neoclassical approach to economic theory whereby the factors responsible for uniqueness or otherwise of equi­librium are independent of those responsible for local and global stability. In turn, this implies that the factors responsible for the trend are independent of those responsible for the cycle. As this too is rejected, it is one reason why cumulative causation and cyclical growth theory are closely related to each other. The most succinct statement of all this is by Kalecki: “The long-run trend [is] but a slowly changing component of a chain of short-period situations... [not an] independent entity” (Kalecki 1968 [1971]: 165).

Whether Keynes would have accepted IS-LM as a representation of his views, a proposition consistently and vehemently denied by those closest to him, Joan Robinson and Richard Kahn, is a moot point. An IS-LM interpretation may be read into page 173 of The General Theory “We have now introduced money into our causal nexus for the first time, and we are able to catch a first glimpse of the way in which changes in the quantity of money work their way into the economic system” (CW 1973 VII: 173). Then, fortified by ceteris paribus which in the event may not actually hold, he sets out monetary and real relationships which may be captured in IS-LM terms and were in fact done so by, for example, Reddaway, Champernowne, Meade, Harrod and Hicks when The General Theory was first published. However, the limitations of this representation are also clearly implied - it requires that the IS and LM relationships be independent of each other - as Donald Moggridge set out succinctly and persuasively in the appendix to his Modern Masters volume on Keynes (1976).

Another major area that comes under the rubric of Keynesianism is the hotly debated question of whether money and finance are exogenous or endogenous variables. For Keynes, over his lifetime, the evidence is that he thought of them as endogenous. This must be coupled with his methodological view that whether variables are regarded as endogenous, to be determined, or exogenous, to determine, was a relative not an abso­lute judgement. It depended on the issue being analysed and how far processes had gone before analysis of a particular situation started.

As Sheila Dow (1997) has argued, this explains why many interpreters (including Kaldor) have criticized Keynes for taking the money supply as exogenous in The General Theory (even if not in the rest of his writings). Dow argues that it should be regarded as a given for Keynes’s then major purpose. This allows Dow to develop an analysis in which the significance of Keynes’s theory of liquidity preference in an explanation of the demand for money and other financial assets, and of banks extending credit guided by their own states of liquidity preference, so that not all demand is accommodated, are brought together in her arguments. Therefore, Dow distinguishes the demand for and supply of money from the corresponding demands for and supplies of credit. This interpretation places Keynes himself sensibly in between the extreme horizontalists (for example, Basil Moore) and the extreme verticalists (for example, Milton Friedman) (see Harcourt 2006: ch. 5). As we have noted above, Keynes’s view is encrusted in “the most fundamental of [his] conclusions”, coupled with Meade’s Keynesian investment dog, saving tail, turn around.

The General Theory has been interpreted as way off Keynes’s usual regression line. This is especially so with regard to the quantity of money, as we noted above but rejected, but also with regard to the principal setting of The General Theory being a closed economy, in which reading there is more substance. However, if the whole span of Keynes’s interests and contributions over his life are taken into account, it is clear that he analysed open economy interactions and proposed international institutions and policies with which to tackle the problems they threw up. Vines (2003) points out that much of A Treatise on Money is concerned with these issues of international macroeconomics, that Keynes had already recognized the major problems but had not yet made a completely satisfactory analysis of why they arose and what to do about them, mainly because the analytical system of A Treatise on Money was a halfway house between the old and the new.

A more satisfactory analysis was to come in the years following The General Theory when Keynes worked on wartime finance in open economies, especially in the United Kingdom, the workings of the world economy with emphasis on the source of contractionary biases in it, and the interrelationships of internal and external balance in individual economies and the world as a whole.

Keynes was concerned to show why creditor nations could be bad world citizens and to design carrot and stick measures, and the institutions to implement them, to redeem this. He also emphasized the prior need for economies to reach internal balance before tackling the issues of external balance. The role of international institutions was partly to devise measures which allowed interrelated processes of vastly different lengths of historical time to operate in systemically acceptable manners. Keynes was much more favourable to freer trade than to unregulated international capital movements even when internal balance had been obtained. He wanted international institutions to create adequate liquidity so as to tide over economies that had to make structural adjustments without being forced to ally them with contractionary measures.

Keynes also analysed the problems of post-war reconstruction, especially the United Kingdom’s plight owing to inescapable changes associated with fighting World War II, and the United States’ dominant role in the post-war period. All these issues lay behind setting up the International Monetary Fund and the World Bank, and negotiating the post-war loan from the USA to the UK.

As we know, the Americans dominated the forms and conditions all these took, bring­ing in a modified form of the Gold Standard. They failed to create adequate provisions of liquidity and appropriate checks and balances within institutions to encourage good behaviour by creditor nations. Thus Bretton Woods built into its foundations its ulti­mate break down. Keynes was aware of all this but lost the battle. He did though leave the conceptual bases for overcoming these problems if only economists and politicians had had the goodwill to do so.

G.C. Harcourt

See also:

Business cycles and growth (III); Cambridge School of economics (II); John Richard Hicks (I); Richard Ferdinand Kahn (I); Nicholas Kaldor (I); John Maynard Keynes (I); Labour and employment (III); Macroeconomics (III); James Edward Meade (I); Money and banking (III); Post-Keynesianism (II); Joan Violet Robinson (I); Piero Sraffa (I); Uncertainty and information (III).