THE KEYNESIAN ECONOMIC MODEL

John Maynard Keynes was born in 1883 and died in 1946; he was educated at Eton and studied mathematics at Cambridge as well as taking courses in philosophy and economics.

This Model arose because after the depression full employment did not return. Of course it could be argued that they did not wait long enough or that the Classical Model was attenuated by constant interference with the liaise fare principles on which it rested.

 Keynes posited that total expenditure must be raised to adequate levels to cause full employment. However, it seems to me that total expenditure is already total and axiomatically cannot be increased - another case of Economese.

In any case what are adequate levels? If government spends more by increasing taxation it follows that the public will spend less and therefore no increase in total expenditure can take place. There will only be increases in relative and favoured production at the expense of other things.

In reality, to increase expenditure must mean rather to increase production and this can surely only be done by borrowing - hopefully for productive investment. If the government attempts to do this without fiscal (tax) interference it then must borrow by creating a deficit in its budget and causing an increase in the supply of money and thereby inflation. This led to the old chestnut or conundrum you cannot have full employment and no inflation at the same time.

Keyne’s critics pointed out that focusing on increasing expenditure is like flogging the wagon instead of the horse, or to extend the analogy, it is using the stick instead of the carrot. For expenditure to increase (and hopefully thereby to soak up unemployment) there must be savings available to be borrowed - together with incentives such as a drop in interest rates.

This expectation can be realised up to a point but when that point is reached, and savings have been all invested, and it is then found (as it was found during the depression) that these savings were hopelessly insufficient, the momentum could only be carried forward by borrowing or creating more funny money. (We will return to Funny money later)

This is likely to be expensive and will tend to force interest rates up rather than down (as one of the incentives demands). The exchange rate will also go down, particularly if the borrowing is done from abroad, adding further to the cost of money and thereby once again putting upward pressure on interest rates. This will have the consequence of stopping further spending - the exact opposite of what Keynes hoped for. Thus the Keynesian Model is contradictory. It is of course implicit that by increasing expenditure borrowing must be increased beyond what is naturally available.

None of this seemed to bother Lord Keynes. Real increase in expenditure requires borrowing and foreign borrowing introduces more money into the economic system which causes inflation. Alternatively the government Monetizes its own debt which increases the money supply, and because this happened, and we should not be surprised by it, an impatience began to develop with Keynesian fiscal policy after the war. This led to a new theory of Monetarist Economics, developed by Milton Friedman.

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