Keynes’s 1936 General Theory was a response to the Great Recession of the early 1930s, which was worse in the USA than in the UK. However, Keynes also discussed the early stages of the Great Recession in his 1930 Treatise on Money, which was much influenced by the Swedish economist, Knut Wicksell. He recommended an extreme form of monetary stimulus, with official purchases of bonds to drive down the long yield. He termed this type of stimulus as ‘monetary policy à outrance’ and it resembles the QE of modern times. In the General Theory Keynes’s emphasis moved towards fiscal policy. However, both books have important lessons in understanding the Great Recession of 2008–09.
Keynes began as a monetary theorist, but by the 1930s he had come to believe that monetary conditions reflect the state of aggregate demand, not the amount of exogenously supplied money. His General Theory, published in 1936, was a theory of employment, not money. In this chapter, I examine the causes and implications of this shift in Keynes’s thinking. The General Theory challenged the neoclassical theory of an optimally self-correcting economy. It demonstrated the possibility of “under-employment equilibrium”; this short-run model offered a justification for policies to maintain or restore full employment. However, Keynes’s theoretical ambition went deeper. It was to show that the existence of radical uncertainty made it unlikely that economies would naturally achieve full employment, except in moments of excitement. The theoretical counter-attack against Keynes’s theory, however, left too narrow a policy space to guard against the slump of 2008–09 or bring about strong recovery.
In light of Victoria Chick’s work on Keynes and economic methodology, in this chapter I explore why there was a Keynesian revolution at all. The reason I give is that existing political solutions to unemployment were blocked. Keynes offered an unblocking intellectual alternative in which both capitalists and workers would gain. I argue that The General Theory can be read on at least two levels: one responding to the institutional facts of the time, the second a more general rebuttal of the neoclassical road to full employment. Though the first reading has been more popular – the orthodox economics profession has always preferred Keynesian policy to Keynesian theory – Victoria Chick’s work and our experience of the Great Recession require us to build a better macroeconomics based on the second.
I explore how Keynesian ideas made their way into British public policy. I argue that the breakdown of pre-First World War macroeconomic conditions led to a ‘blocked’ system, where the adjustment mechanisms presupposed by classical economics were jammed, and that Keynesian economics offered an escape from this system. I explain the Keynesian response to the new problems in monetary and fiscal policy: the gold standard impeding credit control, and the tenacity of the balanced budget rule, respectively. Finally, I outline how Keynes's ideas took hold after the Great Depression via the events at the Macmillan Committee, and their policy implications.