Keynes & Money
Jude Wanniski
January 18, 2002


Memo To: SSU Students
From: Jude Wanniski
Re: John Maynard Keynes & Deflation

Supply-Side commentators have had great fun over the past 30 years in ridiculing Keynesian economics. I confess to having joined in the fun too. Yet I never forgot that John Maynard Keynes (pronounced “Canes”) was one of the greatest economists of all time, but like Karl Marx and Ludwig von Mises, has been abused by the works of his second-string followers. There is almost nothing in Keynes’ writings prior to the Wall Street Crash of 1929 that is not a joy for me to read. Because he never connected the Crash with the Smoot-Hawley Tariff Act, his writings into the 1930s became so jumbled in their contortions that he even apologized to his readers now and then for the complexity of his thinking. I would never suggest you attempt to read The General Theory of Employment, Interest and Money, his Magnum Opus,. It is practically gibberish, written in 1936 in an attempt to explain the Great Depression. It’s hard to attack a thesis you cannot understand, and like hieroglyphics, the General Theory allowed so many interpretations that it produced myriad branches of “Keynesianism.” To really appreciate Keynes, you should read his early work, the best of which I find in his Essays in Persuasion, published in 1931 before he began his ramblings. As an example, here is an excerpt from his 1923 essay on “The Social Consequences in the Value of Money,” under a chapter heading of “Inflation and Deflation.” It indicates that if Keynes were alive today, he would know immediately what is going on.

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If, for any reason right or wrong, the business world expects that prices will fall, the processes of production tend to be inhibited; and if it expects that prices will rise, they tend to be overstimulated. A fluctuation in the measuring-rod of value does not alter in the least the wealth of the world, the needs of the world, or the productive capacity of the world. It ought not, therefore, to affect the character or the volume of what is produced. A movement of relative prices, that is to say of the comparative prices of different commodities, ought to influence the character of production, because it is an indication that various commodities are not being produced in the exactly right proportions. But this is not true of a change, as such, in the general price level.

The fact that expectation of changes in the general price level affects the processes of production, is deeply rooted in the peculiarities of the existing economic organization of society. We have already seen that a change in the general level of prices, that is to say a change in the measuring-rod, which fixes the obligation of the borrowers of money (who make the decisions which set production in motion) to the lenders (who are inactive once they had lent their money), effects a redistribution of real wealth between the two groups. Furthermore, the active group can, if they foresee such a change, alter their action in advance in such a way as to minimise their losses to the other group or to increase their gains from it, if and when the expected change in the value of money occurs. If they expect a fall, it may pay them, as a group, to damp production down, although such enforced idleness impoverishes Society as a whole. If they expect a rise, it may pay them to increase their borrowings and to swell production beyond the point where the real return is just sufficient to recompense Society as a whole for the effort made. Sometimes, of course, a change in the measuring-rod, especially if it is unforeseen, may benefit one group at the expense of the other disproportionately to any influence it exerts on the volume of production; but the tendency, in so far as the active group anticipate a change, will be as I have described it. This is simply to say that the intensity of production is largely governed in existing conditions by the anticipated real profit of the entrepreneur. Yet this criterion is the right one for the community as a whole only when the delicate adjustment of interests is not upset by fluctuations in the standard of value.

There is also a considerable risk directly arising out of instability in the value of money. During the lengthy process of production the business world is incurring outgoings in terms of money – paying out in money for wages and other expenses of production – in the expectation of recouping this outlay by disposing of the product for money at a later date. That is to say, the business world as a whole must always be in a position where it stands to gain by a rise of price and to lose by a fall of price. Whether it likes it or not, the technique of production under a regime of money-contract forces the business world always to carry a big speculative position; and if is reluctant to carry this position, the productive process must be slackened. The argument is not affected by the fact that there is some degree of specialisation of function within the business world, in so far as the professional speculator comes to the assistance of the producer proper by taking over from him a part of his risk.

Now it follows from this, not merely that the actual occurrence of price changes profits some classes and injures others (which has been the theme of the first section of this chapter), but that a general fear of falling prices may inhibit the productive process altogether. For if prices are expected to fall, not enough risk-takers can be found who are willing to carry a speculative "bull" position, and this means the entrepreneurs will be reluctant to embark on lengthy productive processes involving a money outlay long in advance of money recoupment, – whence unemployment. The fact of falling prices injures entrepreneurs; consequently the fear of falling prices causes them to protect themselves by curtailing their operations; yet it is upon the aggregate of their individual estimations of the risk, and their willingness to run the risk, that the activity of production and of employment mainly depends.

There is a further aggravation of the case, in that an expectation about the course of prices tends, if it is widely held, to be cumulative in its results up to a certain point. If prices are expected to rise and the business world acts on this expectation, that very fact causes them to rise for a time and, by verifying the expectation, reinforces it; and similarly, if it expects them to fall. Thus a comparatively weak initial impetus may be adequate to produce a considerable fluctuation.

The best way to cure this mortal disease of individualism must be to provide that there shall never exist any confident expectation either that prices generally are going to fall or that they are going to rise; and also that there shall be no serious risk that a movement, it is does occur, will be a big one. If, unexpectedly and accidentally, a moderate movement were to occur, wealth, though it might be redistributed, would not be diminished thereby.

To procure this result by removing all possible influences towards an initial movement would seem to be a hopeless enterprise. The remedy would lie, rather, in so controlling the standard of value that whenever something occurred which, left to itself, would create an expectation of a change in the general level of prices, the controlling authority should take steps to counteract this expectation by setting in motion some factor of a contrary tendency. Even if such a policy were not wholly successful, either in counteracting expectations or in avoiding actual movements, it would be an improvement on the policy of sitting quietly by whilst a standard of value, governed by chance causes and deliberately removed from central control, produces expectations which paralyse or intoxicate the government of production.

We see, therefore, that rising prices and falling prices each have their characteristic disadvantage. The Inflation which causes the former means Injustice to individuals and to classes, – particularly to rentiers; and is therefore unfavourable to saving. The Deflation which causes falling prices means Impoverishment to labour and to enterprise by leading entrepreneurs to restrict production, in their endeavour to avoid loss to themselves; and is therefore disastrous to employment. The counterparts are, of course, also true, – namely the Deflation means Injustice to borrowers and that Inflation leads to the over-stimulation of industrial activity. But these results are not so marked as those emphasised above, because borrowers are in a better position to protect themselves from the worst effects of Deflation than lenders are to protect themselves from those of Inflation, and because labour is in a better position to protect itself from overexertion in good times than from underemployment in bad times.

Thus Inflation is unjust and Deflation is inexpedient. Of the two perhaps Deflation is, if we rule out exaggerated inflations such as that of Germany, the worse; because it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier. But it is not necessary that we should weigh one evil against the other. It is easier to agree that both are evils to be shunned. The Individualistic Capitalism of today, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient – perhaps cannot survive – without one.

For these grave causes we must free ourselves from the deep distrust which exists against allowing the regulation of the standard of value to be the subject of deliberate decision. We can no longer afford to leave it in the category which the distinguishing characteristics are possessed in different degrees by the weather, the birth-rate, and the Constitution, – matters which are settled by natural causes, or are the resultant of the separate action of many individuals acting independently, or required a Revolution to change them.

Pp. 98-104, Essays in Persuasion, W.W. Norton & Co., NY, 1963.

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Please send me your comments or questions on this brief Keynesian exposition. Next week’s lesson will conclude the Fall Semester. The Spring Semester will put monetary issues to the side and concentrate on the mechanisms of politics in the political economy.