Keynes for Kids

Demonstrable Analytical Modeling of the General Theory of Fun!

Why, hello there! It's a pleasure to meet. To my students, I'm Professor Keynes.

You can call me John.

Macroeconomics is a funny thing. About 80 years ago, on the heels of our earlier depression, I wrote a book. It seemed as though people enjoyed The General Theory well enough, since the the ideas I described in it — along with some very silly ones that I disproved — became rather popular in the years that followed. Then, to my great disappointment — roughly around the time of a couple garish trends called "disco" and the "Rubik's Cube" — it seems my book became an embarrassment to certain Chicago raconteurs. Dispiritingly, as culture slid further toward "synthesized keyboards" and "supply-side economics", so too did my ideas retreat deeper into the abyss.

Class, this folderol ends today. The fates of money supplies, unemployed lads, and comatose economies mean too much to me to let this nonsense go unchecked. Books out and pencils sharpened, please.

For those students who are new this term, let me introduce myself. My name is Keynes — no no, say it like canes — yes, that's good — and I am a professor of economics here at Cambridge.

Before I came along, most people happily thought about money in ways that were — well, let's call them "classical," or pre-modern. But those ideas made as much sense to economies as classical ideas could explain the planets — they didn't! The entrenched policies in my day were, deep down, Newtonian: people assumed that money, even on a big scale, works just fine on its own, and that for any dollar that someone has in their wallet, they'll automatically buy things with it. More than anything else, I tried to make it clear that this was bananas — that it was entirely possible for an economy to hit the brakes because there wasn't enough demand. And it had nothing to do with morals, or molecular harmony, or "the free market." It was just the way macro really works — pure and simple.

At least, it was simple until now. Let's dive in!

Thinking caps on! It's a

Pop Quiz!

Boy, this economy's in the pits! If only workers would accept wage cuts, we could grow our way out!

  • Option A:Hey, that sounds all right! In fact, my buddy knows a guy who just saw a teacher buy a new car...
  • Option B:Wait, what? No! In a recession, we need to keep wages high enough to supplant the spending that isn't happening otherwise.

Aw, c'mon. Everyone's gotta tighten their belts, right? How about a modest wage cut. We're in a depression!

  • Option A:Yeah, that's probably right. Workers really should pitch in.
  • Option B:Jeez, no! That actually makes a recession worse, because when everyone's in a deleveraging slog together, wage cuts make the real effect of paying down debt that much harder!

Awright, let's switch to policy. What's with all this stimulus talk, am I right?

  • Option A:Ugh, you said it. Every time they reach in and sell billions more in Treasury debt, they're just yanking dollars away from the private sector! It's crowding out all the growth we could be doing on our own!
  • Option B:Arrgg, no! In a recession, government borrowing does not "crowd out." There's no private spending happening anywhere. Left to ourselves, it's all just excess saving!

But you gotta admit that all this government borrowing will shoot interest rates up.

  • Option A:Exactly. Any day now.
  • Option B:I can't believe you two. No, when you're up against the zero lower bound, a government with cheap buying power is the only thing left that will spend money. Look, this is right there in The General Th— wait, did you even do the reading?

Let's bring this down to basics. Fill in the blank: Unemployment is caused by _____.

  • Option A:Weak morals. Wait, no: laziness. Lazy morals! Laziness and moral weakness and, uh, capital requirements, probably. And college.
  • Option B:Insufficient demand. Are we done?

Wow, that…was an effort!

You scored 0 points.

(Out of five.)

Dig out those scarves & snorkels! it's time to

Dress-up Andrew Mellon!

Hats! Head! Shirts! Pants! Torso!

Liquidate labor! Liquidate stocks! Liquidate the farmer! Liquidate real estate! It will purge the rottenness out of the system! People will work harder, lead a more moral life!

Andrew Mellon was President Hoover's Secretary of the Treasury.

He had oversight over the American economy during the immediate aftermath of the Stock Market Crash of 1929, and during the first years of the Great Depression. Like many of his "classical economics" generation, Mellon hated the thought of any proactive government help, and saw lousy employment as a moral problem. Do you think Mr. Mellon's ideas about how to fix a recession economy eventually went away? (Spoiler! No, Mr. Mellon's views about how to fix a recession economy did not go away.)

Take Mr. Mellon's silliness to its logical conclusion! Use the four blue buttons to pick his outfit and accompanying (terrible) quote.

Coalmine Calamity!

“If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.”

The General Theory, ch. 10

Hey, that's a great idea! Help out the intrepid businessmen by finding all six bottles.

I'm the first bottle! I'm the second bottle! I'm the third bottle! I'm the fourth bottle! I'm the fifth bottle! I'm the sixth bottle!
Coalmine strewn with bottles, descended upon by private-enterprise businessmen.
Economies have bendable parts

The Samuelson Cross!

Aggregate economy A rendering of Paul Samuelson's original chart
Click to see it in action

Mapping our way to desired total spending.

“…Spending by everybody is an increasing function of income — because [as] people are richer they'll spend more of their money (but not all of it) — and that always, of course, the economy ends up on that 45° line, where income equals expenditure. Okay, there's an accounting identity that says ‘income equals spending’ — but if you increase the amount that people are willing to spend at any given level of income — shift that thing up! — then you will actually move to a higher level of income. And that shows you, very simply, that the accounting identity does not mean that an increase in spending by the government must come at the expsense of private spending. Actually, on the contrary.” (Krugman: Keynes and the Moderns [17:42])

Raters gonna rate

The Chapter 14 Slope!

X: Interest rate Y: Savings rate A rendering of the original graph from Chapter 14 of The General Theory
Click to see it in action

Putting the classical theory of interest to rest.

“…If the economy expands, income will be higher, some of that income will be saved, also possibly investment demand will shift. Here Keynes explained it with this diagram. […] This is just saying, suppose income rises. All things being equal, at any given interest rate, people will save more, because they have more income. Probably, also, firms will want to invest more, because there'll be more demand. Normally — though we don't know this for sure — the place where they cross will be lower, so the interest rate would be lower. What this is doing is actually telling you that there are — this is the point Keynes was making in that horrible diagram — there's no unique level of interest rate that matches savings and investment. It depends on something else: Namely, the level of income in the economy. The other way to say this is, actually — and this is the way we more often think about it — that the lower the interest rate, the higher will be the level of GDP. And that's on schedule. That doesn't tie it down. That's just a relationship. (Krugman: Keynes and the Moderns [21:34])

Discredited Economic Theory Trading Cards!

Before, during, and beyond Keynes's time, we've lived with some zany economic models. But while The General Theory did its best to prove that these simply don't appear in the real world, we can't seem to completely get rid of 'em. (Especially on the editorial pages.) Click each card to learn more about its fantastical, disproven, baseless, sounds-good-at-a-cocktail-party, pseudo-intellectual silliness!

Say's Law
The most prehistoric — and stubbornly persistent — of them all. Named for French economist Jean-Baptiste Say, the Law assumes that money supply will always, perfectly, equal money demand. Of course, the implications are hilarious. There can never actually be any unemployment! Stuff for sale will always have a willing buyer — because people would never want to hoard money, right? And government intervention would never actually be needed! Heck, it'll only get in the way!
Rational Expectations Theory
Oh boy, another way to prove that unemployment can't be real! This time around, it's because people who spend money can tell the future. (No, really!) See, all of us ordinary schlubs are actually a lot smarter than we look. In fact, each of us "has perfect information about future events" (Skidelsky, 2009)! See, there's a whole general equilibrium at play here — and if you average out what we're all doing independently, then we all come out awfully smart! This "assum[es] rational agents maximising utility in complete and perfectly competitive markets. […] By means of rational expectations…economists came to believe that the future was certain, that unemployment was voluntary and that numbers could substitute common sense." (And government should back off.)
Real Business Cycle Theory
Okay, okay, we'll concede reality for a minute: If markets are all-knowing, then how come we do have slumps sometimes? A-ha! Easy! According to R.B.C.T., it's simply because, enh, you're just not adjusting to the slump fast enough. And yes, I really do mean you, Mister Working-to-Middle-Class Wage Laborer. See, in the eyes of R.B.C.T., "cycles are due not to temporary deviations from an optimal level of output, but to fluctuations in the level of potential output itself" (Skidelsky, 2009). In other words, you should really fluctuate (lower) your standards in this new climate, pal. Accountants should become taxi drivers! Cartoonists should become chimney sweeps! And quickly! Anyone who's unemployed is just doing it by choice, because they like naps. (Oh, and government should back off.)
Efficient Market Theory
(Disclaimer: This one is insane.) All right, fine, so maybe the future has some risk. But all that risk is diversified and crowd-shared and analyzed, right? Looking at "standard deviation" trends worked great for insuring cars and boats and fires and death, so let's throw it at macroeconomics, too! By the looks of some handy Gaussian curves, we can safely believe that stock shares are always correctly priced. And hey, that means there's no risk! (Any "thin tail" risk is probabilistically measurable, anyway, so you're probabilistically fine!) It's a measurable, averaged, post-enlightenment age. Buy! Sell! Ha ha ha ha ha ha! (And NO GOVERNMENT.)
When models need metaphors

The Prof's Parables

Beauty pageant

“[P]rofessional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view.”

The General Theory, ch. 12
Broken magneto

The world has been slow to realise that we are living this year in the shadow of one of the greatest economic catastrophes of modern history. […] The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for every one a high standard of life—high, I mean, compared with, say, twenty years ago—and will soon learn to afford a standard higher still. We were not previously deceived. But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time—perhaps for a long time. […] The machine would merely have been jammed as the result of a muddle. But because we have magneto trouble, we need not assume that we shall soon be back in a rumbling waggon and that motoring is over.

Essays in Persuasion: The Great Slump of 1930
Stacks of green cheese

“Unemployment develops, that is to say, because people want the moon; — men cannot be employed when the object of desire (i.e. money) is something which cannot be produced and the demand for which cannot be readily choked off. There is no remedy but to persuade the public that green cheese is practically the same thing and to have a green cheese factory (i.e. a central bank) under public control.”

The General Theory, ch. 17
Aaauuggghh tell me more

Further Reading

Paul Krugman

Paul Krugman teaches at Princeton, writes for the New York Times, won the 2008 Nobel Prize in Economics, and has one heck of a cool beard. If I've ever appeared to understand anything about modern fiscal policy, it's because Krugman explained it in print. Eat your favorite snack while watching his hands-down delightful (and funny) Keynes and the Moderns talk from 2011 at Cambridge, then immediately subscribe to his NYT blog and never miss a post, ever. You'll be a walking, talking, pop-culture-aware macroeconomics fan in no time.

Robert Skidelsky

Robert Skidelsky is an accomplished British economist, academic, political figure, and writer who has published more individual books on Keynes than the total number of frozen pizzas I've eaten. I spent a month listening to the audiobook of Skidelsky's wonderful & timely Keynes: The Return of the Master while running, which both taught and fueled me. (Plus, the narrator sounds awesome. The way he says "pareto efficiency" will get lovingly stuck in your head for days.)

Robert Reich

Robert Reich is cooler than you and me combined. He was our nation's labor secretary under President Clinton, which coincidentally was a time when a giant chunk of Americans were employed. He's also written several books on economic & labor policy as they specifically work (or don't work) in our United States, which, again, he has a particularly keen insider's perspective on. Plus, he draws. Man, I want to be him when I grow up. Reich's Aftershock was exceedingly helpful.

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