Although much of his ideas were often misunderstood throughout his life, Keynes offered bright new insights into the nature and origin of financial theories. In his most well known writings, The General Theory of Employment, Interest, and Money, which was published in 1936, Keynes worked to break down the prior ideas of traditional economics and point out its inadequacies, which became obvious during the downturn of the economy.
He felt a new approach was needed, and through his work in The General Theory, he sought to bring this transformed stance to light and make sense of the economic crisis that surrounded him. Keynes entire social theory is based upon the concept of human behavior in regards to their money and the expectations of which will always be brought into a future which is uncertain.
It was a time of great economic hardship, jobs were scarce and the economy was in a downward spiral, it was then that Keynes took to his efforts in shifting the economic ideas from those of the classical model to one of a more hands on approach. In his book Keynes speaks to three main ideas, the propensity to consume, the state of ones liquidity preference as determing the rate of interest, and the marginal efficiency of capital or the anticipated return on their investment in capital assets.
The propensity to consume is one which we use most in our everyday lives and one which involves the least amount of uncertainty. We all use our money to purchase goods for our every day lives, whether it be in the form of food, a car, or perhaps a novel, we all purchase things on a regular basis and though we may not be able to accurately predict the quality of said item we usually have a basic understanding of what it is we are to getting from the transaction and what the results will be.
It is this propensity to spend, or consume that we are most familiar with in our everyday lives and one which Keynes explains in terms of having the least amount of uncertainty as it is the simple act of purchasing that which you need for the sole purpose of having that item, there is no expectations beyond the receiving of that particular merchandise, you are not looking to turn a profit nor are you anticipating any kind of increase in value, the value is simply within the use of the item which you purchased.
The effective demand of the propensity to consume is composed of two items, first, that of the investment, or expenditure, and second, the act of consumption. It is believed by Keynes that ones propensity to consume is directly related to their income, when someone’s income goes up, so does their propensity to consume. However, there are exceptions to this rule. If one makes such a large income that they find it hard to completely dispose of every month and receives some kind of increase in their income, their propensity to consume goes down considerably as they would most likely save the majority of their income.
Also, if ones income is small enough that they usually end up spending the majority of their income every month, if they receive an increase in income they will most likely have a much higher propensity to spend then that of someone who has a much larger, harder to spend income. This is an illustration of the level of effective demand within ones propensity to consume. The propensity to consume is the most simple, and purest form of what someone can do with their money and one that is used on a regular basis by people everyday.
Another action you can do with your money according to Keynes is loan, with his second point being on the state of ones liquidity preference as determing the rate of interest. Ones liquidity preference really refers to how readily available one would like their money to be to them, in the form of high liquidity preference one would want their money in the most liquid or readily available form to them, as not to have to go through several institutions or have to jump through hoops in order to get said money.
This liquidity preference usually comes in the form of cash, or other quick and readily available forms, which do not present much effort in the retrieving of funds. People with this liquidity preference simply like to have the security of having their money more quickly available to them and within their control at all times. These forms of liquid money bring the investor a sense of security and control over their assets something that will comfort them in times of uncertainty. According to Keynes, there are two types of moneys of account, first, there s normal money, or money proper, then there is bank money.
These are just two different forms the amount of exchange value can take in the form of the dollar. Whenever ones actions with money projects their expectations into the future there is always a higher level of uncertainty, with loaning having a considerable level of uncertainty. With this uncertainty, the expectations of the investor, or that of effective demand, may often require some form of disquietude in order to feel more comfortable and safe dealing in such uncertain terms.
This disquietude can often be offered in the form of the rate of the rate of interest on ones investments. It is the amount the interest that will greatly determine whether or not one will be willing to give the loan, for the rate of interest works to deter ones propensity to hoard. The higher the rate of interest, the more likely an individual would be to let go of some of their money and invest it in a certain form. The rate of interest is a very important aspect of the investing process and one that should never be over looked.
Not only does the rate of interest break the propensity to hoard and offers them piece of mind to part with said money, but also in the end is what ultimately increases the value of ones investments. It is this expansion of value due to the rate of interest that promotes the concept of bank money in regards to loaning. When dealing with bank money, one usually speaks in terms of an individual or company approaching a bank in an attempt to pursue a loan. This is when a bank will in a sense make a claim against itself in the form of that money given to the individual or company.
How this process really is able to flourish is by the means of that bank giving the person or entity seeking the loan a bit more than they should, slightly over extending themselves. Though this would normally be seen as being quite risky on the banks part especially for the reason that it is making a claim against itself, it is by this action that the bank will ultimately benefit most greatly. After the individual seeking the loan receives it, they will almost immediately this money from the first bank and put it directly into another bank in order to buy something, perhaps a car, boat, whatever have you.
After the individual or company puts this money into the second bank, because the first bank over extended itself, then surely the second bank will receive this money and then in turn be able to over extend itself to another person who comes in seeking a loan. This process repeats over time and eventually bank one will reap the benefits of having originally overextending itself to the person seeking the loan because that money will eventually make its way right back to bank one and allow for this process to continue.
As long as other banks are also over extending themselves it will eventually come back to these banks and make up for the difference. They in turn, over each other as they are all interconnected. What drives this process is that someone decides to deposit their money into the bank in the first place, this is the starting point of the process and the action that allows for it to happen in the first place.
The driving force of this expansion is the fact that all the banks are over reaching at the same time allowing for the money to come back to these institutions in the form of a deposit from another bank, ultimately increasing the value. This is how money grows and expands from the process of loaning. The third and final concept Keynes illustrates is that of the marginal efficiency of the expected return on ones investment in capital assets. In a modern capitalist monetary economy, investment lays at the heart for the reason that it works to increase and expand value through the purchase of capital assets.
The formula for this type of action is Money-Commodity- Money1 where the first “money” represents the initial investment that is then turned into a commodity, perhaps in the form of materials or labor, which is then in turn transformed into an increased and expanded value on the original investment where the profit occurs. When one is looking to invest there is plenty of room for uncertainty, as investing is one of the more risky things to do with money as it is the action which has the most uncertainty involved. According to Keynes, an investor cannot look to the past as a reliable
Indicator for how their investments will behave today nor can one look to present conditions and make an accurate prediction for how their investments will behave tomorrow, there is no reliable way to calculate how the market will treat you and your investments. Knowing one must enter into an investment completely blind as to what their ultimate results will be, there is obviously quite a bit of risk and uncertainty involved, but in order to be successful in ones investments it is very important that one has a solid understanding of the demand for the commodity.
It is this expectation that gets the process of investment going for the reason that if you have a strong understanding of what is in demand for a specific commodity or product, you can have a better, but never completely accurate, expectation for what your effective demand will be and what you can expect to get in return fro the initial investment. When one considers making in investment, there is almost always factors involved that bring the investor into the future, whether it be in the form of production, machinery, or costs, there will always be a need to look to the future when investing.
For example, if one wants to invest in selling the latest version of action figures that are popular today, one must not only invest in today, but tomorrow, as well as into a significant part of the future. There are many things to consider not only for the present, but also the future of the investment, such as will this still even be popular 2, 3 years down the road? Will I even want to be paying for these machines then if they aren’t? It is up to the investor to decide if the risk is worth the potential gain, and unfortunately most of the time the investor can have no way of knowing if they will be wrong or right.
It is the act of true investment, according to Keynes, that needs to take place during an economic down turn, in order to bring it back to order and allow for it to reach a level of equilibrium once again. The revival of the expectation of effective demand in terms of investment needs a jump start when the economy does a nose dive, and often times for Keynes, this investment needs to be induced. The marginal efficiency of capital must be great enough to offset costs and costs of money at current interests rates for an investor to even consider moving forward.
The factor to induce this investment will be the marginal efficiency of capital, which is purely an estimate that drives the investor into the future. According to Keynes the first stage of financalization is stocks and bonds, which have a huge impact on investment. What induces investors is the concept of separation of legal ownership and management, which is what stocks do. Stockholders have little to no direct effect on the company and focuses the investment decision on the short term rather than looking into the future.
In the absence of stock and bonds there is more emphasis on the future and long term, which involves a great deal of uncertainty where as short term is irrelevant to the viability of the future. Financialization has caused a divide between building an enterprise and speculation; there is a lot of speculation and uncertainty involved. However, more wealth flows to speculation, and then to investments. It is the trap of the capitalistic society, to get caught up in speculation.