Sunday, 30 May 2010


The Keynesian economic theory has been praised as much as it has been refuted.

According to Keynes, the real driving force behind the economy is not money - it is the desire to keep producing goods, which in turn makes money. Keynes calls this 'the real economy'.

Therefore, he argued that spending was almost always a good thing as it encouraged businesses and their employees to contribute more to the economy.

Keynes blamed the Great Depression in America on a lack of goods production and mass unemployment as a result of high wages. His methods of pumping in money and regaining trust in the economy helped to get the country out of this era. He was acclaimed for saving capitalism as a result.

It involved the theory of the 'multiplier effect', which is triggered by extra government spending (or 'quantitative easing').

1. Employ worker
2. Worker makes widget for £1
3. Employer sells widget for £2

However, Economists like Friedrich von Hayek and Milton Friedman saw limitations in the multiplier effect...

4. Worker can't afford widget
5. Less demand for their production as it is to expensive
6. Worker loses job

Hayek identified, as shown in point 6, pumping money into creating jobs cannot last forever. He was strongly against Keynes as he felt his attitudes devalued money, which would lead to hyper-inflation and mass social unrest.

Hayek said: "The widespread emotional aversion to capitalism is closely connected with this belief that undeniable growth of wealth was purchased at the price of depressing the standard of life of the weakest elements of society*".

It seems that this unrest was evident in one of the most unstable states of the 20th century - the Weimar Republic. Weimar was relying on short-term loans from the USA until the Wall Street Crash of 1929. It was effectively spending money that it did not have, which Keynes said would work in the long-term.

"The economic position is only flourishing on the surface. Germany is in fact dancing on a volcano. If the short-term credits are called in, a large section of our economy would collapse."
- Gustav Stresemann, served as Chancellor and Foreign Minister during the Weimar Republic

Hyperinflation kept coming and going during the Weimar years, here is an anecdote from 1923.

"The price increases began to be dizzying. Menus in cafes could not be revised quickly enough. A student at Freiburg University ordered a cup of coffee at a cafe. The price on the menu was 5,000 Marks. He had two cups. When the bill came, it was for 14,000 Marks. "If you want to save money," he was told, "and you want two cups of coffee, you should order them both at the same time.""

The 1918 Treaty of Versailles ordered harsh repayment packages to the allies, which the Weimar government could not keep up with. It kept printing money to avoid raising taxes, but this Keynesian approach did not work as it did in 19th century America. The level of hyperinflation in the ensuing years was shocking, the German wholesale price index went from 2.6 (Jan 1919) to 726,000,000,000 (Nov 1923). Hence, here is an example of Keynes destroying capitalism.

READ MORE: 'A German nightmare' (

* - F. A. Hayek - 'Capitalism and the Historians'

No comments:

Post a Comment