On J.M. Keynes’s Complete Rejection of Marshall’s Ricardian, Utilitarian Approach to the Theory of the Rate of Interest in the General Theory

Keynes was very clear in the General Theory that he was no longer a Marshallian economist. He was rejecting the Marshallian approach to economics, except at the microeconomic level as regards the theory of the firm, because it is based on utilitarianism. Keynes, like Adam Smith, completely rejected the consumer theory of utility maximization because it directly conflicted with the virtues of Prudence and Temperance. The basic assumption of utility maximization, that consumer wants are insatiable, is Jeremy Bentham’s position that Adam Smith and Keynes rejected because Bentham’s utilitarian position directly conflicted with the Smith-Keynes Virtue Ethics position.

In its place, both Smith and Keynes argued that the upward sloping supply curve and downward sloping demand curve are simply the result of judicious, careful, circumspect, prudent and temperate behavior on the part of consumers and producers operating under conditions of partial uncertainty, whom Smith called the “sober” people. His famous discussion of the brewer, bread maker and butcher incorporates prudence as the first virtue that must be satisfied. However, there is another group of upper income class individuals who are not prudent and not temperate. Smith called these individuals imprudent risk takers, projectors, and prodigals. The directors of the British East India Company is Smith’s main example of this class of citizen. Keynes described these types of upper income class citizens as rentiers and speculators, who were supported by the forces of banking and finance, in chapter 12 of the General Theory.

Keynes makes it very clear in the preface that he can no longer accept Marshall’s Ricardian approach to economics. Of course, Ricardo, like J. B. Say, J. Mill, J.S.Mill, N. Senior, and L. von Walras, were all Jeremy Bentham’s students: “I myself held with conviction for many years the theories which I now attack, and I am not, I think, ignorant of their strong points… When I began to write my Treatise on Money I was still moving along the traditional lines of regarding the influence of money as something so to speak separate from the general theory of supply and demand… We are thus led to a more general theory, which includes the classical theory with which we are familiar, as a special case.” (Keynes,1936,pp.ix-xi).

Keynes completely rejected Marshall’s theory of the rate of interest, which was that M=L(Y), where Y =C+I, so that Aggregate Income=aggregate consumption + aggregate Investment. In its place, Keynes developed his Liquidity Preference Function on page 199 of the General Theory, L=(Y,r). Both constituents, the propensity to consume (Y) and liquidity preference (r), determine the equilibrium rate o interest, and not just Y or r separately. Keynes’s discussions in chapter 13 of the General Theory dealt only with a strict discussion of liquidity preference that Keynes isolated from chapter’s 8-12 ,which dealt strictly only with the propensity to consume. The misbelief, that Keynes’s theory of liquidity preference was specified as L=M(r), as presented on page 168 of the General Theory, has led to the mistaken belief that Keynes’s only break with Marshall was over the theory of the rate of interest, so that Keynes’s only major change was that L=M(r) was replacing Marshall’s L=M(Y).

Keynes also rejected Marshall’s labor market analysis ,which considered that unemployment of resources had to be analyzed in this market. Given the correct theory of the rate of interest, Involuntary Unemployment was due to a deficiency in I in the aggregate(macro) output market and had nothing to do with a partial equilibrium analysis of the labor market under conditions of ceteris paribus. This deficient aggregate investment then led to a fall in the price of investment goods, so that the real wage, (w/p), would rise. This rise in the real wage was then mistakenly attributed, not to low investment good prices, but to high money wages, w, by classical, neoclassical, and modern economists.

Keynes’s position was that his General Theory was given by M=L(Y,r). There are then two, separate, special theories-M=L(Y) and M=L(r). The Pseudo Keynesian or New Marshallian school (Joan Robinson, Austin Robinson, Richard Kahn, Cambridge University, England), which continued to base their analysis on Marshall’s overall approach, erroneously latched on to M=L(r), while the old Marshallian school, represented by Pigou, Henderson, Hawtrey, Harrod and Robertson, continued to argue that Marshall’s M=L(Y) was superior to Keynes’s M=L(r).