General Theory of Keynes

How much Keynes sees the stock market as a source of economic uncertainty
Building on speculation and short-term profits for individuals, bursaries lead to economic uncertainty. In a free market economy where government participation is limited, the situation is deteriorating. Government intervention is necessary if companies are to prevent their shares from being manipulated in order to attract unknown investors (Andrada 2017, p. 20-21). The desires to acquire wealth short-term within a short term period encourage investment on companies based on inside information without the future prospects of the companies, and their capacity to be profitable in the long-run. The stock market contributed to one of the worst economic instability in recent time that took place between 2007 and 2008. The economic crisis started in the US housing bubble and reached the entire globe through the financial market. The real economic situation is affected by the fluctuation in stock prices. In 2008, the world economy was adversely affected by the housing bubbles and the collapse of the stock market.

Keynesian General Theory focuses on addressing financial instability by putting in place the right policies. Keynes principle advocate for real evaluation of long-term investment instead of focusing in short-term speculative buying and selling of securities. The financial market can become disconnected from the real evaluation that shows long-term prospects of various investments by focusing on speculative short term forecasting. Unsustainable asset bubbles have contributed to the failure of economies. It is important to build economies that do not rely on bubbles ((Marsay 2016, p. 250).

The involvement of the government in the stabilisation of an economy is the central tenet of the Keynesian ideology. Other prevailing economic principles failed to provide the explanation behind the economic crisis that took place all over the world during the Great Depression and 2007-2008 economic downturns that contributed to a severe collapse of the global economy. The theories failed to propose appropriate public policy solution that was capable of providing a solution to the economic problems. Keynes is one of the economic think tanks who played a critical role in pioneering the revolution of economic ideologies. The objective of the economic principles was to overturn the then-prevailing concept that considered free market economy to be capable of addressing the problem of employment in the society (Currie 2016, p. 61-62).

According to the free market theory, every individual who wants a job is capable of getting one so long as they are flexible when it comes to demanding wages. According to the Keynesian theory, an essential driving force in the economy is the aggregate demand which is derived by adding the sum of households, business, and government spending. Free markets cannot obtain the goal of full employment due to the lack of self-balancing mechanisms. Keynesian economist advocated for the involvement of the government using public policies to attain full employment and price stability (Currie 2016, p. 65).

Keynesian principles provide ideas that government can use in case of financial crisis. Fiscal and monetary policies are economic tools used by governments to stabilise an economy of a country. These policies can either be used to stimulate the economy during economic downfall or to slow down it down in case of hyperactivity. There are two main schools of thought in economics that have a different approach regarding policies that are best suitable for attaining full employment in the economy (Langdana 2009, p. 8-10). The first is the Keynesians, which tend to favour demand-side policies that favour government intervention in the market. The theory advocates for the use fiscal policy to stabilise the economy. The second is the monetarist who believes that adjustments in money supply is more appropriate in stabilising economic situation and would, therefore, preferring monetary policy.

The government uses the fiscal and monetary policies in a market economy to control aggregate demand. These policies can be used to stimulate the economy in case of a recession. In such a situation the government is said to be pursuing expansionary economic policies. The two economic policies can also be used in contracting the economy when the rate of economic expansion is rapid. The approach is commonly referred to as contractionary economic policies (Dow 2016, p. 19).

Fiscal policy involves changing the level of taxation and spending of the government to expand or contract the extent of cumulative demand. An expansionary policy is usually applied in case of a recession. It entails lowering the level of taxation and increasing the expenditure of the government. Contractionary fiscal policy is employed in a case of the hyper-economy by decreasing spending and increasing taxation. According to the Keynesian principle deficit spending is vital during a recession and a budget surplus is appropriate during high expansion. There are two types of fiscal policies utilised by the federal government to stabilise the economy. The first one is called Discretionary Fiscal Policy (DFP). DFP is used during severe recession. The second policy is called Automatic Stabilizers (AS). (nondiscretionary fiscal policy). Discretionary Fiscal Policy is based on the federal budget process and is often utilised during a severe recession. It involves adjusting expenditure and taxation by the government (Rosenberg 2010, p. 120).

Langdana (2009) postulates that monetary policy entails changing the rates of interest and money supply in an economy. It aims at expanding or contracting the aggregate demand. It is an entirely discretionary process which is under the control of Federal Reserve. During an economic downturn, the interest rate is lowered by the Federal Reserve with the aim of increasing the supply of money. In a situation of economic expansion the rates of interest are increased by the Federal Reserve to reduce the supply of money. The main form of DFP is the monetary policy. Monetary policy has the advantage of being independent as compared to the fiscal policy since it is not influenced by the president and the Congress (Langdana 2009, p. 69-70).

The Keynesian postulates have a significant impact on the financial market sector. The impact of the stock market on the macro economy is addressed in chapter 12 of the General Theory. Many behavioural economists continue to be inspired by the Keynes argument on the ‘animal spirits’ of the market. According to Barnes (2016), Keynesian principles have become relevant in addressing recent economic bubbles such as the 2007-2008 economic recessions that had a great impact all over the world. While working as a manager in Chest Fund, Keynes became fond of making a long-term investment in firms with impressive long-term investment, and companies with good prospects for future investment. He valued careful analysis of a company instead of its inside information (Barnes 2016, p. 40)

In 1938, Keynes stated that if only the dealers of Wall Street had on inside information, then it could be possible for them to make a big fortune. Keynes adopted an investment strategy that is similar to Warren Buffets. Keynes played a critical role in influencing the thinking of Buffet concerning investing in the stock market. Keynes principles favour long-term investment and investing in a small number of enterprises (Harcourt and Kriesler 2016, p. 20).The critics of Keynesian theory state that it is not appropriate to ignore short-term problems and focus on the long-term benefit when making an investment decision. Unlike his critics, Keynes applied the contrarian style of investing.

The Keynesian economics is based on the principles of the modern founder of macroeconomics, John Maynard Keynes who lived between 1883 and 1946. The principles of Keynes are still relevant in the current macroeconomic environment and are applied in the analysis of stock market. Problems are likely to occur if there is frequent purchase and sale of capital assets in the stock market (Tily and Keynes 2016). According to Keynes the purchase are never made to retain assets in the long run. The stock market often fails to evaluate existing stocks. This causes fluctuations of new physical investment (Palley, Rochonn and Vernengo 2016, pp. 1). Establishing the basis of decisions made by investors’ concerning the shares they would like to invest is very important during the period when the financial market is highly unpredictable. The role played by convention and fundamental uncertainty should not be underestimated when undertaking an investment in the stock market. It is unfortunate that most investors never have the idea of how any company may perform in the future.

Keynes sound investment manifesto is based on concentrated balanced portfolio that focuses on an appropriate selection of few investments that have potential intrinsic value in the long run, and a balanced investment position. Keynes considered the speculative activity to be economically damaging. Investment should be based on forecasting and not speculation. Performing equity analysis is one of the powerful tools that can make investors make wise investment decisions, and avoid investing their money in the volatile stock market. Equity research entails the financial analysis of a company, analysis of performance ratio, forecasting, and exploring scenarios with the aim of making buy/sell recommendation on the stock investment (Palley, Rochonn and Vernengo 2016, pp. 2-3).Dividends and price appreciation depends on the profitability of a company. The business performance of a company is a strong determinant of profitability. Sustainable growth, low gearing, high returns on equity and high margins can only be realised by companies with strong businesses.

Keynes is a liberal thinker who considers it unacceptable to restrict the economic choices of people. Individuals should be granted the freedom of investing their income. He states that the stock market is not an efficient institution, and individuals who spend a large portion of their investment to buy shares with the aim of making easy money are taking a big risk, and they may end up losing their investment unknowingly. The approach is hazardous to investors since they take the risk by floating their earnings (Marsay 2016, p. 300). The financial investment is at the risk of creating fluctuations in relation to the extent of physical investment, and eventually, has an impact on aggregate demand leading to economic instability. The Keynesian principles do not encourage investors with extra cash to engage in more long-term investment despite having extra cash other than the ones already invested in the stock market. Instead, the extra cash can be invested physically in coming up with a new business or in existing business.

References

Andrada, A. F. (2017). From Ricardo to Keynes: Notes on the Origins of Macroeconomics.

Barnes, P. (2016). Stock market efficiency, insider dealing and market abuse. CRC Press.

Dow, S. (2016). The Political Economy of Monetary Reform. Cambridge Journal of Economics, p.bew013.

Currie, L. (2016). The General Theory of Employment, Interest and Money, by JM Keynes. Review of Keynesian Economics, (1), pp.61-66.

Harcourt, G.C. and Kriesler, P. (2016). The Enduring Importance of The General Theory. In Post-Keynesian Essays from Down Under Volume I: Essays on Keynes, Harrod and Kalecki (pp. 15-33). Palgrave Macmillan UK.

Langdana, F. K. (2009). Macroeconomic policy demystifying monetary and fiscal policy (2nd ed.). New York: Springer.

Marsay, D. (2016). Decision-making under radical uncertainty: An interpretation of Keynes’ Treatise. Economics, 10(1), 1.

Palley, T., Rochon, L.P. and Vernengo, M. (2016). The relevance of Keynes’s General Theory after 80 years. Review of Keynesian Economics, (1), pp.1-3.

Tily, G., and Keynes, J. M. (2016). Keynes’s General Theory, the Rate of Interest and’Keynesian’Economics: Keynes Betrayed. Springer.

Rosenberg, J. M. (2010). The concise encyclopedia of the great recession, 2007-2010. Lanham [Md.: Scarecrow Press.