The General Theory of Employment, Interest, and Money

Keynes explores how his theory of output and employment applies to the recurring ups and downs of business activity. He contends that while numerous elements—such as changes in the propensity to consume and interest rates—can magnify short-term swings, cyclical fluctuations fundamentally stem from shifts in the marginal efficiency of capital. The boom phase features over-optimism about future returns on new investments; entrepreneurs continue pouring money into capital projects until suddenly, doubts arise, precipitating a sharp collapse in confidence and in investment demand. This abrupt downturn, or crisis, generally occurs more violently than the slower, more gradual transition back toward recovery.

Keynes explains that, during a slump, the decline in the marginal efficiency of capital is often so severe that monetary policy alone (for example, lowering interest rates) may fail to rekindle investment promptly. The slump’s duration partly reflects how long it takes for surplus capital and inventories to be used up or replaced, tying the cycle to tangible factors like the lifespan of capital goods and the cost of carrying inventories. Further, in earlier eras, agricultural cycles often triggered or magnified the trade cycle through swings in harvest output and the size of crop carry-overs.