The General Theory of Employment, Interest, and Money

Keynes argues that both short-term and long-term expectations significantly influence output and employment, though each operates over a different time horizon. Short-term expectations drive a firm’s immediate decisions regarding daily production and pricing, often revised gradually in response to recent sales outcomes. By contrast, long-term expectations shape decisions about capital equipment and other investments that take longer to adjust, making them susceptible to sudden shifts in optimism or pessimism. Keynes observes that when expectations change—either positively or negatively—employment rarely jumps directly to a new steady state. Instead, it can oscillate, temporarily overshooting or undershooting the eventual long-period level. He also points out that in practice, states of expectation frequently overlap: New shifts in outlook can emerge before prior adjustments have fully played out. Ultimately, Keynes stresses that current employment is governed by today’s expectations in conjunction with existing capital, not by any single past result. Because of this dynamic, analyzing how expectations form and evolve is vital for understanding fluctuations in economic activity—and underscores why classical theories, which often assume instantaneous adjustment, fail to account for persistent unemployment and other market inefficiencies.

Keynes shows how to measure income in a way that reveals why saving and investment always match. He begins by distinguishing between an entrepreneur’s total sales and costs, which he divides into user cost—the value sacrificed by using existing capital to produce output—and factor cost, which includes wages and other expenses. Income is defined as total sales minus user cost, reflecting the resource depletion involved in generating those sales. Keynes then defines net income by subtracting supplementary cost, covering normal depreciation or wear beyond direct usage. Under these definitions, saving naturally equals investment, since any portion of income not spent on consumption is effectively funneled into capital formation.

Keynes illustrates that this equivalence holds even amid real-world accounting complexities, including the treatment of depreciation and how surplus equipment influences production decisions. User cost must be included alongside factor cost to fully capture a firm’s true expense in creating output. Surplus capital sometimes keeps user cost low initially but can escalate rapidly if market conditions shift, thus affecting prices and employment levels. By emphasizing that present capital usage constrains future production potential, Keynes underscores the centrality of user cost to investment decisions. Ultimately, his analysis confirms the inescapable logic that aggregate saving—the excess of income over consumption—equates to aggregate investment, cementing a foundational principle in his broader economic theory.

Keynes clarifies further why, in aggregate, saving always equals investment and addresses several misconceptions arising from different definitions of these terms. He notes that while individuals can acquire assets (and thus “save”), such personal actions invariably influence broader economic outcomes, preventing the community as a whole from saving an amount different from its total investment. Keynes points out that once income is properly defined, saving—spending less than one’s income—must necessarily match the simultaneous addition to capital equipment, i.e. investment. When bank credit expands and stimulates new investment, the resulting boost in incomes leads to correspondingly higher savings; in conditions short of full employment, there is no “forced saving” absent a specific benchmark for normal saving rates. He revisits his own earlier writings, acknowledging that special definitions can make saving and investment appear unequal, but emphasizes that these are semantic rather than substantive differences. Keynes also rebuts the idea that the banking system can create investment with no corresponding saving, explaining that every act of lending or asset purchase has a matching counterparty. Throughout, he underlines the notion that demand is a two-sided transaction: In aggregate, one person’s decision to save directly affects someone else’s income, ultimately steering total output, employment, and the alignment between saving and investment.