The General Theory

by Merve Emre


In recent years, Modernist Studies has witnessed a resurgence of interest in John Maynard Keynes, the eminent British macroeconomist and Bloomsbury intimate. The impressive reissue of Keynes’ collected writings by The Royal Economic Society in 1981 centralized Keynes’ articles, public broadcasts, and correspondence within 34 hefty volumes, each bound in dusky blue cloth and ornamented with magnificent gold lettering. While many of Keynes’ canonical tracts and treatises were already well circulated amongst economists, his writings on art and literature provided new primary source materials for literary scholars. Given Keynes’ immersion in Bloomsbury, it seemed only natural that Keynesian economics would have influenced the political and aesthetic sensibilities of his writerly neighbors, particularly Virginia Woolf, with whom Keynes was quite friendly.

Jennifer Wicke’s article “Woolf, Keynes, and Modern Markets” is a celebrated example of the Keynesian turn in Modernist Studies.[1] Wicke argues that Keynes brought about a “sea change in market consciousness” (6) by undercutting orthodox economists’ assumptions of market rationality. “For the ordered, rationalist image of the market and its laws,” she writes, “Keynes substitutes an insistence on the chaotic nature of the market, no longer chartable in regularized terms, but recognizable as a preternaturally sensitive organism ready to ramify the smallest shock throughout its limpid, limbic system” (11). Although she denies her project’s status as an “influence study,” Wicke does focus on the circulation of intellectual ideas in the Bloomsbury “life-space” (7), and argues that Bloomsbury’s position as a space of exchange, a market in its own right, led Keynes and Woolf to “[do] the same thing” (12): to theorize irrationality as a defining characteristic of civil society. Aesthetically, the chaos of the Keynesian marketplace mirrors the “fleeting, frangible […] blooming, buzzing, dispersed, and displaced” (11) exchanges in Mrs. Dalloway’s urban consciousness.

However, there exists a definitional problem in Wicke’s treatment of “irrationality” in Keynes’ macroeconomic narrative. Wicke fails to explain why or how it is appropriate to draw ontological parallels between an economist’s disciplinary understanding of irrationality and its subsequent aestheticization in consciousness. This is a troubling move, as it performs a considerable disservice to the Keynesian legacy. As economist Ted Winslow writes, “Interpretations of Keynes’ economics frequently provide excellent illustrations of the misunderstanding that results from the failure to read texts hermeneutically” (64). Keynes, as Winslow and others have demonstrated, developed a very specific theory of “rationality as proportionality” in A Treatise on Probability, which subsequently shaped much of his analyses of investor psychology in The General Theory.[2] Wicke, however, treats irrationality with some hermeneutic slippage, depicting market behavior as systemically over-sensitive and generically unstable. This gloss of Keynesian “irrationality,” as we will soon see, bears very little resemblance to Keynes’ understanding of it.

The obvious question then becomes: what did Keynes mean by irrationality? What did he mean by rationality? What was his understanding of investor psychology and how does it impact the nature of exchange? These are important questions to answer before literary theorists can integrate Keynes into modernism’s aesthetic discourses. As many contemporary economists have pointed out, Keynes develops a rather sophisticated understanding of convention to stabilize both the psychological and the calculable aspects of investment behavior. Markets which operate under imperfect information constraints promote the aggregation of investors’ beliefs and actions into observable conventions, which are both dialectical and dynamic in nature: dialectical because conventions proxy the convergence of individual market activity around identifiable valuation norms; dynamic because conventions change in response to observed individual behavior, and individual behavior changed in response to observed conventions. Keynes then suggests that although conventions themselves may represent substantively irrational norms, the process by which they do so is proportional, observable, and incremental: in a sense, rational.

The Keynesian market is indeed systemic, but it is neither, in Wicke’s words, “limpid” or “limbic,” nor does it allow the “smallest shocks” to register as totalizing, organismic spasms. If literary critics want to seriously and fairly engage Keynes as an important figure in modernism’s intellectual history, they should begin with the vision of Keynesian economics laid out in The General Theory, one which posits convention as the ultimate structuring principle of exchange and consciousness.

Overview to The General Theory

Before delving into an exposition of Keynesian rationality, it is necessary to begin with a short summary of The General Theory. Non-economists have not sufficiently elucidated the fundamentals of macroeconomics as they are laid out in The General Theory.[3] Some reparative work is necessary to bridge the disciplinary divide between the economists and the literary critics. In his introduction to The General Theory, Nobel Prize winning economist Paul Krugman gives a lucid summary of Keynes’ argument: “Stripped down, the conclusions of The General Theory might be expressed as four bullet points:

*Economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment. *The economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully.
*Government policies to increase demand, by contrast, can reduce unemployment quickly. *Sometimes increasing the money supply won’t be enough to persuade the private sector to spend more, and government spending must step into the breach” (xxvii).
The first bullet point expresses the notion of “underconsumption” and is worth discussing in some technical detail, as it establishes the premises from which the rest of Keynes’ argument follows. Prior to the publication of The General Theory, orthodox economics was based on Say’s Law and its subsequent canonization as the “law of markets.” Briefly, Say’s Law postulated that the aggregate supply of products in the economy created their corresponding aggregate demand, i.e. the sale of Product A by Person X paid for Person X’s purchasing of Product B from Person Y, which in turn paid for Person B’s purchasing of Product Z from Person C, ad infinitum. The market was thought to stabilize at a defined and unique equilibrium point where aggregate supply equaled aggregate demand, and full employment levels sustained uninterrupted production and consumption patterns across all commodities. Say’s Law enjoyed privileged status amongst nineteenth century market theorists, but reached its theoretical break point during the Great Depression, when confronted with depressed consumption levels and persistent unemployment.

In response to the limited explanatory power of Say’s Law during the Great Depression, Keynes challenged its equilibrium assumption by expressing “aggregate supply” and “aggregate demand” as functions of the employment level. Instead of modeling supply and demand as autotelic processes, Keynes derived both from the number of men allocated to a particular productive function: the aggregate supply function was the output, Z, from employing N men (Z = φ(N)), and the aggregate demand function was the proceeds, D, from employing N people (D = f(N)), whereby the aggregate volume of employment would be given by the value of N where Z=D (Figure 1). Say’s Law, Keynes wrote, assumed that “f(N) and φ(N) were equal for all values of N,” but if this were true, “competition between employers would always lead to an expansion of employment up to the point at which the supply of output as a whole ceases to be elastic” (26). More simply put, Say’s Law categorically asserted that full employment would be an economic constant, a hypothesis that flew in the face of the 1930s’ economic experiences.

To account for recessionary economics, Keynes formulated the relationship between employment and aggregate supply and demand as follows: increases in employment (N) would increase aggregate income and aggregate consumption but not in a one-to-one relationship, as an individual would not always consume 100% of what he or she earned. He or she would have a choice, Keynes wrote, between consuming, saving, and investing his or her savings. The individual’s propensity to consume would depend not only on an increases in his or her earnings, but on his or her “the current amount of investment” (27); this, in turn, would depend on “the relation between the schedule of the marginal efficiency of capital and the complex of rates of interest on loans of various maturities and risks” (28), i.e. a future discounted cash flow (DCF) calculation of the internal rate of return from an investment made today (Figure 2). Keynes claimed that both the propensity to consume and the propensity to invest would set the new rate of employment, which could only correspond to full employment under a very specific set of circumstances.

From there, the prescriptive recommendations of The General Theory were easily derived. In times of widespread unemployment, simply printing more money (as Say’s Law advocated) would not necessarily increase economic activity, as individuals would be inclined to allocate that money towards savings or investment, rather than consumption. Rather, for consumption to increase, individuals with little or no income – mainly the unemployed – would have to find means of generating income in order to increase their real purchasing power. From this observation, Keynes concluded, “A somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment […] If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments [of production] and the basic rate of reward to those who them, it will have accomplished all that is necessary” (378). This section of The General Theory was forever memorialized as Keynes’ famous gesture towards the contemporary welfare state: governments ought to establish public service programs that provided employment for the unemployed, and subsequently increased real purchasing power in the economy.[4]

Keynesian Rationality

When Wicke differentiates between the “chaotic image of the market” and the “ordered, rationalist” one, to what part of Keynes’ argument is she referring? How does the rationality of markets become important for the consumption versus investment decision?

Keynes never gave his readers a specific definition of rationality in The General Theory, but did provide one in his earlier work A Treatise on Probability. In the treatise, Keynes first positioned himself against orthodox economists’ models of “rational” investors: self-interested profit-maximizers who quantified their expectations of future events. In contrast, Keynes wrote: “When once the facts are given which determine our knowledge, what is probable or improbable in these circumstances has been fixed objectively, and is independent of our opinion. The theory of probability […] is concerned withthe degree of belief which it is rational to entertain in given conditions, and not merely with the actual beliefs of particular individuals” (4; italics mine). Note the conceptual differences not only from orthodox economists’ definition of rationality, but also from Wicke’s understanding of it. The rationality of an individual has nothing to do with whether or not a given belief is cohesive, quantifiable, or even correct, e.g. “The value of gold will rise 25% this year,” “Colonial politics will make trade more profitable.” Rather, rationality represents the degrees to which presumed informational constraints, what Keynes calls “knowledge,” inform our probabilistic assessments of future outcomes. For Keynes, rationality is never localized in the substantive end state of a process, e.g. a botched investment based on incorrect cash flow calculations, economic deregulation. Rather it resides in the procedural assessments by which an investor has reached that end.

Given this definition of rationality, there exists an important theory of investment psychology that Keynes outlines in The General Theory to which Wicke pays no attention. In his discussion of investment in Chapters 12 through 15, Keynes suggests that the calculation of investment yields, what he dubs an investor’s “long-term expectations,” are based on “partly existing facts” and “partly future events which can only be forecasted with more or less confidence” (147). Future valuations are arrived at by projecting the current state of affairs into the future, and by accounting for any modifications that may alter existing expectations. The ritualized calculation of long-term expectations based on present day beliefs is an example of what Keynes calls “a convention” (152).

In the economics literature, the importance of convention for Keynes is often marginalized in discussions of rationality. Winslow, P.E. Gregoire, William Darity and Bobbie Horn, and others have, in varying degrees, argued that there exists a tension between convention – an “arbitrary” behavioral norm, or “rule of thumb,” that individuals independently do or do not “follow” – and rationality.[5] Convention, as these critics conclude, proxies a disorganized mass psychology that short circuits proper rationality. However, once we take Winslow’s own advice and read Keynes’ definition of rationality hermeneutically, convention in The General Theory does not assume its traditional, substantive definition, but a more nuanced, procedural one.


Michelle Baddeley and other economic theorist propose that “convention” represents the convergence of investor beliefs in environments plagued with informational uncertainty.[6] To make the link to Keynes’ definition of rationality, it should be added that conventions are dialectically and dynamically updated in proportion to changing probabilistic knowledge. It is no accident that in his description of convention in The General Theory, Keynes echoes the same descriptive characteristics that he attributed to rationality in A Treatise on Probability. Convention, Keynes believed, represents the pooling of investor belief at a point where “the existing market valuation, however arrived at, is uniquely correct in relation to our existing knowledge of the facts which will influence the yield of the investment, and that it will change in proportion to changes in this knowledge” (152).

Because conventions are overtly social phenomena that arise amidst imperfect information, they reflect a totalizing overlap between individual and aggregate belief and behavior – they dialectically proxy “the truth.” To give an example: an individual investor will act according to a particular convention (e.g. “Buy 100 shares of Western Union at $2 per share!”), and that convention will self-perpetuate due to the collective beliefs and subsequent acts of multiple investors (e.g. “Western Union’s stock price just rose from $1.92 to $2!”). Convention, then, cannot rightly be opposed to rationality, as it represents the best, i.e. most informed, or most calculated, valuation that investors arrive at by evaluating the only thing they can evaluate – each other’s beliefs.

It would seem that Keynes’ discussion of speculation, however, complicates this view of convention. Keynes argues that professional investors make money by anticipating disproportionate swings in investment valuations, and moving their money around in response to short-term gains and losses. Highly liquid investments make speculation cheap and easy, and aggregate economic performance becomes dependent on the casino-like strategies of Wall Street and the London Stock Exchange (159-160). The inherently risky nature of speculation can be exacerbated by an individual trader’s appetite for risk – in both Keynesian and modern investment parlance, his “animal spirits.” It is easy to see why critics like Wicke would conclude that conventions are formed and dissolved under irrational pretenses and, by implications, that irrational behavior animates domestic and global markets.

Immediately after presenting his assessment of speculation, however, Keynes issues a caveat against reading too much into irrationality: “We should not conclude from this that everything depends on waves of irrational psychology. On the contrary, the state of long-term expectation is often steady […] Our rational selves choosing between the alternatives as best we are able, calculating where we can, but often falling back for our motive on whim or sentiment or chance” (162-163; italics mine).[7] In one sense, the caveat helps us marginalize complaints about speculation by pointing to its relative infrequency. As Baddeley points out, Keynes believes behavior will be strictly rational when enough information is available with which to make investment decisions. The implication is that the Keynesian market is neither inherently irrational, nor do investors constantly invoke whim, sentiment, or chance when there is information they can leverage. Instead, behavior is dictated by convention only when there is no pure informational basis for one investment strategy over another. Because information aggregates and markets self-correct over time, long-term expectations will converge at some “true” valuation estimate, rather than exhibit constant volatility. The default setting for both individuals and the market is rational decision-making and rational outcomes, even if imperfect or asymmetric information momentarily forces individuals to deviate from strictly rational calculations.

However, speculative behavior can also be accounted for as a type of convention par excellence. Speculative investment decisions are never motivated by a desire not to maximize profits or expose the “true” value of a stock. The animalistic investor, Keynes argued, derives his “spontaneous optimism” (162) from a punctuated, market-wide convention of exuberance. No investor – unless he or she is mentally unhinged and thus subject to unpredictable behavior in any information environment – makes an investment decision without taking his or her cues from the market. Moreover, for the critics that speak of speculation with disapproval, Keynes argued that a certain amount of conventional self-deception is needed if enterprise is not to “fade and die” (162). Optimism is the only means by which credit can circulate.

Decision-making based on convention is, for Keynes, the most rational method of procedural evaluation possible in imperfect informational environments, even if the end result is sub-optimal asset allocation. With the requisite economic theory firmly in hand, it should be clear why Wicke’s reading of market irrationality skews Keynes’ argument in The General Theory. In brief, the Keynesian market is not, and never has been, what Wicke characterizes as a “limpid, limbic system” prone to “small shocks” and exaggerated spasms. Conventions absorb “whim, sentiment, and chance” within a dynamic and dialectic totality, tempering impulse and stabilizing the systemicity of valuation and exchange. It is fair to conclude that the parallels Wicke draws between Keynesian macroeconomics and the representation of consciousness seem misplaced, and that alternative methods of engaging Keynes in modernism’s aesthetic discourses ought to be explored.

If we wanted to further engage Wilke’s argument, we could - as a relatively brief exercise - highlight through imperfect analogy the similarities between Keynesian conventions and Mrs. Dalloway’s steadfastly posh purchasing behavior. The buzzing of patrons, the fidgeting of shopkeepers, and even Mrs. Dalloway’s own displaced consciousness merely constitute the ambient noise that surrounds Clarissa’s ritualized consumption patterns and assessments of value. While walking in London, Clarissa eyes the “lovely old sea-green brooches in eighteenth-century settings,” but knows that they are mere ornamentation to “tempt Americans,” and that “one must economise” (5) when faced with nonsensical temptation. “Bond Street fascinated her," Woolf writes, because it serves as the coordinating nexus of her economic history; “no splash; no glitter; one roll of tweed in the shop where her father had bought his suits for fifty years” (11). Clarissa, we soon learn, walks through Bond Street so that she can frequent Mulberry’s, the flower shop which routinely “kept flowers for her when she gave a party” (11), whose proprieter Miss Pym likes and trusts Clarissa enough to let her select her own arrangement (13). Amidst the old woman chattering on top of omnibuses, the crush of the British middle classes, and the sheer quantity of shops between Bond Street and Brook Street, Mrs. Dalloway inscribes her conventional, calculated footpath of economic valuation onto London’s commercial center.

  1. Jennifer Wicke, “Woolf, Keynes, and Modern Markets,” NOVEL: A Forum on Fiction, Vol. 28, No. 1 (Autumn, 1994).
  2. Ted Winslow, “Keynes on Rationality” in Economics of Rationality, ed. Bill Gerrard (London: Routledge, 1993), p. 64.
  3. John Maynard Keynes, The General Theory of Employment, Interest, and Money, ed. Paul Krugman (New York: Palgrave Macmillan, 2007).
  4. Mark Walsh, Paul Stephens, Stephen Moore, Social Policy and Welfare (Nelson Thomas, 2000).
  5. Darity and Horn call convention a “rule of thumb,” stating that there “are many types of rule of thumb”; P.E. Gregoire is the least generous of all the critics and interprets convention as “an act of faith to cover a lack of knowledge.”
  6. Michelle Baddeley, “Rationality, Expectation, and Investment” in Keynes, Post-Keynesianism, and Political Economy, ed. Peter Kriesler, Claudio Sardoni, Geoffery Colin Harcourt (London: Routledge, 1999).
  7. Krugman underscores this point as well in his introduction: “The General Theory is not primarily a book about the unpredictability and irrationality of economic actors” (xxxv).