This blog post calmly examines how the historical crisis of the Great Depression gave birth to Keynes’s ideas and macroeconomics, exploring its significance within the debate over the roles of the market and government.

The Greatest Economist of the 20th Century

Following the 2008 U.S. financial crisis and the Eurozone fiscal crisis that began in Greece in 2010, newspapers and media outlets flooded the airwaves daily with analyses declaring that neoliberalism was facing crisis once again. Some even suggested that, much like during the Great Depression of the 1930s, the ideas of John Maynard Keynes and Friedrich Hayek were clashing once more. The debate over whether “the role of government is more important, or whether the power of autonomous markets is more crucial” is a question that has persisted for nearly a century.
Let’s hear the explanation from Dr. Steve David, Director of Education at the British Economic Research Institute.

“Why this debate endlessly repeats is very simple: because crises keep recurring. Each time a crisis hits, the two perspectives—which interpret the causes of economic crises differently—resurface. The specters of Keynes and Hayek stir up waves again, appearing in the official debate. Both economists offer consistent yet entirely different explanations for the causes of turmoil and how to respond. Their debate in the late 1920s and early 1930s had a clear historical context, and it is hardly surprising that this debate is reigniting today.

This debate still provides crucial insights today for determining the direction capitalism, now facing crisis, should take. Let us first examine Keynes, who emphasized the role of government.
In July 1914, Austria-Hungary declared war on Serbia, marking the start of World War I. This war raged for over four years before ending with Germany’s surrender on November 11, 1918. The victorious 31 Allied nations convened peace talks in Paris, culminating in the Treaty of Versailles, which held Germany responsible for the war. As a result, Germany was forced to bear enormous war reparations amounting to a staggering 24 billion pounds.
Yet, right there, one economist was the first to foresee the impending crisis. He immediately left the conference hall and submitted his resignation to the British Treasury, where he worked. Two months later, he would capture the world’s attention with a single small book. The author of this book, titled The Economic Consequences of the Peace, was John Maynard Keynes. In it, he wrote:

“I dare to predict that if the intention is deliberately to impoverish Central Europe, the revenge will be swift and easy. Laissez-faire capitalism ended in August 1914.”

It didn’t take long to realize his prophecy had come true. To fund the unbearable war reparations, the German government drastically increased currency issuance through its central bank, resulting in the catastrophe of hyperinflation. The easiest solution to this problem was to issue government bonds and sell them abroad at rock-bottom prices, but this choice led to unimaginable consequences.
By July 1923, German prices had risen over 7,500 times compared to a year earlier. Just two months later, they were 240,000 times higher, and three months after that, 7.5 billion times higher. The exchange rate soared to 4.2 trillion marks per dollar.
Robert Skidelsky, a British peer and emeritus professor at the University of Warwick, assesses Keynes thus:

“Keynes was the greatest economist of the 20th century. He changed the paradigm of economic policy through his theory of macroeconomics. He assigned the state a role in managing the economy that had not existed before. He profoundly influenced the very mindset of how economic activity is viewed. From 1945 to 1975, the world was run and managed by Keynesianism. Governments intervened to prevent recessions and sought to balance the economy through fiscal and monetary policy. The key was suppressing major fluctuations, and overall, it was highly successful. The era he lived in can be called the golden age of that system.”

You cannot rely on the ‘invisible hand’

Unlike war-ravaged Europe, the United States was enjoying a post-war boom. But endless greed eventually created a bubble. On October 24, 1929, known as ‘Black Thursday,’ that bubble burst. From that day onward, the U.S. economy began its descent into the vortex of the Great Depression.
Black Thursday refers to the massive stock market crash that occurred on October 24, 1929, on the New York Stock Exchange. On September 3, 1929, the Dow Jones Industrial Average reached its then-high of 381.17. Yet just over a month later, at the market close on October 24, it had plummeted to 299.47. It had fallen over 20% in a single day.
A staggering 12.9 million shares were traded that day alone. Considering the previous record was 4 million shares, the term ‘record-breaking’ was by no means an exaggeration. By 12:30 PM, the Chicago and Buffalo exchanges halted trading, but by that point, a staggering 11 investors had already taken their own lives. The stock crash that began this way continued unabated, ultimately becoming the starting point of the Great Depression.
This is the explanation by George Peden, former professor of history at the University of Stirling.

“In the early 1930s, the Great Depression struck. National income plummeted sharply. This phenomenon was far more severe in the United States than in Britain. People began to ponder the actual money available for citizens to spend, and that contemplation ultimately led to Keynes’ General Theory.”

In the early 1930s, fascism was expanding its influence in places like Italy and Germany in Europe. The German people, exhausted by poverty, unemployment, and social turmoil, ultimately handed power to Hitler. During this period, when the crises of the Great Depression and war were simultaneously raging, people began to question the functioning of Adam Smith’s ‘invisible hand’.
Against this backdrop, Keynes published a book in 1936 analyzing the causes of the crisis and proposing solutions to save capitalism. That book was The General Theory of Employment, Interest and Money.
In this book, Keynes identified the cause of the depression as ‘insufficient demand’. He argued that increased income does not necessarily lead to demand growing at the same rate, defining the demand that actually functions in reality as ‘effective demand’. This means that even if people have money to spend, their desire to consume can diminish.
For the economy to function smoothly, income and demand must nearly match. However, as people cut back on spending, the economy stagnated, ultimately leading to a depression. This new perspective on the role of government led to the birth of the discipline known as ‘macroeconomics’.
Economics before Keynes primarily focused on explaining the principles of the market. In other words, microeconomics was the mainstream. The subjects of the capitalist system can be divided into households, businesses, and government. Microeconomics explains the decisions made by households and businesses and how they interact in the market. This was the perspective that had dominated free-market economics since Adam Smith.
As a result, it was believed that the state only needed to perform the role of a night-watchman state, protecting its citizens during war. According to this laissez-faire state philosophy, the state should minimize market intervention and focus solely on maintaining order through defense, diplomacy, and policing.
However, the period when Keynes worked at the Treasury coincided with a time when the entire world was at war. It was a situation where the ‘principles of the market’ alone could not adequately explain the economy. He naturally developed a macroeconomic perspective that looked beyond the market to the economy as a whole.

The government must address employment and equality

Macroeconomics is the study of national income, interest rates, exchange rates, and the flow of the entire national and global economy. Keynes argued that the government should coordinate the actions of households and businesses through planned policies. He believed the way out of a depression was for the government to expand fiscal spending to create jobs, and that once full employment was achieved, effective demand would increase, leading to economic recovery. The logic is that people who previously lacked purchasing power become consumers through employment.
This ‘planned government intervention’ posed a significant challenge to the long-dominant concept of the ‘invisible hand’. Because of this, Keynes even faced questions from the press asking, ‘Are you a communist?’ However, he firmly criticized the argument that one should wait for the market to self-adjust and the short-term perspective.

“In the long run, we are all dead.”

Scholars explain the meaning of this statement as follows.

“Keynes saw two challenges capitalism must solve to survive. One is quality employment; the other is a more equal society. The government must take responsibility for full employment and maintain the highest possible employment and productivity rates.” (Robert Skidelsky, Emeritus Professor of Political Economy, University of Warwick, UK)

“He believed unequal income distribution could be addressed through the tax system. He emphasized that the economy can achieve full employment only when demand is managed, and that the government is the only entity capable of adjusting aggregate demand. Keynes sought to reform capitalism at the macro level, believing micro-level choices should be left to individuals.” (George Peden, Professor of History, University of Stirling, UK)

Keynes’ theory first captivated young scholars in Harvard University’s economics department and soon persuaded even the economic officials of the U.S. government. Consequently, President Franklin Roosevelt actively embraced Keynes’ theory and pursued the New Deal policy. He established welfare policies for the unemployed and the poor and created large-scale jobs through dam and highway construction. At the same time, unprecedentedly strong regulatory policies were also implemented.

The Expanding Role of Government

Keynes’s warning that “the poverty of Central Europe will lead to swift revenge” ultimately became reality. In September 1939, Germany, suffering from hyperinflation, invaded Poland, plunging Europe back into the vortex of war. This marked the beginning of World War II.
In 1941, Germany’s invasion of the Soviet Union and Japan’s attack on Pearl Harbor expanded the war into the Pacific Theater, engulfing Europe, Asia, North Africa, and the Pacific. This war inflicted the most devastating loss of life and property in human history, finally ending with Japan’s surrender on August 15, 1945.
Meanwhile, Keynesian economics spread worldwide. In July 1944, Keynes, as the world’s foremost economist, spearheaded the Bretton Woods Agreement. Ironically, the war became an exit from recession for both Germany and the United States. Borrowing massive funds to finance the war effort lowered unemployment and began restoring the economy. The rapid growth of the military-industrial complex injected vitality into the entire economy.
After World War II, Keynesian economics became the dominant economic principle governing all governments in the capitalist world. Macroeconomics, in particular, made a significant contribution by enabling a comprehensive view of the entire economy. Robert Skidelsky, Emeritus Professor at the University of Warwick, states:

“Governments have a responsibility for full employment. They must maintain the highest possible levels of employment and productivity. Governments adopting Keynesian policies aimed for high employment rates and worked to reduce unemployment to around 3-5%.”

Keynes’ theory subsequently became the theoretical foundation for ‘big government’, and the world enjoyed an unprecedented economic boom for about 30 years under active government intervention.