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Keynes vs. the ‘Old’ Classical Model (Part 2) explores the deep intellectual clash between pre-1930s classical economics and the revolutionary ideas introduced by John Maynard Keynes. Before the Great Depression, the classical model dominated economic thinking. It assumed that a capitalist economy is inherently stable, self-correcting, and naturally moves toward full-employment equilibrium.
These beliefs rested on key principles:
Perfect price and wage flexibility
Say’s Law — the idea that “supply creates its own demand,” ruling out general gluts and involuntary unemployment
A central role for the real interest rate in balancing saving and investment
A strict classical dichotomy separating real and monetary sectors
The assumption that money is neutral, affecting only the price level and not real output
The Great Depression shattered this worldview. In response, Keynes published The General Theory (1936), arguing that the classical model was only a special case—valid during periods of full employment but irrelevant during deep recessions.
Keynes introduced the transformative Principle of Effective Demand, showing that output and employment depend on aggregate spending, not automatic market forces. He rejected Say’s Law using the multiplier, arguing that saving adjusts to investment through income changes, not interest rates. Investment, he claimed, is unstable and driven by shifting expectations and animal spirits.
Keynes also replaced the classical theory of interest with the liquidity preference framework, declaring the interest rate a monetary (not real) variable. Because of these rigidities and instabilities, he concluded that market forces alone cannot ensure full employment.
Instead, active government intervention—especially fiscal policy—is required to stabilize demand and prevent prolonged recessions.
This video continues the story of how Keynes overturned a century of classical thinking and reshaped modern macroeconomics.

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