The Keynes effect is the effect that changes in the

price level The general price level is a hypothetical measure of overall prices for some set of goods and services (the consumer basket), in an economy or monetary union during a given interval (generally one day), normalized relative to some base set. ...

have upon goods market spending via changes in

interest rates An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, ...

. As prices fall, a given nominal

money supply In macroeconomics, money supply (or money stock) refers to the total volume of money held by the public at a particular point in time. There are several ways to define "money", but standard measures usually include currency in circulation (i ...

will be associated with a larger real money supply, causing interest rates to fall and in turn causing

investment Investment is traditionally defined as the "commitment of resources into something expected to gain value over time". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broade ...

spending on

physical capital Physical capital represents in economics one of the three primary factors of production. Physical capital is the apparatus used to produce a good and services. Physical capital represents the tangible man-made goods that help and support the pr ...

to increase. This implies that insufficient demand in the product market cannot exist forever, because insufficient demand will cause a lower price level, resulting in increased demand. There are two case in which the Keynes effect does not occur: in the

liquidity trap A liquidity trap is a situation, described in Keynesian economics, in which, "after the rate of interest has fallen to a certain level, liquidity preference may become virtually absolute in the sense that almost everyone prefers holding cash rathe ...

(when the LM curve is horizontal and thus changes in the real money supply do not affect interest rates), and when expenditure is inelastic with respect to (unresponsive to) interest rates (when the IS curve is vertical). The Patinkin-Pigou real balance effect suggests that due to wealth effects of changes in the price level upon spending itself, insufficient demand cannot persist even in the two cases in which the Keynes effect does not operate.

References

Keynesian economics Economics effects {{macroeconomics-stub

See also

References