Financial Instability and Crises in Keynes’s Monetary Thought

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This chapter explores Keynes’s monetary thought with a focus on financial instability and crises. Keynes’s early monetary work, Indian Currency and Finance (1913), shows his keen concerns for financial instabilities and his appreciation of central banks’ lender-of-last-resort role. In his attack on the Versailles Treaty, The Economic Consequences of the Peace (1919), Keynes analyzes the challenges posed by debt overhangs in the aftermath of World War I and the deflationary strategy for their resolution that is the core of the infamous “peace” treaty. The unfolding of events in the 1920s and 1930s then shaped Keynes’s three major monetary works. A Tract on Monetary Reform (1923) concerns the price-level instability experienced in Britain and elsewhere in the aftermath of WWI, while A Treatise on Money (1930) is set against the backdrop of Britain’s stagnation in the second half of the 1920s following the country’s return to gold at sterling’s prewar parity. Taking a close look at Keynes’s assessments and writings during the Great Depression, the worldwide deflationary environment that is the background to The General Theory (1936), the analysis reveals Keynes’s deep understanding of the havoc wreaked by deflation in banking systems—an issue pushed aside by assumption in that work.