Keynesian Theory of Trade Cycle: 7 Major Criticisms

The following points highlight the seven major criticisms of the Keynesian theory of trade cycle. Some of the criticisms are: 1. Half the Explanation 2. Psychological Theory in a New Form 3. Neglect of the Role of Accelerator 4. No Explanation of the Trend of Growth with Business Cycles and Others.

Keynesian Theory of Trade Cycle Criticism # 1. Half the Explanation:

A complete theory of the trade cycle must explain not only the turning points of the trade cycle but also the periodicity of the business cycle.

Keynes could not explain the latter. Periodicity means the period from depression to boom of the various trade cycles.

Some cycles are of five years while others are of ten years duration. Why does this time span of the cycles differ? Keynes could not explain this.

Keynesian Theory of Trade Cycle Criticism # 2. Psychological Theory in a New Form:

Keynes told us that the major cause of the burst of a boom is the over-optimism of the business community. It brings about the sudden collapse of the MEC. Likewise, Keynes asserted that recovery will start only after the confidence of the investors in investment profitability gets restored. This brings Keynes’s theory very near to the psychological theory of trade cycles given by some classical writers.

Keynesian Theory of Trade Cycle Criticism # 3. Neglect of the Role of Accelerator:

Keynes explained the cumulative nature of the upswing and downswing through his concept of investment multiplier. But income does not increase or decrease through the multiplier process alone. ‘Accelerator’ which can be called the process of induced investment is also instrumental in bringing about rapid changes in income.

In fact, Clark had discussed the role of accelerator much before Keynes wrote his ‘General Theory’. But Keynes did not incorporate this concept in his theory. Later on, Samuelson could show with the help of an exercise that multiplier accelerator interaction is capable of generating different types of trade cycle under different values.

Keynesian Theory of Trade Cycle Criticism # 4. No Explanation of the Trend of Growth with Business Cycles:

It has been noticed that all private-enterprise economies continue to grow while they suffer from cyclical fluctuations in economic activity. Keynes provided the concept of equilibrium level of income for the short period. He avoided discussing growth with business cycles.

This deficiency in Keynes’ analysis was removed by Professor Roy Harrod who distinguished between three rates of growth of the economy the actual rate of growth, the warranted rate of growth and the natural rate of growth. This way he could explain simultaneously both growth and trade cycles.

Keynesian Theory of Trade Cycle Criticism # 5. Asymmetry of the Expansion and the Contraction Phases:

It has been observed that the rate of rise in income during the expansion phase is much more than the rate of fall of income during the contraction phase. There is an asymmetry here which Keynes did not record or analyse. Prof. Hicks provided an explanation of the same in his theory of the trade cycles. This asymmetry is due to the inactivity of accelerator in the downturn.

Keynesian Theory of Trade Cycle Criticism # 6. Neglects the Theory of Capital:

Keynes observed that the duration of contraction is related definitely to the life of capital assets and the carrying costs of inventories. But he did not care to introduce this aspect of the theory of capital in his theory of the business cycles.

Prof. Von Hayek had given a theory of the business cycles which was entirely based on the changes in the nature of capital assets and product techniques during booms and depressions. But Keynes stuck to his liquidity preference theory of the rate of interest thereby rejecting the real theory of the rate of interest. This left his theory incomplete.

Keynesian Theory of Trade Cycle Criticism # 7. Doubtful Efficacy of the Anti-cyclical Policy:

Keynes advocated a cheap- money policy along with the policy of public works for fighting a depression. His policy was successful in many countries. But his policy did not prove to be successful against inflation. In fact, Keynes’ ‘General Theory’ was depression economies.

It did not analyse well the nature of booms and as such could not provide a satisfactory anti-inflationary policy. Rather it was felt that the classical policy proved to be better during inflation.

We can conclude by saying that Keynes gave us valuable insights into the theory of business cycle in his ‘General Theory’. He never intended to deal with the problem exhaustively. His main occupation was to provide the analytical tools for such a theory.

In this lie did commendable work. It was on the foundations laid down by Keynes that Professors Hicks, Goodwin and Mathews could build the modern theories of the trade cycle.