Keynes effect

The Keynes effect is a term used in economics to describe a situation where a change in interest rates affects expenditure more than it affects savings.

As prices fall, a given nominal amount of money will become a larger real amount. As a result the interest rate will fall and investment demanded rises. ^[1]

This means that insufficient demand in the product market cannot exist forever.

There are two cases in which the Keynes effect does not occur: in the liquidity trap (when the LM curve is horizontal), or when expenditure is inelastic with respect to interest rates (when the IS curve is vertical). The Patinkin-Pigou real balance effect suggests that due to wealth effects of changes in price level, insufficient demand cannot persist even in the two cases above.

See also

• Pigou effect
• John Maynard Keynes

References