Keynes’ principal insight into the functioning of the economy was about the problem of effective demand. The problem of the “classical” view of the economy that supply would always create its own demand (“Say’s Law of markets” pace J. S. Mill) is that cybernetic problems can create market failures.
As Axel Leijonhufvud is wont to tell us, there are basically two such situations that arise in the General Theory. First, a fresh act of saving is not an effective demand for future goods. Second, the wishes of the unemployed for consumer goods do not constitute an effective demand. But he also tells us that there is a third effective demand failure that can be very important. This is when the financial system is in a state where for most entrepreneurs it is not possible to exert an effective demand for today’s factors of production by offering future goods. That is, it is not possible to make a deal by saying: ‘I have this investment project that will pay off in the future and I want to trade that prospect for the factors of production today necessary to produce those future goods’. And that’s where we end up if the financial system is totally clogged up with bad loans.
There are basically three reasons: (1) Deregulation, especially the repeal of Glass-Steagall (2) the incorporation of investment banks and limiting the liability of the directors (3) Central Bank CPI targeting whilst the banking system went around the back of authorities to leverage on long-term assets, which were securitised to give them a false quality of liquidity, whose prices were not under the control of the authorities. Since the failure of these investments, there has been little change in monetary policy, except to institute unprecedented financial repression, crushing small savers and allowing banks a dream positive-carry free ride, whose serious distributional consequences Leijonhufvud points out, but which also feeds into funding the increasing government debt used to finance what ends up being a carousel.