Banana Parable

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Banana Parable

The banana parable is found both in A Treatise on Money (Keynes 1930) and in John Maynard Keynes’s exposition to the McMillan Committee, which was established in 1930 by Prime Minister Ramsay MacDonald to evaluate the performance of the economy in Great Britain. The committee consisted of senior ministers and outside experts, of which Keynes was one. In the Treatise it is presented as an illustration that saving by itself does not guarantee that investment will increase proportionally. In the explanation to the MacMillan Committee it is presented in relation to a closed or an open economy with a gold standard and in the context of an evaluation of the role of the banking system in effecting saving and investment.

In the 1920s Great Britain experienced high levels of unemployment with large fluctuations in its economy. Keynes turned his attention to those issues in A Treatise on Money, in which he attempted to reexamine the relationships among money, prices, and unemployment. He believed that the main cause of unemployment and economic fluctuations was the relationship of saving to investment. When individuals save more than the amounts businesses want to invest, that leads to excess capacity and too few buyers of the goods produced.

The saving-investment relationship was an important concern that was brought out in Keynes’s “banana parable.” In the story Keyes envisions a simple economy that produces and consumes only bananas and in which “ripe” bananas keep only for a week or two. There is a thrift campaign in that closed economy to increase saving with no corresponding increase in investment in bananas. With the same amount of bananas being produced as before the thrift campaign, savings will lower demand, causing the price to fall. This might seem desirable, Keynes points out, for it may increase saving and reduce the cost of living. However, if wages have not changed along with the falling price, the cost of production becomes greater than the revenue represented by the price and businesses will lose an amount of money equal to the saving rate. The consequence is that businesses need to cut costs by lowering wages or by firing workers, and this only makes matters worse. As the overall income level falls, this pushes the economy into a deeper recession. Keynes argued that the best way out of the economic downturn is for the central bank to pump more money into the economy to increase investment.

This parable presented a significant critique of classical economics by showing that flexible wage rates do not lead automatically to full employment. It also raised questions about the classical view of Say’s law and the relationship between saving and investment. The parable also can be looked at as a demonstration of the neutrality of money wages as brought out in Keynes’s General Theory, in which money wages follow falling prices so that the real wage remains relatively unchanged. The importance of this parable and the way in which it led Keynes to his views in the General Theory on the consumption function and the principle of effective demand is explained by Ingo Barens (1989).

The parable also provides insights into the debate between Friedrich Hayek and Keynes about the market economy. Hayek believed that market forces always align saving and investment in a smooth way unless there are distortions in the markets caused primarily by monetary policy. Keynes saw the economic landscape quite differently, positing that monetary policy and credit creation are absolutely necessary to stabilize the relationship between saving and investment, as is brought out in the parable.

SEE ALSO Involuntary Unemployment; Keynes, John Maynard; Unemployment; Wages

BIBLIOGRAPHY

Barens, Ingo. 1989. From the “Banana Parable” to the Principle of Effective Demand: Some Reflections on the Origin, Development and Structure of Keynes’ General Theory. In Perspectives on the History of Economic Thought; 20^th- Century Economic Thought: Selected Papers from the History of Economics Society Conference, ed. Donald Walker, 111–132. Cheltenham, U.K.: Edward Elgar.