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.
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.
Famous quotes containing the word effect:
“Reckoned physiologically, everything ugly weakens and afflicts man. It recalls decay, danger, impotence; he actually suffers a loss of energy in its presence. The effect of the ugly can be measured with a dynamometer. Whenever man feels in any way depressed, he senses the proximity of something “ugly.” His feeling of power, his will to power, his courage, his pride—they decline with the ugly, they increase with the beautiful.”
—Friedrich Nietzsche (1844–1900)