"Keynes's theory, and its application to our current economic plight, is best understood if one bears in mind one historical fact and three claims that he made in the book. The historical fact is that England, between 1919 and 1939, experienced persistent high unemployment--never less than 10 percent, and 15 percent in 1935, when Keynes was completing his book. Explaining the persistence of unemployment was the major task that Keynes set himself. Though he famously declared that "in the long run, we are dead," he tried to solve a problem that, already when he wrote, had had a pretty long run.
The three claims are, first, that consumption is the "sole end and object of all economic activity," because all productive activity is designed to satisfy consumer demand either in the present or in the future. "Consumption" is not in the title of the book, however, because the only thing that interested Keynes about it was how much of their income people allocated to it--the more the better, as we will see. The second claim is the importance (and the deleterious effect) of hoarding. People do not save just to be able to make a specific future expenditure; they may also be hedging against uncertainty. And the third claim, related to the second, is that uncertainty--in the sense of a risk that, unlike the risk of losing at roulette, cannot be calculated--is a pervasive feature of the economic environment, particularly with respect to projects intended to satisfy future consumption.
A nation's annual output, which is also the national income, is the market value of all the goods (and services, but to simplify the discussion I will ignore them here) produced in a year. These goods are either consumption goods, such as the food people buy, or investment goods, such as machine tools. What people do not spend on consumption goods they save: income minus consumption equals savings. Since income minus consumption also equals investment, savings must, Keynes insists, equal investment. But equating savings with investment is confusing. If you stuff money under your mattress, you are saving, but in what sense are you investing? If you buy common stocks, you are investing, but the contribution of your investment to the productive capital employed in building a factory is attenuated.
At the very least, we should (and Keynes implicitly does) distinguish between enabling productive investments and actually making them; or, equivalently, between passive investment and active investment. If you deposit some of your savings in a bank, the bank--not you--will decide whether to lend the money to a businessman to invest in his business (or to an individual to invest in buying a capital asset, such as a house). Still, the money is invested. Even the money you stuff under your mattress can be considered a form of investment, for in all likelihood it will be spent eventually (though perhaps not for generations), and thus, like all investment, it is an aid to future consumption. But as in this example, passive investment may take a long time to stimulate active investment.
The lag can retard economic growth. Income spent on consumption, in contrast to income that is saved, becomes income to the seller of the consumption good. When I buy a bottle of wine, the cost to me is income to the seller, and what he spends out of that income will be income to someone else, and so on. So the active investment that produced the income with which I bought the wine will have had a chain-reaction--what Keynes calls a "multiplier"--effect.
And here is the tricky part: the increase in income brought about by an investment is greater the higher the percentage of income that is spent rather than saved. Spending increases the incomes of the people who are on the receiving end of the spending. This derived or secondary effect of consumption is greater the higher the percentage of a person's income that he spends, and so it magnifies the income-generating effect of the original investment. If everyone spends 90 cents of an additional dollar that he receives, then a $1 increase in a person's income generates $9 of additional consumption ($.90 + $.81 [.9 x $.90] + $.729 [.9 x $.81], etc. = $9), all of which is income to the suppliers of consumer goods. If only 70 cents of an additional $1 in income is spent, so that the first recipient of the expenditure spends only 49 cents of the 70 cents that he received, the second 34.4 cents, and so on, the total increase in consumption as a result of the successive waves of spending is only $1.54, and so the investment that got the cycle going will have been much less productive. In the first example, the investment multiplier--the effect of investment on income--was 10. In the second example it is only 2.5. The difference is caused by the difference in the propensity to consume income rather than save it. (No one today, by the way, thinks that investment multipliers are that high.)
For a confidence-building public-works program to be effective in arresting an economic collapse, the government must be able to finance its increased spending by means that do not reduce private spending commensurately. If it finances the program by taxation, it will be draining cash from the economy at the same time that it is injecting cash into it. But if it borrows to finance the program (deficit spending), or finances it with new money created by the Federal Reserve, the costs may be deferred until the economy is well on the way to recovery and can afford to pay them without endangering economic stability. When investors passively save rather than actively invest, government can borrow their savings (as by selling them government bonds) and use the money for active investment. That is the essential Keynesian prescription for fighting depressions."
-More Here (I wish, I read this piece in 2009; I guess it's never too late)
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