What Is Keynesian Economics?

Keynesian economics is a macroeconomic theory of total spending in the economy and how it affects output𒆙, employment, and inflation. It was developed by British economist John Maynard Keynes during the 1930s in an attempt to deal with the effects of the Great Depression.

The central belief of Keynesian economics is that government intervention can stabilize the economy. Keynes’ theory was the first to sharply separate the study of economic behavior and individual inဣcentives from the study of broad aggregate variables and constructs.

Based on his theory, Keynes advocated for increased government expenditures and lower taxes to stimulate demand and pull the gl🍰obal economy out of the Depression.

Subsequently, Keynesian economics was used to refer to the concept that optimal economic performance could be achieved—and economic slumps could be prevented—by influencing aggregate d𒁃emand through economic in🤪tervention by the government.

Keynesian economists believe that such intervent🧸ion can result in full employme🔥nt and price stability.

Understanding Keynesian Economics

Keynesian economics represented a new way of looking at spending, output, and inflation. Previously, 澳洲幸运5开奖号码历史查询:classical economic thinking held that cyclical swings in employment and economic output create profit opportunities that individuals and entrepreneurs would have an incentive to pursue. In so doing, they would correct imbalances in the economy.

According to Keynes’ view of this so-called classical theory, if 澳洲幸运5开奖号码历史查询:aggregate demand in the economy fell, the resulting weakness in production and jobs would precipitate a decline in prices and wages. A lower level of 澳洲幸运5开奖号码历史查询:inflation and wages would induce employers to make capital investments and employ more people, stimulating employment and restoring 澳洲幸运5开奖号码历史查询:economic growth.

However, Keynes believed that the depth and persistence of the 澳洲幸运5开奖号码历史查询:Great Depression severely tested this hypothesis.

Disagreement with Classical Economics

In his book “The General Theory of Employment, Interest and Money” and other works, Keynes argued against this construct of classical theory, asserting that, during 澳洲幸运5开奖号码历史查询:recessions, business pessimism and certain characteristics of market economies would exacerbate economic weakness and cause aggregate demand to plunge further than it already had.

For example, Keynesian economics disputes the notion held by some economists that lower wages can restore 澳洲幸运5开奖号码历史查询:full employment because labor demand curves slope downward like any other normal demand curve.

Similarly, poor business conditions may cause companies to reduce 澳洲幸运5开奖号码历史查询:capital investment rather than take advantage of lower prices to invest in new plants and equipment. This also would have the effect of reducing overall expenditures and employment.

Keynesian Economics and the Great Depression

Keynesian economics is sometimes referred t🌠o as “depression economics,” as Keynes’ “General Theory” was written during a time of deep depression—not only in his native United King🧜dom, but worldwide.

The famous 1936 book was informed by Keynes’ understanding of events arising during the Great Depression, which Keynes believed could not be explained by classical economic theory as he portrayed 🌠it in his book.

Keynes’ Growing Belief in Govܫernm🌜ent Intervention

Other economists had argued that, in the wake of any widespread downturn in the economy, businesses and investors taking advantage of lower input prices in pursuit of their own self-interest would return output and prices to a state of 澳洲幸运5开奖号码历史查询:equilibrium, unless otherwise prevented from doing so. Keynes believed that the Great D𒁃epression seemed to counter this theor✃y.

Output was low, and unemployment remained high during this time. The Great Depres🧸sion inspired Keynes to think differꦬently about the nature of the economy. From these theories, he established real-world applications that could have implications for a society in economic crisis.

Keynes rejected the idea that the economy would return to a natural🎐 state of equilibrium. Instead, he argued that, once an economic downturn sets in, for whatever reason, the fear and gloom that it engenders among businesses and investors will tend to become self-fulfilling and can lead to a sustained period of depresse🌠d economic activity and unemployment.

In response to this, Keynes advocated a countercyclical fiscal policy by which, during periods of economic woe, the government should undertake 澳洲幸运5开奖号码历史查询:deficit spending to make up for the decline in investment and boost consumer spending to 澳洲幸运5开奖号码历史查询:stabilize aggregate demand.

Criticism o▨f Existing Governme♛nt Policy and Personal Saving

Keynes was highly critical of the British government at the time. The government greatly increased welfare spendingꦏ and raised taxes to balance the national books. Keynes said that this would not encourage people to spen༒d their money, thereby leaving the economy unstimulated and unable to recover and return to a successful state.

Keynes also criticized the idea of excessive saving, unless it was for a specific purpose such as retirement or education. He saw it as dangerous for the economy, because more money sitting stagnant meant less money in the economy stimulating growth. This view was tied t🐈o another of Keynes’ theories geared toward preventing deep economic depressions.

Many economists have criticized Keynes’ approach. They argue that businesses responding to economic incentives will tend to return the economy to a state of equilibrium unless the government prevents them from doing so by interf🐟ering with prices and wages, and making it appear as though the market is self-regulating.

On the other hand, Keynes, who was writing while the wo🥃rld was mired in a long-standing period of deep economic depression, was not as optimistic about the natural equilibrium of the market. He believed that the government was in a better position than market forces when it came to creating a robust economy.

Keynesian Economics and Fiscal Policy

The multiplier effect, developed by Keynes’ student Richard Kahn, is one of the chief components of Keynesian counꦡtercyclical fiscal policy.

According to Keynes’ theory of fiscal stimulus, an injection of government spending eventually leads to added business activity and even more spending. This theory proposes that spending boosts aggregate output and generates more income. If workers are willing to spend their extra income, the resulting growth in 澳洲幸运5开奖号码历史查询:gross domestic product (GDP) could be even greater than the initial stimulus amount.

Keynesian Multiplier

The magnitude of the Keynesian multiplier is direღctly related to the marginal propensity to consume. Spending by consumers becomes income for businesses that then spend on equipment, worker wages, energy, materials, purchased services, taxes, and investor returns. Workers’ income can then be spent, and the cycle continues.

Keynes and his followers believed that individuals should save less and spend more, raising their 澳洲幸运5开奖号码历史查询:marginal propensity to consume to effect full employment and economic growth.

Alternate Views

Keynes’ fiscal stimulus theory was the dominant paradigm in academic economics for decades. Eventually, though, other economists, such as 澳洲幸运5开奖号码历史查询:Milton Friedman and 澳洲幸运5开奖号码历史查询:Murray Rothbard, showed that the Keynesian model misrepresented the relationship between savings, investment, and economic growth. Many economi🌟sts sti💖ll rely on multiplier-generated models, although most acknowledge that fiscal stimulus is far less effective than the original multiplier model suggests.

The fiscal multiplier commonly associated with the Keynesian theory is one of two broad multipliers in economics. The other multiplier is known as the money multiplier. This multiplier refers to the money creation process that results from a system of fractional reserve banking. The money multiplier 🐠is less controversial than its Keynesian fiscal counterpart.

Keynesian Economics and Monetary Policy

Keynesian economics focuses on demand-side solutions to recessionary periods. The intervention of government in economic processes is an important part of the ♑Keynesian arsenal for battling unemployment, underemployment, and low economic demand. The emphasis on direct government intervention in the economy often places Keynesian theorists at odds with those who argue for limited government involvement in the markets.

How It Works

Wages and employment, Keynesians argue, are slower to respond to the needs of the market and require government intervention to stay on track. Furthermore, they argue, prices do not react quickly and change only gradually when monetary policy interventions are made, giving rise to monetarism.

If prices are slow to change, this makes it possible to use the 澳洲幸运5开奖号码历史查询:money supply as a tool and change 澳洲幸运5开奖号码历史查询:interest rates to encourage borrowing and lending. Lowering interest rates is one way that governments can meaningfully intervene in economic systems, thereby encouraging consumption and investment spending.

Short-term demand growth initiated by interest rate cuts reinvigorates the economic system and restores employment and demand for services. The new economic activity then feeds continued growth and employment.

Spending Is Key

Without intervention, Keynesian theorists believe, this cycle is disrupted, and market growth becomes more unstable and prone to excessive fluctuation. Keeping interest rates low is an attempt to stimulate the economic cycle by encouraging businesses and individuals to borrow more money. They then speꦑnd the money that they borrow. This new spending stimulates the economy. Lowering interest rates, however, does not always lead directly to economic improvement.

Downside of Lowering Rates

Monetarist economists focus on managing the money supply and lowering interest rates as a solution to economic woes, but they generally try to avoid the 澳洲幸运5开奖号码历史查询:zero-bound problem. As interest rates approach zero, stimulating the economy by lowering interest rates becomes less effective because it reduces the incentive to invest, rather than simply hold money in cash or close substitutes like short-term 澳洲幸运5开奖号码历史查询:Treasurys.

Interest rate manipulation may no longer be enough to generate new economic activity if it can’t spur investment, and the attempt at generating economic recovery may stall completely. This is a type of 澳洲幸运5开奖号码历史查询:liquidity trap.

When lower interest rates fail to deliver results, Keynesian economists argue that other strategies must be employed, primarily fiscal policy. Other interventionist policies include direct control of the labor supply, changing tax rates to increase or decrease the money supply indirectly, changing monetary policy, or placing controls on the supply of goods and services until employment and demand are restored.

Keynesian Economics and the 2007–08🌞 Financial Crꩲisis

In response to the Great Recession and financial crisis of 2007–2008, the U.S. Congress and the executive branch undertook several measures that drew from Keynesian economic theory. The federal government bailed out debt-ridd𒁏en companies in several industries, including banks, ꦺinsurers, and automakers.

It also took into conservatorship 澳洲幸运5开奖号码历史查询:Fannie Mae and Freddie Mac, the two major m๊arket makers and guarantors of mortg✱ages and home loans.

In 2009, then-President Barack Obama signed the 澳洲幸运5开奖号码历史查询:American Recovery and Reinvestment A🍸ct, an $831 billion government stimulus package designed to save existing jobs and create new ones. It included tax cuts, credits, and unemployment ꦜbenefits for families; it also earmarked expenditures for healthcare, infrastructure, and education.

These stimulus mea✱sures and federal interventions helped America’s economy recover, preventing the Great Recession from becoming another full-blown depression.

The Bottom Line

John Maynard Keynes and Keynesian econo♕mics were revolutionary in the 1930s and did much to shape post-World War II 🎀economies in the mid-20th century. His theories came under attack in the 1970s, saw a resurgence in the 2000s, and are still debated today.

Keynesian economics recognizes the role of government in sparking aggregate demand. For instance, federal spending and tax cuts leave more money in pe🏅ople’s pockets, which can stimulate demand and investment.

Unlike free market economists, Keynesian econom𒈔ics welcomes limited government intervention and stimul𒆙us during times of recession.

Correction—Oct. 6, 2024: This article was corrected to state that monetarism was developed as a rejection and criticism of Keynesian economics, not as a branch of Keynesian economics.