Keynesian Economic Theory

Major Schools of Economic Theory: Keynesian

In laymen’s term, the main belief of Keynesianism is that when the free market fails, the government should spend money it doesn’t have to stimulate and balance the economy. Unlike Classicists, John Maynard Keynes believed that collective demand of the people determined the economy’s activity and that in adequate demand would lead to high, drawn out periods of unemployment. The theory was adopted post WWII by western nations (1950-1960’s) and later by most capitalist governments. In the 1970’s many governments began to jump ship when highly respected economists questioned the ability of the government to regulate business cycles. Today, this school of economics can nonetheless, still be found worldwide in many dynamics of a national economy. Whether it is the right policy to be utilized has always been in question and will probably remain to be until adequate proof of its success or failure can be established.
Keynes adamantly argued against the gold standard post WWI. In Britain 1920, he advocated a fiscal response where government could create jobs by spending on public works. In that time, his views had limited effect on policy makers and academic opinion. He claimed the gold standard could lead to deflation at a time economy needed expansion to prevent rising unemployment. The banks disagreed and eventually the gold standard had the depressing effect he predicted.
Not until during the Great Depression did he analyze the relationship between unemployment, money and prices, primarily based on his experience in Britain. He published, Treatise on Money in 1930. This brought about the point that if the amount of money saved exceeds the amount being invested (spent), unemployment will rise. This would be as a result of people not wanting to spend and consequently, making it difficult for employees to make profit, causing them to lay-off workers and increasing unemployment. A ferocious cycle.
In 1933, during the Great Depression, he published his take on how to tackle the cycle. It was titled The Means to Prosperity. Both Britain and the US were sent copies, but it proved to be too diverse to be agreed upon. Nonetheless, this period provided the best opportunity for Keynes to test his theory of counter cyclical public spending. Despite having senior economists against his theory and marginal influence in the US economy, Keynes published The General Theory of Employment, Interest and Money, in 1936. He stated that the classical economic theory that supply creates its own demand was only correct in specific or special situations. That his theory, which was quite the opposite, should be considered a more general theory, hence the title.
The theory argues that it is demand, not supply, that ascertains the economy. That non-hoarded money in a society is decided by the sum of consumption or investment. He states that government intervention, - and this is where most find reason to begin to detract from the theory,- was necessary to increase (not deflate) expenditures. That the economy, otherwise, would be trapped in high unemployment. In other words, when people spend their earnings, the money spent is another person’s earnings. It is a basic cycle. When people lack confidence in an economy during bad times, they tend to save or hoard money. This decreases the earnings of others, making already bad conditions worse. Keynes solution was simple: Make money more available to people. If they have more money, they will spend it. This creates more confidence and helps get back to normal flow. He believed it was the banks job to get the expanded money into people’s pockets during a recession and in desperate times such as a depression; it fell to the mercy of the government.
Keynes pitched this idea to President Roosevelt but was respectfully rejected. It was the start of WWII that probably ended the recession. War = Jobs. The “New Deal” promised and enacted by the Roosevelt presidency, shows signs of Keynesian. For instance the Federal Emergency Relief Act established the Federal Emergency Relief Administration to distribute $500million to states and localities for relief. Eventually, that agency put out about $3 billion. There was the creation of the US Employment Services, and Homeowners Refinancing Act. Also, the Civil Works Administration, which provided funds to city and state leaders for public projects, including construction, restoration and other. There were many more examples of the government intervening and providing cash directly or indirectly to revive the economy – or as it’s commonly called, “priming the pump” (New, 2010).
This leads back to the opening statement of this essay that the government should spend money it doesn’t have. Interestingly enough, in 1916, government spending was $697million. In 1936, it was $9 billion! (New, 2010) The National debt rose to uncharted heights. How much influence Keynes had on FDR is not known, but again, it was the United States entering the war that eventually got the nation back on track. Large scale production of military equipment and such aided the nation back to a more normal cycle.
Many leading economists and macroeconomic thinkers alike are against Keynesian still today. The opinion of one blogger points out an argument of the current unemployment situation. This is a prime example of the classicist vs. Keynesian debate. The Keynesian point of view tells us that there are five unemployed…for every available job and thus the free market can’t absorb the unemployed. Since the free market can’t adequately provide the unemployed a wage, then the government policy must step in or else all is lost. Not extending this important government policy would be cruel…since…four out of five unemployed would have no ability to earn a wage. The implication...is that without government policy, there will inevitably be four homeless, starving individuals for each newly employed worker…Since the enacted unemployment insurance policy currently assumes that there is no choice on the part of the worker, four out of five are doomed to failure as the Keynesians argue, then this policy is simply providing a salary for which some work should have been required. (Top, 2010)
In the case of unemployment insurance, one wonders if the school of Keynesian simply did not add into the equation the dynamism of the individual spirit. In tough times, people who have the opportunity and ability to recreate themselves, will. Secondly, while unemployment provides for the individuals missing wage, it does not provide for the individual to earn that wage. Also, if out of work long enough, wouldn’t an individual adjust their wage request in order to attain employment? Personal experience tells me this theory is true in most cases. Having been unemployed the past 7 months, I have significantly lowered my ‘asking price’ to what the market is offering.
That last scenario pointed out an example of what possibly would happen in a matter of time. Another case in point that goes to prove the omission of the factor of time from the Keynesian theory was done by a study in an Austrian school of economists who “counter (Keynesian). They explain reduction in demand by introducing time into their analysis. People may reduce the present demand for consumer goods and use the savings to increase their future consumption. The savings today enable the funding of future investments that allow an increase in production to help meet the future demand for more goods. The lower the demand today need not cause unemployment. Workers can shift from industries that produce consumption goods to industries that produce capital goods.” (Temp, 2010)
Keynes argued that expenditures should be inflated in order to bring more profit and allow businesses to hire more employees. The Austrian school states “Deflation is not inherently undesirable. Lower process means that more people can afford consumption goods. In fact, lower prices should come to be expected as, over time, the production prices for specific goods become more efficient because of experience” (Temple, 2010)
According to Richard Epstein “The motivation of individuals are, of course, not amenable to public intervention, but the rules that either shackle or encourage innovation are” (Epst, 2010) His opinion “is that we must start dismantling these programs if we as a nation are to get out of the long term stagflation (or inflation?) that is overdue” That government intervention is creating insecurity and sapping the confidence that it’s supposed to be building!
Keynesian methods have been used in economic policies in one form or the other in many US Presidencies, from the afore mentioned F.D. Roosevelt, to the stimulus packages of G.W. Bush and President Obama. Social Security and Unemployment insurance, Medicaid and Medicare and Public Pension are all forms of government intervention and all are very debatable programs. Most people agree to disagree on the affects of Keynesian policies. In any effect, it is hard to find valid successes or failures of this school of thought. It seems that this theory, along with the others- whether it is classical, laisse-faire, Marxist or any of the others- all are very case specific economic theories. Meaning depending on the causes of the economic down-turn, one or the other theory may work. The other day I awakened with severe nasal congestion. I took a Claritin because it worked for me earlier in the year when I had this symptom. Well, guess what? Last time, I was suffering from allergies. It was spring time after all. This occasion, I had a legitimate cold and found I was better off after I took some Nyquil. My point is research might make one conclude that a lot of governments resort to what seemed to have worked in the past, rather than analyzing out the legitimate causes and figuring out a respectful solution.
The debate on unemployment and what is the best course of action to dispel it will remain argumentative for an infinite time. Some believe the support the government gives is unnecessary or at best overzealous. They believe one big omission from Keynes general theory was a warning against such misguided government intervention. That it fails to trust that human motivation and innovation will kick in, but that instead they will forever be doomed without aid. The idea that jobless citizens will not reinvent themselves to merge back in the free market is pretty foolhardy. There’s ongoing inquiry similar to the chicken or the egg, as to whether government assistance is there as a helping hand to people who can’t help themselves, or whether people choose not to help themselves because of the government assistance. Others believe that the intervention is necessary simply for ‘pump priming’. That it will get people consuming. This spending will in turn, jump start the economy. All the theories have weight as well as have a place in a troubled economy. It’s when, where and to what extent to use them that remains unsolved. One last quote comes from the contribution of Tony Lawson, a point he made was “that you need to use different kinds of models for different situations. Maths isn’t neutral: it is a particular way of structuring reality. It requires what (he) called “event regularity”. But social reality is not typically like that. It is open, not closed, it is emergent, it is meaningful, it is “valuey”. Economics should not give up maths, but should understand the limits of its applicability to economic problems.” (Skid, 2010) Either way, I am glad I’m not an economist.

WORKS CITED

1. Tempelman, J.. "Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles, and Busts. Financial Analysts Journal 66.6 (2010): 101-102. ABI/INFORM Global, ProQuest. Web. 30 Dec. 2010.
2. Skidelsky, R.. "Why markets need governments. " Organisation for Economic Cooperation and Development. The OECD Observer 279 (2010): 13-14. ABI/INFORM Global, ProQuest. Web. 30 Dec. 2010.
3. Top, S.A. (2010, August 10) Keynesian Policy Junkies and Working Off Extended Unemployment Benefits. Retrieved December 28, 2010, from Seeking Alpha: http://seekingalpha.com
4. Epstein, Richard A. "WHY I WILL NEVER BE A KEYNESIAN." Harvard Journal of Law & Public Policy 33.2 (2010): 387-406. Academic Search Elite. EBSCO. Web. 30 Dec. 2010.
5. The New Deal: Presidents, 1933-1938. Retrieved December 27 2010, from United States History: http://u-s-history.com

Cited: 1. Tempelman, J.. "Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles, and Busts. Financial Analysts Journal 66.6 (2010): 101-102. ABI/INFORM Global, ProQuest. Web. 30 Dec. 2010. 2. Skidelsky, R.. "Why markets need governments. " Organisation for Economic Cooperation and Development. The OECD Observer 279 (2010): 13-14. ABI/INFORM Global, ProQuest. Web. 30 Dec. 2010. 3. Top, S.A. (2010, August 10) Keynesian Policy Junkies and Working Off Extended Unemployment Benefits. Retrieved December 28, 2010, from Seeking Alpha: http://seekingalpha.com 4. Epstein, Richard A. "WHY I WILL NEVER BE A KEYNESIAN." Harvard Journal of Law & Public Policy 33.2 (2010): 387-406. Academic Search Elite. EBSCO. Web. 30 Dec. 2010. 5. The New Deal: Presidents, 1933-1938. Retrieved December 27 2010, from United States History: http://u-s-history.com