Keynesian Economic Theory

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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...
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