Keynesian economics

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Keynesian economics

An economic theory of British economist, John Maynard Keynes that active government intervention is necessary to ensure economic growth and stability.

Keynesian Economics

A theory stating that government intervention is necessary to ensure an active and vibrant economy. According to this theory, government should stimulate demand for goods and services in order to encourage economic growth. It thus recommends tax cuts and increased government spending during recessions to reinvigorate growth; likewise, it recommends tax increases and spending cuts during economic expansion in order to combat inflation. Many economists believe that Keynesian economic theory is more efficient than supply-side economics, though critics point to the theory's inability to explain stagflation in the United States during the 1970s.


The view held by KEYNES of the way in which the aggregate economy works, subsequently refined and developed by his successors.

Much of what is today called Keynesian economics originated from Keynes’ book The General Theory of Employment, Interest and Money (1936). Keynes gave economics a new direction and an explanation of the phenomenon of mass unemployment so prevalent in the 1930s. Economic doctrine before Keynes was based primarily upon what is now termed MICROECONOMICS. Keynes switched from the classical concentration on individual prices and markets and individual demand functions to aggregate analysis, introducing new concepts such as the CONSUMPTION FUNCTION.

The classical economists argued (and were officially supported by the monetary authorities, up to the time of accepting Keynes’ arguments) that FULL EMPLOYMENT is the result of a smooth-working PRIVATE-ENTERPRISE ECONOMY. If UNEMPLOYMENT occurred, then WAGES would fall (because of competition in labour markets) to such an extent that unemployed labour would be re-employed (the neoclassical analysis that marginal productivity of labour would now exceed or equal its marginal cost). Keynes introduced the possibility of ‘rigid wages’ in an attempt to explain what was inconceivable to classical and neoclassical economists, general equilibrium within the economy at less than full employment.

Keynes argued that INCOME depends upon the volume of employment. The relationship between income and CONSUMPTION is defined by the PROPENSITY TO CONSUME.

Consumption, therefore, is dependent upon the interrelated functions of income and employment. Anticipated expenditure on consumption and INVESTMENT is termed AGGREGATE DEMAND and, in a situation of equilibrium, equals AGGREGATE SUPPLY. Keynes is of the opinion that, in a state of equilibrium, the volume of employment was dependent upon the aggregate-supply function, the propensity to consume and the amount of investment. The level of employment would therefore increase if either the propensity to consume increased or the level of investment increased, i.e. greater demand for consumer and producer goods leads to an increase in supply. Increasing supply tends to lead to higher levels of employment.

The difficulty of reducing wages (because of trade union pressure to maintain living standards) means that ‘rigidity of wages’, or WAGE STICKINESS, may lead to a situation of equilibrium at less than full employment. Where this occurs, the government, as a buyer of both consumer and producer goods, can influence the level of aggregate demand in the economy. Aggregate demand may be increased by FISCAL POLICY or MONETARY POLICY. Keynes placed the emphasis on fiscal policy whereby the government spends more on investment projects than it collects from taxes. This is known as DEFICIT FINANCING and stimulates aggregate demand when the economy finds itself in a condition of DEPRESSION. Through the MULTIPLIER effect, the stimulus to aggregate demand is a number of times larger than the initial investment. The effect is to move the economy towards a situation of full employment.

Certain Western countries began to question Keynesian economic ideas in the 1970s as they embraced MONETARISM and began to revert to the classical economic idea that government intervention is unnecessary and that markets can ensure prosperity, provided that market rigidities are removed. See EQUILIBRIUM LEVEL OF NATIONAL INCOME, BUSINESS CYCLE, CIRCULAR FLOW OF NATIONAL INCOME, CLASSICAL ECONOMICS, DEFLATIONARY GAP, MONEY SUPPLY/ SPENDING LINKAGES, QUANTITY THEORY OF MONEY, I-S/L-M MODEL, SAY'S LAW, INFLATIONARY GAP, SUPPLY-SIDE ECONOMICS.

References in periodicals archive ?
Some readers may recall that there was much scoffing at predictions from Keynesian economists, myself included, that interest rates would stay low despite huge budget deficits; that inflation would remain subdued despite huge bond purchases by the Fed; that sharp cuts in government spending, far from unleashing a confidence-driven boom in private spending, would cause private spending to fall further.
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Keynesian economists argue, however, that government can use increases in transfer payments to cushion business slumps in the same way that it can use increases in its purchases of final goods and services because increases in transfer payments augment personal income and stimulate greater consumption spending, hence greater investment spending, and therefore, from both sources, an increase in GDP.
To be sure, more liberal, Keynesian economists, who believe that government spending is a strategic weapon in the fight against unemployment and stagnation, contend that the Obama administration and the Fed have not gone far enough to jumpstart the economy with their stimulus and monetary initiatives.
At the same time, Keynesian economists proffered the promise of full employment, taken to be 4 percent unemployment, at an acceptable cost in terms of inflation.
Also, Keynesian economists widely predicted that a large decline in federal spending after the war, with millions of soldiers returning home and armament industries laying off workers, would result in a return to high unemployment and depression (Nasar 2011: 385-86).
I think both parties are Keynesian economists and support positions that I do not like.
Three-hundred and sixty-four Keynesian economists signed a statement in The Times decrying the move and predicting economic collapse.
While Keynesian economists have been advocating government intervention and stimulation through liquidity, economists like Faber are warning that the consequences will manifest themselves in huge volatility.
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The only purpose of having a core CPI is for Keynesian economists like Krugman to use it to mislead Americans and deceive them into believing that inflation is not a problem.
Such a strategy ignores the advice of Keynesian economists to use public works as a means of investing through a recession and risks damaging the recovery by eliminating business opportunities.