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Transcript
2015-01-20 A Contrast to the Classical School of Thought Exploring the Theories of Keynesian Economic Theory: Championed by John Maynard Keynes (1883 – 1946). Published “The General Theory of Employment, Interest, and Money” in 1936. John Maynard Keynes Keynes argued that the economy could settle into an equilibrium at any level of unemployment. (It wouldn’t necessarily move toward fullemployment output.) A primer on Keynesian Economics This meant that classical policies of nonintervention would not always work: especially at particularly low levels of economic activity (i.e. very low levels of aggregate demand and aggregate output). From time to time the economy would need prodding if it was to head in the right direction, and this meant active intervention by the government to manage the level of demand. Classical economists believed that disequilibrium between leakages and injections would be resolved by price levels that would adjust to restore the equilibrium. Keynes, however, believed that it was in fact the level of output (i.e. production levels, GDP) that would adjust to lower levels of demand. If that happened, then the economy could stagnate at that lower level of employment – setting at that state, not unlike hardened cement. Thus, Keynes supported government intervention: particularly the idea of taxing during prosperity, and spending during recession, so that the economy would not be permitted to stagnate at a low level of employment. Criticisms of Keynesian Economics • Crowding Out: Large amounts of government borrowing causes higher interest rates and “crowding out” of private borrowing. • Inflation: Large government expenditures can contribute to inflation. • Time Lag: The results of fiscal (taxing and spending) expansion can come too late (when economy is recovering anyway) and can therefore lead to unanticipated results (such as inflation). • Difficulty Assessing Output Gap: An assumption of Keynesian economics is that it is possible to measure, and fill, an output gap (the shortfall from full employment output). Critics say this is actually quite difficult to measure. • Big Government: In a recession, governments increase spending, but, after recession government spending remains leading to high tax and spend regimes. • Subsequent Deficits: Temporary government spending projects can lead to short-term benefits but long-term maintenance costs. Keynes and the Business Cycle de cli er y peak re co v Keynesian Theory Keynesian theory is best understood as a criticism of, or at least a response to, classical theory. In essence, Keynes argued that markets would not automatically generate full-employment equilibrium. ne trough Keynes believed that the government could use its tremendous economic influence to moderate the economic cycle - making the peaks less aggressive, and the troughs less severe. Specifically, he proposed that a government could implement a system of economic "stabilizers." Stabilizers would be policies that would have the effect of automatically modifying the economic cycle as it traveled through its phases. For example, welfare payments will provide cash inflows during recessions, while taxation would remove cash during periods of economic prosperity) John Keynes: Other Views and Perspectives • Believed an interconnected global economy needed all countries to have strong economies: not a mix of strong and weak. • Argued at the Treaty of Versailles that Germany should not be forced to make war reparations, as this would prevent Germany’s economic recovery – which would be bad for all of Europe. • Wanted to learn how to tame the economy in order to control it. • Came to realize that economies are inherently unpredictable because they are comprised of people who don’t always act in a rational manner. • Identified “herd behaviour” as tendency to act the same as others. • Identified a phenomenon he called “animal spirits” to describe how human emotions impact economic activity. Low animal spirits (apathy) repressed spending, investment, and initiative. • Successfully argued for creation of IMF and World Bank at the Bretton Woods Conference. Failed to convince strong countries to export less and import more in order to balance trade. 1