Download John Maynard Keynes

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