The 5 Minute Guide to Keynesian Economics

If the thought of an economic discussion is only slightly more interesting than watching a giant tree sloth do the mambo – wait a second, that actually MIGHT be interesting – then you’re in luck. We’re going to tell you everything you need to know about Keynesian economics in five minutes or less. First of all, the term Keynesian is derived from the last name of a 20th century economist named John Maynard Keynes.

The Big Picture idea of this school of thought is that we should pursue a mixed economy, which he defines as one characterized predominantly by the private sector but with a significant role reserved for government and the public sector. So-called monetarists (classical economists), who espouse a view contrary to Keynesians, begin to get nervous when the government gets too involved with monetary policy. They see the potential for abuse as excessive, and claim monetary policy as it has traditionally been practiced by the Federal Reserve is largely ineffective.

But back to Keynes.

It is interesting to note that the idea of an expanding government role in the economy came into play during the latter part of the Great Depression. Whether or not President Franklin Delano Roosevelt was a true believer in Keynesian thought or just desperate to try anything to get America out of the economic pit she was in could be debated. What is crystal clear is that the government role in the United States economy increased dramatically just prior to the second world war, and continued mostly unabated until President Reagan begin resisting in the 1980’s.

But what did John Maynard Keynes actually advocate?

Getting Out of Depression
Keynes proposed that the way to escape the Great Depression was through a combination of two approaches. First we should reduce interest rates. Secondarily, the government should begin investing in infrastructure, which injects income into the economy, creating increased spending by the public. Theoretically, this increased spending stimulates business investment, along with more production to meet the increased demand. This cascade of events jumpstarts a moribund economy and, voila, no more Great Depression.

But World War II came along about the time FDR was putting his Keynesian ideas into practice and shook up the whole basket. The government was forced to radically ramp up spending in order to manufacture equipment and supplies needed for war activities. Subsequent attempts to spend ourselves out of recession, such as efforts currently underway by the Obama administration, have been less effective without a war to help out.

Moderate Boom and Bust Cycles
One of the central Keynesian concepts is that it takes an active government monetary policy to stabilize the economy against the natural boom and bust cycle of business. On a chart, Keynes would seek to keep the amplitude of the graph from reaching peaks and troughs, preferring to see it as a series of small, gentle waves continuously lapping against the shore of fiscal serenity.

The Keynesian approach to economic woe would be:

1. Increased government spending increases demand.

2. Higher demand increases overall economic activity.

3. Lower unemployment and reduced deflation are a natural result.

According to this theory, when unemployment is high, the government should begin expanding activity designed to stimulate the public into parting with more of their money. In other words, spend, spend, spend!

Too Much Saving
Excessive saving, which Keynes deemed to be anything beyond money needed for predictable needs like retirement or education, was a serious problem for the economy, and would likely result in recession or even depression. Saving means people are not spending, and when there’s not enough spending going on, the economy declines.

Don't Balance That Budget
The idea of a balanced governmental budget, which is so important to classical economists, was lost on Keynes, who was convinced that such an economic state was something to be avoided – it would only exacerbate the underlying problem. According to Keynesian theory, monetary policy should always be either expanding or contracting, but never reach equilibrium. He advocated a countercyclical fiscal policy, that is, one that always acted against the current business tide. In other words, the government should undertake deficit spending when an economy is in recession, and either increase taxes or cut spending during boom times.

As might be expected, classical economists and free market advocates have a big problem with some characteristics of the Keynes approach, since it places the government in the superior position to free market forces when it comes to creating a robust economy. It’s the age old argument of intervention versus non-intervention and we’re not any closer to finding a mutual solution than we were back when Keynes was whispering in FDR’s ear.

The American Monetary Association Team

Flickr / aldenjewell

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