An Analysis of John Maynard Keynes Economic Theory
An Analysis of John Maynard Keynes Economic Theory
An Analysis of John Maynard Keynes Economic Theory
John Maynard Keynes developed the Keynesian theory of economics. The ideas refer to a group of macroeconomic interventions that the government can use to stimulate economic growth during a recession. The ideas were developed during the 1930s when the world was suffering the Great Depression and the classical theories failed to alleviate the situation. The theory was used in the reconstruction of Europe after the Second World War. However, the 1970s oil shocks cast doubts about its effectiveness. Keynesian theory of economics came back to prominence after the 2007-2008 global financial crises. Moreover, global governments had to make direct interventions in the market to avert further economic problems. The failure of the classical economic theories during the 1930s led to the development of the Keynesian theory of economics that guided Europe to recovery after the Second World War and global economic recovery after the 2008-2009 financial crises.
John Keynes developed the Keynesian economic theory during the Great Depression in the 1930s. The publication influenced the economic thoughts of capitalism. The writer was specific about the issues that a country needs to address during challenging economic periods such as recessions and depression. Keynes attacked the ideas that national economies are self-regulating. He advised that governments need to make interventions in the market regularly using monetary policies to stabilize prices and interest rates (Ebenstein, 2003). However, it must avoid involvement in the activities of the private sector, which is the primary drivers of national production (Davis, 1989). He opined that these strategies would stimulate demand, which would increase economic activity and end the great depression.
The Keynesian theory was a new approach to government spending, inflation, and national productivity. Keynes disputed the classical theory that argued that industrial output and employment would always self-regulate. According to classical theorists, a fall in national production results in job losses and the prices of goods and services. The theory further alleges that investors would take advantage of the low levels of employment to inject capital to grow the economy and create employment (Davis, 1989). However, the theory could not explain the great depression, the severity of unemployment, and the high inflation rates. It could also not explain the source of capital that investors would use to invest in the market to stimulate growth. The Keynesian economics approach bridged the gap and was used in the 20th century by most industrial nations to recover from recessions.
Keynesian economics advises government what to do to recover from difficult economic periods. It explains what to do increase employment and the supply of affordable money in the economy. He opined that most characteristics of the free market are likely to get worse during recessions. It would weaken the economy further and plunge the demand for goods and services. The theory disputes the classical economist’s ideas that lower wages can help in the recovery of an economy by increasing the number of workers (Accominotti & Chambers, 2016). He refuted the argument that it is difficult for investors to invest their resources in producing goods in a market that has no purchasing power. Keynes further claimed that poor business conditions cannot inspire a capitalist to use his money in building new plants to sell the products at lower costs later. Economic recession discourages investors take thereby influencing the economy, employment, and interest rates negatively.
Keynes explanation of the Great Depression
Keynes General Theory on economics came out during the Great Depression in the United Kingdom and the rest of the world. Keynes was critical of the activities of the U.K. government during the period because it was cutting expenditure, wages, and increasing taxes. The citizens were critical of capitalism as a system of governance because it left many people disillusioned without work (Spiegel, 1991). During this difficult period, Keynes pointed to a different direction advising governments to be active in alleviating the suffering of the citizens. Keynes opined that national government must spend more resources to stimulate economic growth (Backhouse & Bateman, 2006). Once activities increase in the market, then the private sector would invest more and drive the growth of the country further. As a result, a country can overcome all forms of economic challenges.
According to Keynes, changes in income reflect changes in investment. In most cases, investors decide the on the investment portfolio depending on possible rates of return. As a result, he was critical of the culture of saving more and minimizing expenditure (Spiegel, 1991). He suggested that the best approach was to save for specific purposes such as education or retirement and invest the rest. He thought that the culture was not good because it leads to the underutilizing of resources available to the citizens and the country. The more an individual withholds money from circulating in the economy, the more they interfere with the economic recovery of a nation. Therefore, governments should consider investing funds in critical sectors of the economy rather than saving.
Free markets and classical theorists disagree with Keynes economic theory. The two schools of thought hold the view that markets should regulate in a free market economy. However, they also agree with Keynes that businesses can respond well to incentives in the marketplace because they can return it to a state of equilibrium (Chambers & Dimson, 2013). Keynes was also sure that the government could not wait for the economy to re-engineer it back during extraordinary periods of economic depression. It is crucial for the state to participate in the recovery because it is responsible to the citizens at all times. It cannot leave the welfare of the citizens to the mercies of the market because it may take longer to recover yet elected leaders to have the mandate to resolve issues of concern to the public. Although the free market, classical, and Keynes theories differ in many areas, they agree that the government can play a major role in stimulating economic growth after a recession.
Keynes on Fiscal Policy
Keynes thought that one of the methods that a government can apply in handling cases of economic emergencies is developing fiscal policies. Some of his proposals were on countercyclical budgetary policies, which had multiplier effects in an economy. The most critical role of fiscal stimulus was to increase business activities in a country. If the business made more income, they would still spend in the country and if the process takes place repeatedly, then the economy would improve (Chambers & Dimson, 2013). The theory suggests that spending boasts the aggregate output in an economy and generate more income. The individuals who have more income are likely to spend more in other sectors and improve the economy. Once the workers are willing to pay for goods and services from the wages that they make, the growth that it generates would be greater compared to the initial capital invested by the government. Eventually, the greatest beneficiary of fiscal stimulus is the state because it empowers its people and expands the size of the economy under its control. The government can use various strategies to stimulate the growth of the economy, which increases its influence.
According to the Keynesian theory, the purchasing power of citizens can create employment in an economy. The concept proposes that once one consumer is in a position to spend a certain amount in the economy, then they can generate income for another worker. If the worker uses the wages in the market, they create a chance for another worker to get employment, and the same cycle continues. Keynes suggests that employees working and spending their resources domestically are creating employment than individuals who save and fail to spend their money.
Keynes economic thought was a paradigm shift during the 20th century that disturbed the proponents of classical economists. Most classical theorists fear that the use of fiscal policies can crowd out the private sector from the market (Chambers & Dimson, 2013). Increasing investments in the country lead to a rise in demand for labor and wages, which reduces the profits of firms. Similarly, when governments are operating on deficit budgets, it increases the government bonds that reduce their prices in the market. These developments can lead to an increase in interest rates that makes it more expensive for investors to fund fixed investments. Thus, it is possible to stimulate the economy, but the process could be self-defeating in some cases.
According to the Keynesian theory, it is important to use fiscal policies sparingly, especially during difficult phases characterized by high unemployment rates. They are also important when the inflation rates are high. The most crucial issue in stimulating an economy is raising the market for business output, building cash flow in the business, and eventually making it profitable (Chasse, 1991). The Keynesian theory insists that fiscal policies are necessary as long as they can spur optimism in the market and return confidence in the management of the economy. Keynes thought that the private and public sectors were complements that could not substitute each other. Therefore, when the private sector experiences slow growth, which causes loss of employment, the state must take action to correct the situation.
The GDP of a country increases once the stimulus program starts. These developments further increase the savings available for investment in fixed assets. When the government invests in infrastructure and other programs, the private sector also benefits by getting business from the state (Chasse, 1991). As a result, they can increase the number of employees working in their factories and stores. Therefore, state investment in education, research, and public health result in a productive society that increases its output in the long-term.
Keynes Theory on Monetary Policies
Keynes focus on monetary policy was on the development of a system that can help a country recover from a recession. He argues that it is the duty of the government is to employ people, perform public works, maintain high spending among the people of a society, and provide social security. Keynes was certain that the interventions were critical to save capitalism. It was evident from the experience of the 1920s that the monetary policies were not working to save the British economy from recession (Ebenstein, 2003). At the same time, the classical theorists were not working to stabilize the markets (Dillard, 2018). Wages and employment also take long to respond to the market forces, thereby requiring government interventions to cushion the citizens.
Since markets take long to self-regulate, interventions to increase the supply of money hastens the changes. When interest rates are low, more people in an economy can access credit. After such an intervention, demands for money increases in the short-term and stimulates economic activities. The reinvigorated economic activities continue to assist in the recovery of the economy as well as in creating jobs. According to the Keynesian theorists, it is crucial for the state to make regular interventions in the market. Failure can result in a recession, which would be more expensive (Dillard, 2018). Governments can achieve these objectives if it is vigilant and understands when to intervene and when to let the market regulate itself. Therefore, allowing the market to self-regulate may take longer, which necessitates government intervention to hasten the process.
The Keynesian theory argues that government intervention creates stability because the markets are prone to extreme fluctuations. The monetary policy that keeps interests low allows the government and the private sector to borrow more. When borrowing is encouraged, businesses and individuals record more productivity (Dillard, 2018). On the other hand, the government borrows from the local market to create infrastructure that benefits the public. Moreover, government spending sustains the spending habits that stimulate economic growth. Although lower interest rates lead to economic growth, they fail sometimes, especially when the government is not vigilant.
The concept of lowering interests to spur economic growth may not work if it is not accompanied with investments. The explanation tries to avoid the zero-bound problems. The more the interest rates move towards zero, the less effective it is in stimulating economic growth. Moreover, lending institutions are discouraged by the little income they get from the investment. In fact, they prefer to hold the money in cash or its substitutes such as short-term Treasuries. Japan faced such a situation in the 1990s when the interest rates were low, but failed to stimulate the economy of the country (Dillard, 2018). Low-interest rates fail to spur economic growth when they do not encourage spending and investments.
Keynesian theorists argue that if the monetary policies are not successful, the state should shift to fiscal policies. They also suggest government control in sectors such as the creation of intervention policies to control the supply of labor. The state can also intervene in the market through taxation policies that either increase or decrease market liquidity (Dillard, 2018). It can also place restrictions on the supply of goods and services until it is possible to sustain regular aggregate demands and employment. Therefore, governments should always be ready to shift between monetary and fiscal policies depending on the behavior of the economy.
The developed nations used the Keynesian theory in the latter years of the Great Depression. In the American example, the government invested in the major infrastructure programs through the Leap Forward agenda that helped it recover. After World War II (WWII), the reconstruction of Europe relied heavily on the Keynesian theory. The ideas were used to kick start the economies that collapsed during the war, remove uncertainties, and rebuild the destroyed capital (Steil, 2013). Most of the social-democratic sections of Europe and the U.S. used the Keynesian ideas to reconstruct their economies, which was successful in the 1950s and 1960s.
Keynes was also concerned with the balance of trade among nations. In the 1940s, he participated in the establishment of the Bretton Woods institutions (the World Bank and the International Monetary Fund) as a representative of the British government. He made proposals for the creation of an International Clearing Union to settle outstanding trade balances. The proposal was to create a bank resembling a central bank in a country. Delegates led by the American team did not agree with the design as it did not support liberalism ideas (Steil, 2013). Keynes opined that surpluses in the international market are responsible for weakening global aggregate demands. He also thought that the country deficits in trade were hindrances to international trade that needed correction before they affected most nations negatively. Keynes proposal to have an institution to balance trade could have been a revolutionary way of maintaining economic stability globally but was rejected by larger economies such as the United States.
The Keynesian economic thoughts have shaped the management of most economies in the world since the 1930s. The theory gives suggestions that states can use to overcome short term challenges such as recessions characterized by high unemployment levels and high inflations rates that could destabilize a government. Keynes made the proposals in the 1930s as most countries were struggling to get a formula to get out of the Great Depression. According to Keynes, the productivity of a country allows it to create jobs and control inflation. Therefore, government makes interventions when their economy goes through a period of recession. Examples of such investments were the infrastructure developments made in the United States through the Great Leap Forward programs. Similarly, most European countries used the concept after World War Two to reconstruct their economies. The idea lost its influence during the 1970s stagnation mostly because of the oil shock. However, the financial recession of the 2007 and 2008 led to a relook and reapplication of the ideas that economists call the new Keynesian economics. The Keynesian theory proposed during the great depression allowed many economies to recover but balancing the aggregate demand was problematic.
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