Keynesian economics

Keynesian economics (/ˈkeɪnziən/ KAYN-zee-ən; sometimes called Keynesianism) is a group of various macroeconomic theories about how in the short run – and especially during recessions – economic output is strongly influenced by aggregate demand (total demand in the economy). In the Keynesian view, named for British economist John Maynard Keynes, aggregate demand does not necessarily equal the productive capacity of the economy; instead, it is influenced by a host of factors and sometimes behaves erratically, affecting production, employment, and inflation. Keynesian economics served as the standard economic model in the developed nations during the later part of the Great Depression, World War II, and the post-war economic expansion (1945–1973), though it lost some influence following the oil shock and resulting stagflation of the 1970s. The advent of the financial crisis of 2007–08 caused a resurgence in Keynesian thought, which continues as new Keynesian economics. Keynesian economics developed during and after the Great Depression from the ideas presented by Keynes in his 1936 book, The General Theory of Employment, Interest and Money. Keynes contrasted his approach to the aggregate supply-focused classical economics that preceded his book. The interpretations of Keynes that followed are contentious and several schools of economic thought claim his legacy. Keynesian economists generally argue that as aggregate demand is volatile and unstable, a market economy often experiences inefficient macroeconomic outcomes in the form of economic recessions (when demand is low) and inflation (when demand is high), and that these can be mitigated by economic policy responses, in particular, monetary policy actions by the central bank and fiscal policy actions by the government, which can help stabilize output over the business cycle. Keynesian economists generally advocate a managed market economy – predominantly private sector, but with an active role for government intervention during recessions and depressions. John Maynard Keynes (1883–1946) set forward the ideas that became the basis for Keynesian economics in his main work, The General Theory of Employment, Interest and Money (1936). It was written during the Great Depression, when unemployment rose to 25% in the United States and as high as 33% in some countries. It is almost wholly theoretical, enlivened by occasional passages of satire and social commentary. The book had a profound impact on economic thought, and ever since it was published there has been debate over its meaning. Keynes begins the General Theory  with a summary of the classical theory of employment, which he encapsulates in his formulation of Say's Law as the dictum 'Supply creates its own demand'. Under the classical theory, the wage rate is determined by the marginal productivity of labour, and as many people are employed as are willing to work at that rate. Unemployment may arise through friction or may be 'voluntary,' in the sense that it arises from a refusal to accept employment owing to 'legislation or social practices ... or mere human obstinacy', but '...the classical postulates do not admit of the possibility of the third category,' which Keynes defines as involuntary unemployment. Keynes raises two objections to the classical theory's assumption that 'wage bargains ... determine the real wage'. The first lies in the fact that 'labour stipulates (within limits) for a money-wage rather than a real wage'. The second is that classical theory assumes that, 'The real wages of labour depend on the wage bargains which labour makes with the entrepreneurs,' whereas, 'If money wages change, one would have expected the classical school to argue that prices would change in almost the same proportion, leaving the real wage and the level of unemployment practically the same as before.' Keynes considers the second objection more fundamental, but his expectation concerning the classical school contradicts the quantity theory of money, and most commentators concentrate on his first objection. Saving is that part of income not devoted to consumption, and consumption is that part of expenditure not allocated to investment, i.e., to durable goods. Hence saving encompasses hoarding (the accumulation of income as cash) and the purchase of durable goods. The existence of net hoarding, or of a demand to hoard, is not admitted by the simplified liquidity preference model of the General Theory.