According to Keynesian theory, what is the typical behavior of aggregate demand, and what are the consequences?

Keynesian economists generally believe that aggregate demand is volatile and unstable. This instability can lead to inefficient macroeconomic outcomes, such as recessions when demand is too low, or inflation when demand is too high. These fluctuations can be mitigated by government and central bank policies.

What is the preferred economic system according to Keynesian economists?

Keynesian economists generally favor a regulated market economy. This typically involves a predominantly private sector, but with a significant and active role for government intervention, particularly during economic downturns like recessions or depressions.

When and from whose work did Keynesian economics primarily develop?

Keynesian economics developed during and after the Great Depression, stemming from the ideas presented by British economist John Maynard Keynes in his influential 1936 book, *The General Theory of Employment, Interest and Money*.

How did Keynes's approach contrast with the prevailing economic thought of his time?

Keynes's approach, focusing on aggregate demand, was a significant departure from the preceding classical economics, which primarily focused on aggregate supply and assumed that economies would naturally self-correct to full employment.

What are some of the newer directions or developments in Keynesian thought?

In recent decades, Keynesian thought has evolved with Post-Keynesian and New Keynesian economists introducing concepts like income distribution, labor market frictions, and institutional reform. Scholars have also explored how uncertainty, expectations, and psychological factors like "animal spirits" influence investment and demand.

What was the historical period during which Keynesian economics served as the dominant macroeconomic model?

Keynesian economics, as part of the neoclassical synthesis, was the standard macroeconomic model in developed nations from the later part of the Great Depression through World War II and the post-war economic expansion, roughly from the 1930s to the early 1970s.

What economic events led to a decline in the influence of Keynesian economics?

The influence of Keynesian economics waned following the oil shock of 1973 and the subsequent stagflation (high inflation combined with high unemployment) of the 1970s, which challenged the predictions and policy prescriptions of traditional Keynesian models.

How did Keynesian economics re-emerge or adapt in response to later economic challenges?

Keynesian economics was redeveloped into New Keynesian economics, becoming part of the contemporary new neoclassical synthesis that informs mainstream macroeconomics. The 2008 financial crisis also sparked a resurgence of interest in Keynesian ideas, leading to increased government intervention globally.

What were the key macroeconomic variables studied in pre-Keynesian macroeconomics?

Pre-Keynesian macroeconomics focused on variables such as the overall price level, the interest rate, the level of employment, and income or output measured in real terms. These were often analyzed through separate, partial equilibrium theories.

What was the classical tradition's approach to analyzing the economy?

The classical tradition typically analyzed the economy by dividing it into separate markets, each with its own equilibrium conditions. This approach used supply and demand curves, as developed by economists like Fleeming Jenkin and Alfred Marshall, and generalized into general equilibrium theory by the Lausanne School.

What specific classical theories did Keynes aim to supplant?

Keynes sought to challenge and replace three core aspects of classical theory: the Quantity Theory of Money, which determined the price level; the classical theory of the interest rate; and the principle that wages equal the marginal product of labor, which determined employment levels.

What were some precursors to Keynesian economics, and what was their focus?

Precursors to Keynesianism included underconsumption theories from authors like John Law and Thomas Malthus, as well as the Birmingham School and American economists Foster and Catchings. These thinkers were concerned with the failure of aggregate demand to meet potential output, advocating for economic interventionism.

What was Keynes's unique contribution in relation to earlier economic ideas?

While earlier economists had proposed ideas similar to Keynes's, such as the paradox of thrift and government deficit spending, Keynes's unique contribution was providing a comprehensive "general theory" that integrated these concepts and gained acceptance within the economic establishment.

What was Keynes's view on the automatic self-correction of the economy?

Keynes argued against the classical tenet that economies automatically return to a state of general equilibrium and full employment. He contended that the economy could become stuck below its potential output due to insufficient aggregate demand, necessitating government intervention.

What is the 'paradox of thrift', and who discussed it prior to Keynes?

The paradox of thrift describes how individual attempts to save more during an economic downturn can collectively lead to lower aggregate demand and thus lower overall income, potentially resulting in less total saving. J. M. Robertson discussed this concept as early as 1892.

What is the 'multiplier' concept in Keynesian economics, and who developed it?

The multiplier concept, developed by Richard Kahn and later refined by Keynes, suggests that an initial increase in spending (like government investment) leads to a larger increase in overall economic income due to a chain reaction of secondary spending. Kahn's initial formulation was termed the "employment multiplier" and was later renamed the "multiplier" at Keynes's suggestion.

How did Keynes's *General Theory* address the problem of unemployment?

Keynes's *General Theory* proposed that unemployment could arise from a shortfall in aggregate demand, not just from high wages as classical economists believed. He argued that insufficient investment, driven by factors like low "animal spirits" or high interest rates, could lead to a situation where saving exceeds investment, thus reducing overall income and employment.

What are the two main policy recommendations Keynes proposed to combat the Great Depression?

Keynes recommended a combination of monetary policy, specifically reducing interest rates to encourage investment, and fiscal policy, involving government investment in infrastructure projects to stimulate demand and employment.

What is the IS-LM model, and how does it represent Keynes's theories?

The IS-LM model, popularized by John Hicks, graphically illustrates Keynes's system by showing the equilibrium in the goods market (IS curve) and the money market (LM curve). The intersection of these curves determines the economy's equilibrium level of income and interest rate, demonstrating how policy changes affect these variables.

What is the 'liquidity trap' in Keynesian economics?

The liquidity trap is a situation where monetary policy becomes ineffective because interest rates are already extremely low, and people prefer to hold cash rather than invest or lend. In such a scenario, increasing the money supply does not lower interest rates further or stimulate investment.

What was Keynes's view on international trade and protectionism, particularly after the Great Depression?

Initially a proponent of free trade, Keynes became more protectionist after the Great Depression. He criticized the assumptions of free trade models, particularly wage flexibility, and advocated for tariffs and other measures to manage trade imbalances and protect domestic industries, believing national self-sufficiency was sometimes preferable to excessive international economic entanglement.

How did Keynes view the role of surplus countries in international trade?

Keynes believed that countries running persistent trade surpluses could negatively impact global aggregate demand. He argued that surplus countries exerted a "negative externality" on their trading partners and should be incentivized, perhaps through taxation, to reduce their surpluses to maintain global economic balance.

What was the status of Keynesian economics in the post-World War II era?

Keynesian economics provided the primary framework for economic policy in Western industrialized nations from the end of World War II until the early 1970s. This period, often called the Golden Age of Capitalism, saw low unemployment and moderate inflation, with governments actively using fiscal and monetary policies.

What is the difference between Neo-Keynesian and New Keynesian economics?

Neo-Keynesian economics emerged from the neoclassical synthesis, integrating Keynesian ideas with neoclassical models. New Keynesian economics, developed later, sought to provide more rigorous microfoundations for Keynesian concepts like sticky prices and wages, becoming part of the new neoclassical synthesis.

What is Post-Keynesian economics, and how does it relate to Keynes's original work?

Post-Keynesian economics is a heterodox school that views itself as remaining closest to the spirit of Keynes's original work. It emphasizes his monetary theory, rejects the neutrality of money, and often critiques mainstream Keynesian interpretations for deviating from Keynes's core insights.

What criticisms did Marxist economists level against Keynesian economics?

Some Marxist economists, like Paul Sweezy, criticized Keynesianism for being a prisoner of neoclassical upbringing, failing to view the capitalist system as a totality, and treating the state as a deus ex machina. Michał Kalecki predicted that full employment policies would lead to a more assertive working class, prompting elites to abandon such policies.

What criticisms did public choice theorists, like James M. Buchanan, have of Keynesian economics?

James M. Buchanan criticized Keynesian economics for its implicit assumption of wise, apolitical policymakers. He argued that political pressures and electoral considerations would prevent governments from implementing optimal Keynesian policies, leading to fiscal indiscipline and deficit spending.

What was the 'Lucas critique' and its impact on Keynesian economics?

The Lucas critique, developed by Robert Lucas Jr., argued that Keynesian macroeconomic models were inconsistent with microeconomic theory based on rational choice. It highlighted that people's expectations and behavior would change in response to policy changes, invalidating simple extrapolations from past data, which led to the development of New Classical macroeconomics.

How did Monetarism differ from Keynesian economics in the 1960s and 1970s?

Monetarism, championed by economists like Milton Friedman, differed from Keynesianism primarily in its emphasis on the role of money supply and its advocacy for rules-based monetary policy over discretionary fiscal and monetary interventions. While both schools agreed on the cause of economic fluctuations (inadequate demand), they disagreed on the appropriate policy response and the economy's self-correcting capabilities.

What is the Austrian School's perspective on Keynesian economics?

Austrian economists like F.A. Hayek and Ludwig von Mises criticized Keynesian economics as an "economics of abundance" that ignored real scarcity and relied on inflationary "money and credit" expansion. They viewed Keynesian policies as leading to uncontrolled inflation and unchecked central banking power.

What is the significance of the "Keynesian cross" diagram?

The Keynesian cross, devised by Paul Samuelson, visually represents Keynes's theory of aggregate demand. It shows how the equilibrium level of national income is determined by the point where the aggregate demand curve (sum of consumption and investment) intersects the 45-degree line, illustrating the relationship between income, consumption, and investment.

What is the 'marginal efficiency of capital' in Keynes's theory?

The marginal efficiency of capital refers to the expected rate of profit on new investment, influenced by physical production conditions and psychological anticipations of future profitability. Keynes suggested this rate, along with the interest rate, determines the level of investment.

How did Keynes view the relationship between government spending and private investment?

Keynes argued that during periods of high unemployment and slack labor markets, government spending could act as a complement, rather than a substitute, for private investment. By increasing aggregate demand, government spending could boost business profits and optimism, thereby spurring private investment through an "accelerator effect."

What was Keynes's stance on the idea of "Say's Law"?

Keynes explicitly rejected Say's Law, which states that "Supply creates its own demand." He argued that there was no guarantee that goods produced would be met with sufficient aggregate demand, leading to potential periods of high unemployment and underutilized productive capacity.

What did Keynes mean by "involuntary unemployment"?

Keynes defined involuntary unemployment as a situation where individuals are willing to work at the prevailing wage rate but cannot find employment. This contrasts with classical economics, which primarily recognized voluntary unemployment (refusal to work at the going wage) or frictional unemployment.

What role did the concept of "animal spirits" play in Keynes's economic thought?

Keynes introduced the concept of "animal spirits" to describe the psychological factors, such as confidence and optimism, that influence investment decisions. He believed these subjective, often irrational, expectations could significantly impact aggregate demand and economic stability, independent of purely rational calculations.

What was Keynes's proposal for an International Clearing Union?

Keynes was a principal author of the plan for an International Clearing Union, which aimed to establish a global bank issuing its own currency, the "bancor." This system was intended to manage international trade imbalances by treating debtor and creditor nations similarly and creating international money to settle balances.

What was the Bretton Woods system, and what was Keynes's role in its establishment?

The Bretton Woods system was established in 1944 following the United Nations Monetary and Financial Conference, where Keynes led the British delegation. The system aimed to create a stable international monetary order, though it ultimately adopted features different from Keynes's original proposals for the International Clearing Union.

How did Keynes's views on free trade evolve over his career?

Initially aligned with classical free trade principles, Keynes's views shifted after the Great Depression. He began to question the realism of free trade assumptions, particularly wage adjustment, and became more supportive of protectionist measures like tariffs to manage trade deficits and protect domestic industries.

What is the "Lucas critique" in the context of macroeconomic modeling?

The Lucas critique, named after economist Robert Lucas Jr., argues that traditional Keynesian macroeconomic models fail to account for how people's expectations and behavior change in response to policy interventions. This implies that historical data used to estimate these models may not accurately predict outcomes under new policy regimes.

What is the "natural rate of unemployment" concept, and how does it relate to Keynesian economics?

The "natural rate of unemployment" is a concept associated with New Classical macroeconomics, suggesting there's a baseline unemployment rate determined by structural factors, independent of aggregate demand in the long run. This contrasts with Keynesian views, which emphasize that unemployment can be persistently high due to insufficient aggregate demand and can be reduced through policy intervention.

What is the "Taylor rule" in monetary policy?

The Taylor rule is a guideline for setting interest rates, often credited with contributing to the "Great Moderation." It suggests that central banks should adjust interest rates based on inflation and the output gap (the difference between actual and potential GDP), a principle that gained prominence after the decline of strict Keynesian dominance.

What criticism did Milton Friedman have regarding Keynes's political legacy?

Milton Friedman argued that Keynes's political bequest was harmful because his economic theories appealed broadly due to their link to his political approach, potentially leading to totalitarian societies if benevolent dictatorship were implemented. He also believed Keynesianism's appeal to a wider audience than just economists was problematic.

What is the core debate between Monetarists and Keynesians regarding economic stabilization?

The core debate centered on the effectiveness and desirability of government intervention. Keynesians favored discretionary fiscal and monetary policies to actively manage aggregate demand, while Monetarists argued for rules-based monetary policy, emphasizing the primacy of controlling the money supply and expressing skepticism about the efficacy and political feasibility of discretionary fiscal policy.

How did the 2008 financial crisis impact the perception of Keynesian economics?

The 2008 financial crisis led to a resurgence of interest in Keynesian economics. It highlighted the limitations of monetary policy alone, especially in a liquidity trap scenario, and reinforced the argument for government fiscal interventions to stimulate economies during severe downturns.

What is the "neoclassical synthesis" in macroeconomics?

The neoclassical synthesis was an attempt to reconcile Keynesian macroeconomics with neoclassical microeconomics. It dominated mainstream thought from the post-war era until the 1970s, generally accepting that economies might not automatically reach full employment but would behave according to neoclassical principles once policy ensured full employment.

What is the main argument of the "New Classical" school of thought against Keynesianism?

The New Classical school argued that Keynesian economics relied on unrealistic assumptions about economic agents' behavior, particularly their lack of rational expectations and their tendency to be influenced by nominal rigidities. They advocated for models grounded in microeconomic optimization and rational expectations, leading to theories like the real business cycle.

What is the "Keynesian Revolution"?

The "Keynesian Revolution" refers to the profound shift in macroeconomic thought and policy that occurred following the publication of Keynes's *The General Theory*. It moved the focus from aggregate supply and self-correcting markets to aggregate demand and the potential need for government intervention to stabilize the economy.

What is the "multiplier effect" in Keynesian economics?

The multiplier effect describes how an initial change in spending, such as government investment, leads to a proportionally larger change in overall national income. This occurs because the initial spending becomes income for others, who then spend a portion of it, creating a ripple effect throughout the economy.

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What is Keynesian Economics?

Core Tenets

Keynesian economics comprises macroeconomic theories and models positing that aggregate demand—the total spending in an economy—significantly influences economic output and inflation. It posits that aggregate demand does not always equal the economy's productive capacity, leading to fluctuations influenced by various factors.

Market Regulation

Keynesian economists advocate for a regulated market economy, primarily private sector-driven, but with a crucial role for government intervention. This intervention aims to stabilize economic output, inflation, and unemployment over the business cycle, particularly during recessions and depressions.

Policy Intervention

Keynesian theory suggests that economic fluctuations can be mitigated through coordinated fiscal policy (government spending and taxation) and monetary policy (central bank actions). These policies aim to manage aggregate demand and steer the economy toward stability and full employment.

Historical Context

Pre-Keynesian Thought

Prior to Keynes, macroeconomic analysis largely focused on aggregate supply, assuming economies naturally gravitated towards full employment. Classical economics relied on partial equilibrium theories and concepts like Say's Law ("Supply creates its own demand"), with limited focus on aggregate demand management.

Early Influences

Ideas predating Keynes, such as underconsumption theories and the work of the Stockholm School, explored issues of insufficient aggregate demand and advocated for economic intervention. Keynes synthesized and formalized these concepts, providing a comprehensive theoretical framework.

The General Theory

Published in 1936 amidst the Great Depression, Keynes's seminal work, The General Theory of Employment, Interest and Money, challenged classical assumptions. It introduced concepts like effective demand, the multiplier, and liquidity preference, fundamentally altering macroeconomic thought.

Core Concepts

Aggregate Demand

The total spending in an economy is the primary driver of output and employment. Keynes argued that aggregate demand can be insufficient to maintain full employment, leading to recessions.

The Multiplier Effect

An initial change in spending (e.g., government investment) leads to a larger cumulative change in national income. This effect amplifies the impact of fiscal policy.

Liquidity Preference & Trap

The demand for holding money (liquidity preference) is influenced by interest rates and income. A "liquidity trap" occurs when monetary policy becomes ineffective because interest rates are already very low.

Saving vs. Investment

Keynes separated saving and investment decisions, arguing that they are not automatically equalized by interest rates. A divergence can lead to fluctuations in aggregate demand and employment.

IS-LM Model

Developed by Hicks, this model graphically represents the relationship between interest rates and output, integrating Keynes's theories of goods market equilibrium (IS curve) and money market equilibrium (LM curve).

Policy Implications

Fiscal Policy

Government intervention through spending and taxation to manage aggregate demand. Expansionary fiscal policy (increased spending, tax cuts) is recommended during downturns to boost demand and employment.

Monetary Policy

Central bank actions, primarily adjusting interest rates and money supply, to influence borrowing, investment, and consumption. Expansionary monetary policy aims to lower interest rates to stimulate economic activity.

Trade Policy

Keynes advocated for managing international trade imbalances. He proposed mechanisms like the International Clearing Union and the 'bancor' to stabilize global trade and criticized unchecked free trade, suggesting protectionist measures could be beneficial in certain contexts.

Schools of Thought

Mainstream Keynesianism

Includes Neo-Keynesian and New Keynesian economics, which integrate Keynesian ideas with neoclassical microfoundations. These schools focus on market imperfections like sticky prices and wages.

Post-Keynesianism

This heterodox school emphasizes uncertainty, effective demand, and monetary theory, staying closer to Keynes's original interpretations and often critiquing neoclassical synthesis.

Critiques

Schools like Monetarism, Austrian Economics, Marxism, Public Choice, and New Classical Economics offer significant critiques, questioning Keynesian assumptions about government intervention, rational expectations, and market dynamics.

Debates & Legacy

Politics & Policy

Keynesianism has been associated with both liberal and conservative policies, depending on the specific application of fiscal and monetary tools. Debates persist regarding the political feasibility and effectiveness of government intervention.

Modern Relevance

The 2008 financial crisis spurred a resurgence of Keynesian ideas, highlighting the potential need for fiscal stimulus and the limitations of monetary policy in liquidity trap scenarios, demonstrating the enduring relevance of Keynesian frameworks.

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References

He had been working on the book since 1923, and finally signed the preface on 14 September 1930. Dimand, op. cit., p. 119.

P. A. Samuelson, Economics: an introductory analysis, 1948 and many subsequent editions. 16th edition consulted.

Introduction to the Theory of Employment, which she described as a "told-to-the-children" account (letter to Keynes included in his Collected Writings vol XXIX, p185), referring to a series of retellings of classic stories.

"International difficulties arising out of the financing of public works during depressions," Economic Journal, 1932.

See Dimand, op. cit., p. 114. Kahn's presentation is more complicated owing to the inclusion of dole and other factors.

See the 'General_Theory'.

The interest rate is monetary, and represents the combined effect of the real interest rate and inflation.

D. H. Robertson, "Some Notes on Mr. Keynes' General Theory of Interest", Quarterly Journal of Economics, 1936

P. R. Krugman, "It's baaack: Japan's slump and the return of the liquidity trap," Brookings papers on economic activity, 1998.

James M. Buchanan and Richard E. Wagner, Democracy in Deficit: The Political Legacy of Lord Keynes (1977)

A full list of references for this article are available at the Keynesian economics Wikipedia page

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This page was generated by an Artificial Intelligence and is intended for informational and educational purposes only. The content is based on publicly available data and may not be entirely accurate, complete, or up-to-date.

This is not financial or economic advice. The information provided on this website is not a substitute for professional economic consultation, analysis, or advice. Always refer to official economic documentation and consult with qualified professionals for specific financial or economic decisions.

The creators of this page are not responsible for any errors or omissions, or for any actions taken based on the information provided herein.

The Keynesian Compass

💡 Dive in with Flashcard Learning! 💡

What is Keynesian Economics? ℹ️

📊 Core Tenets

⚖️ Market Regulation

🏛️ Policy Intervention

Historical Context 📜

🧐 Pre-Keynesian Thought

💡 Early Influences

📖 The General Theory

Core Concepts 🧩

➡️ Aggregate Demand

➕ The Multiplier Effect

💧 Liquidity Preference & Trap

🏦 Saving vs. Investment

📈 IS-LM Model

Policy Implications 🛠️

💰 Fiscal Policy

🏦 Monetary Policy

🌍 Trade Policy

Schools of Thought 🎓

🏛️ Mainstream Keynesianism

🔬 Post-Keynesianism

⚔️ Critiques

Debates & Legacy 💬

⚖️ Politics & Policy

🔄 Modern Relevance

Teacher's Corner 🧑‍🏫

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References

📜 References

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Disclaimer ⚠️

📜 Important Notice

Dive in with Flashcard Learning!

What is Keynesian Economics?

Core Tenets

Market Regulation

Policy Intervention

Historical Context

Pre-Keynesian Thought

Early Influences

The General Theory

Core Concepts

Aggregate Demand

The Multiplier Effect

Liquidity Preference & Trap

Saving vs. Investment

IS-LM Model

Policy Implications

Fiscal Policy

Monetary Policy

Trade Policy

Schools of Thought

Mainstream Keynesianism

Post-Keynesianism

Critiques

Debates & Legacy

Politics & Policy

Modern Relevance

Teacher's Corner

True or False?

Test Your Knowledge!

Gamer's Corner

Discover other topics to study!

References

Feedback & Support

Disclaimer

Important Notice