Keynesian Economics: Core Tenets, Policies, and Critiques
Keynesian Economics: An Introduction
Keynesianism emerged as a liberal reaction to the inability of neoclassical orthodoxy and laissez-faire capitalism to automatically solve the serious economic imbalances that were accumulating in industrial countries after World War I.
Historical Context: The Post-1929 Era
The economic instability following the 1929 crash spurred a search for solutions, leading to three primary reactions:
- Marxist: Aimed to attack capitalism from the outside.
- Neoclassical: Sought to defend the existing capitalist framework.
- Keynesian: Focused on finding practical solutions without strict adherence to any single dogma.
During the first quarter of the 20th century, monopolism by large corporations became more pronounced. Simultaneously, workers gained increasing power, leading to tensions (workers vs. large companies) and contributing to an unstable and unreliable economic system.
Core Keynesian Principles
Keynesian economics is built upon several fundamental ideas:
- Denial of Say’s Law: Challenging the notion that supply automatically creates its own demand.
- Marginal Propensity to Consume and Save: Analyzing how changes in income affect consumption and savings.
- Macroeconomic Focus: Emphasizing the study of the economy as a whole, rather than individual economic agents.
- State Intervention: Advocating for government intervention to stimulate the economy, as markets are not inherently self-regulating.
The Aim of the General Theory
The primary objective of Keynes’ General Theory of Employment, Interest and Money was to furnish economic policy instruments. These tools were intended to enable capitalism to surmount its inherent contradictions and to safeguard society from the perceived challenges of liberal socialism. A cornerstone of this theory is the concept of aggregate demand.
Individual Economic Behavior: Psychological Factors
Keynesian theory highlights several psychological factors that influence individual economic decisions:
- Marginal Propensity to Consume (MPC): This refers to the proportion of each additional unit of income that individuals spend on consumption. Generally, as income rises, consumption increases, which can also lead to increased savings.
- Propensity for Investment: This is the portion of savings that is directed towards investment (Savings → Investment).
- Liquidity Preference: This describes the tendency for individuals and businesses to hold a certain amount of their assets in the form of cash for transactional, precautionary, or speculative motives.
Keynes’ Rejection of Say’s Law
Keynes fundamentally disagreed with Say’s Law, which posits that supply creates its own demand, thereby precluding the possibility of general overproduction. According to Keynes, a portion of what is supplied (offer) does not automatically generate an equivalent demand. He argued that if companies increase profits by reducing workers’ wages, an individual company might benefit. However, if this practice becomes widespread (viewed from a macroeconomic perspective), a situation can arise where aggregate supply outstrips aggregate demand, leading to insufficient requests for goods and services.
Keynesian Economic Policy Recommendations
Keynes advocated for proactive economic policies to manage the economy:
- Expansionary Fiscal Policy: This involves increasing government spending, even if it requires financing through a public deficit. The goal is for combined government and private spending to reflate and stimulate the economy.
- Lower Interest Rates: Reducing interest rates makes borrowing cheaper. This encourages individuals to consume more and businesses to invest more, leading to increased productivity, job creation, and overall economic growth.
Criticisms Leveled Against Keynesianism
Keynesian economics has been subject to various criticisms from different schools of thought:
- Neoclassical Critique: Neoclassical economists often criticize what they perceive as an overestimation or overemphasis on the role of the state in economic affairs.
- Marxist Critique: Marxists argue that Keynesian policies merely reform the capitalist system to ensure its survival, rather than bringing about fundamental systemic change.
- The Challenge of Stagflation: A significant practical challenge arose with the phenomenon of stagflation (a simultaneous occurrence of high unemployment and high inflation) in the 1970s, particularly around 1973. Keynesian theories were found to be less effective in addressing this combination, which paved the way for the rise of monetarist theories.
Monetarist Economic Thought
Monetarism, an influential school of economic thought, offers a distinct perspective, particularly in contrast to Keynesianism. Its key tenets include:
- Origins: Primarily associated with the Chicago School of economics.
- Ideological Stance: Strongly advocates for economic liberalism, emphasizing minimal state intervention in the economy to preserve individual freedom of choice.
- Central Focus: Concentrates on the critical influence of the money supply on price levels and the overall functioning of the economy. A core belief is that inflation can be controlled by managing the money supply.
- View on Unemployment: Tends to consider unemployment a less central problem, often referencing principles akin to Say’s Law, suggesting markets will clear.
- Primary Economic Concern: Identifies inflation as the most significant and pressing economic problem to be addressed.