Keynesian Economics

Also known as Keynesian Theory; Keynesian economics is a theory of economics built upon the ideas of John Maynard Keynes. This theory advocates a mixed economy, in which the public sector and the government plays a role in stablizing the output of the business cycle. Keynesian theory argues that complete control of the economy by the private sector will lead to inefficient macroeconomic outcomes (ie: long term recessions).


Published in 1936
Published in 1936

Keynesian Economics was first presented by John Maynard Keynes in The General Theory of Employment, Interest, and Money. This book is generally considered as Keynes' greatest work, and contributed to the shaping of modern macroeconomics.

Principles of Keynesian Economics

Keynesian Theory argues that Classical Liberal Economic Theory is based on a fundamental error, in which there would be full employment if supply and demand were balanced. Using the Great Depression as an example, John Maynard Keynes proved that this assumption is not always applicable. Keynes believed that in times of stress, individuals tend to hoard money and fail to invest back into the economy, thus creating recessions. According to Keynesian Economics, during these periods of crisis, governments should intervene by lowering interest rates and investing in infrastructure. These actions will stimulate the economy because government investment will create more general income, along with lowered interest rates, will give individuals incentive to spend money. Keynes also believed that the economic cycle of inflation and recession is caused by consumer demand. During periods of inflation, Keynesian Economics suggests that governments should intervene by raising interest rates, taxes, and reduce overall government spending. Keynes believed that this would drain away any surplus money from the economy and will therefore stabilze the prices of goods by lowering inflationary demand. By following this cycle, periods of inflation and recession would be less extreme due to government intervention, and thus most individuals will benefit.

Output(GDP) as a function of Time
Output(GDP) as a function of Time
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Relation to Classical Liberalism

Keynesian economics was a solution to extreme ideas of socialism, namely communism, which spurred during the Great Depression amongst society members experiencing extreme poverty. The ideology involved in Keynesian economics takes a step away from the far right side of the economic spectrum of economic intervention. It also makes a step towards the left side of the political spectrum representing how government makes changes in society. It opposes the system of pure capitalism that was present in industrialized nations across the world at the time that Keynes first developed his economic ideas. With his economic ideas, Keynes did not propose a movement completely away from classical liberalism, but a new form of classical liberalism known as a “welfare state” or a “mixed economy”. This allowed individuals to act in their self-interest during times of growth or recession, but cushioned the effects of recession on individuals of all social classes. Keynes did not wish to remove the aspect of individualism from society, but to use the government as a force that could either drain money from or pool money into society. Therefore, many of Keynes’ ideas opposed classical liberalism and supported change towards a more modern form of liberalism.

How it Changed Classical Liberalism

One of the first industrialized nations to adopt Keynesian economics was the United States of America under President Franklin Roosevelt. Many countries across the world adopted Keynes’ principles as a solution to bring the world out of the Great Depression and prevent further extreme recession. These principles are still used in liberal capitalist societies today forming the mixed economy or welfare state that exists in Canada. Classical liberalism was changed by these ideas because a different means of achieving economic success is now in place. The similar goal of individualism is still present in liberalism, but now individuals have a larger “safety net” that prevents individuals from succumbing to the extreme, unpredictable fluctuations of the economy.

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