Keynesian Economics

This study note for A-Level and IB economics covers Keynesian economics

The essence of Keynesian economics

Keynesian economics is a macroeconomic theory developed by economist John Maynard Keynes in the 1930s. It focuses on the role of aggregate demand in determining economic activity, arguing that economic output is strongly influenced by the total demand for goods and services in an economy.

Keynesian economics emphasizes the importance of government intervention to stabilize the economy during recessions, with the belief that markets may not automatically return to full employment in the short run.

Instead, the theory advocates for using fiscal policy, particularly increased government spending and lower taxes, to stimulate demand during downturns. Similarly, contractionary policies are recommended during periods of high inflation.

The essence of Keynesian economics lies in its emphasis on the role of demand-side policies in influencing economic growth and stability, as well as the belief that government intervention is necessary to address market failures and promote full employment.

Keynesian economics, founded by John Maynard Keynes, emphasizes the role of aggregate demand in influencing economic activity and advocates for government intervention to manage economic cycles. It arose in response to the Great Depression and challenges the classical economic belief in self-regulating markets.

Key Principles

1. Aggregate Demand:
   • Aggregate demand (AD) is the total demand for goods and services in an economy at a given overall price level and in a given period.
   • Example: During a recession, a decline in consumer and business spending can lead to a decrease in aggregate demand, causing higher unemployment and lower output.
2. Government Intervention:
   • Keynesians argue that during periods of low demand, government intervention is necessary to stimulate the economy.
   • Example: The New Deal policies in the 1930s, which included large-scale public works programs to reduce unemployment and boost demand.
3. Multiplier Effect:
   • Government spending can have a multiplied impact on aggregate demand. An initial increase in spending leads to further increases in consumption and investment.
   • Example: A government infrastructure project creates jobs, which increases workers' incomes and their consumption, further boosting economic activity.
4. Fiscal Policy:
   • The use of government spending and taxation to influence the economy. During a recession, Keynesians advocate for increased government spending and/or tax cuts to stimulate demand.
   • Example: During the 2008 financial crisis, many countries implemented stimulus packages that included tax cuts and increased public spending.
5. Sticky Wages and Prices:
   • Prices and wages do not adjust immediately to changes in economic conditions, leading to periods of unemployment and unused capacity.
   • Example: During a recession, wages may not fall quickly enough to prevent unemployment, leading to prolonged economic downturns.
6. Paradox of Thrift:
   • If all individuals attempt to save more during a recession, aggregate demand will fall, leading to lower overall savings and economic growth.
   • Example: During the Great Depression, widespread efforts to save money led to decreased consumption and investment, worsening the economic slump.

Key Economists and Contributions

• John Maynard Keynes: Founder of Keynesian economics, author of "The General Theory of Employment, Interest, and Money," which challenged classical economic theories and introduced concepts like aggregate demand and government intervention.
• Joan Robinson: A prominent Keynesian economist who contributed to the development of post-Keynesian economics and theories on imperfect competition.
• Hyman Minsky: Known for his work on financial instability and the "Minsky moment," which describes how speculative bubbles lead to financial crises.
• Christina Romer: An economic historian who has studied the impact of fiscal and monetary policy on the Great Depression and has advocated for Keynesian policies during modern economic downturns.
• Janet Yellen: An economist who has supported Keynesian policies in her roles at the Federal Reserve and as U.S. Treasury Secretary.

Real-World Applications

• New Deal Programs: Large-scale public works and social programs implemented by President Franklin D. Roosevelt in response to the Great Depression.
• Post-2008 Financial Crisis Stimulus: Government stimulus packages in the United States and other countries aimed at reviving economies through increased public spending and tax cuts.
• COVID-19 Economic Response: Massive government interventions, including direct payments to individuals, expanded unemployment benefits, and support for businesses to counteract the economic impact of the pandemic.

Different Economic Perspectives

1. Classical Economics:
   • Emphasizes self-regulating markets and minimal government intervention, in contrast to Keynesian advocacy for active government roles in managing economic cycles.
   • Example: Classical economists argue that markets will naturally return to equilibrium without the need for fiscal stimulus.
2. Monetarism:
   • Focuses on the role of money supply in controlling inflation and economic stability, often critiquing Keynesian emphasis on fiscal policy.
   • Example: Milton Friedman argued that inappropriate monetary policy, rather than insufficient aggregate demand, was the primary cause of economic fluctuations.
3. Post-Keynesian Economics:
   • Builds on Keynesian principles, emphasizing issues like income distribution, financial instability, and the importance of uncertainty in economic behavior.
   • Example: Post-Keynesians argue for policies addressing wage inequality and financial regulation to ensure economic stability.

Timeline of Key Dates and Policy Responses

• 1936: John Maynard Keynes publishes "The General Theory of Employment, Interest, and Money."
• 1933-1939: New Deal programs implemented in the U.S. to combat the Great Depression.
• 1971: Collapse of the Bretton Woods system, leading to more flexible exchange rates.
• 1970s: Stagflation challenges Keynesian policies, leading to the rise of monetarism.
• 2008: Financial crisis leads to a revival of Keynesian fiscal policies to stimulate the economy.
• 2020: COVID-19 pandemic prompts unprecedented government fiscal interventions globally.

Glossary

• Aggregate Demand: The total demand for goods and services in an economy at a given overall price level.
• Fiscal Policy: Government policies regarding taxation and spending to influence economic activity.
• IS-LM Model: A macroeconomic model that shows the interaction between the goods market (IS curve) and the money market (LM curve).
• Keynesian Multiplier: The ratio of a change in national income to the change in government spending that causes it.
• Paradox of Thrift: The concept that increased savings can lead to a decrease in aggregate demand, thus reducing overall savings and economic growth.
• Sticky Wages: The resistance of wages to change downward even in the face of high unemployment.

Essay Questions

1. Discuss the effectiveness of Keynesian fiscal policies in combating economic recessions, using historical examples.
2. Compare and contrast the Keynesian approach to economic stabilization with the monetarist approach.
3. Analyze the role of government intervention in the economy during the Great Depression and the 2008 financial crisis.
4. Evaluate the criticisms of Keynesian economics and how they have been addressed by post-Keynesian economists.
5. How does the IS-LM model explain the interaction between the goods and money markets in determining output and interest rates?

Suggested Books and Articles

1. "The General Theory of Employment, Interest, and Money" by John Maynard Keynes - http://b-ok.cc/book/2492495/2c...
2. "The Road to Serfdom" by Friedrich Hayek (a contrasting perspective) - http://b-ok.cc/book/1882043/40...
3. "Keynes: The Return of the Master" by Robert Skidelsky - http://b-ok.cc/book/1775073/50...
4. "The Great Crash 1929" by John Kenneth Galbraith - http://b-ok.cc/book/588942/99c...
5. "The End of Alchemy: Money, Banking, and the Future of the Global Economy" by Mervyn King - http://b-ok.cc/book/2741994/f1...
6. "Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism" by George Akerlof and Robert Shiller - http://b-ok.cc/book/596138/b09...

These study notes provide a comprehensive overview of Keynesian economics, covering its key principles, theories, applications, and critiques, and incorporating different economic perspectives to deepen students' understanding of this influential economic framework.

Here are some useful YouTube videos on Keynesian Economics:

1. CrashCourse Economics: "Economic Schools of Thought: Crash Course Economics #14"
   • This video provides an overview of various economic schools of thought, including Keynesian economics.
   • https://www.youtube.com/watch?...
2. The School of Life: "Keynesian Economics"
   • A brief introduction to the key concepts of Keynesian economics and its historical context.
   • https://www.youtube.com/watch?...
3. Marginal Revolution University: "Keynesian Economics"
   • A detailed series of videos on Keynesian economics, covering concepts such as aggregate demand, fiscal policy, and the multiplier effect.
   • https://www.youtube.com/watch?...
4. Tutor2u: "Keynesian Economics"
   • An educational video that explains the core principles of Keynesian economics and its applications.
   • https://www.youtube.com/watch?...
5. Jacob Clifford: "Keynesian Economics and Aggregate Demand- Macro Topic 3.1"
   • A classroom-style lecture on Keynesian economics and its focus on aggregate demand.
   • https://www.youtube.com/watch?...
6. The Economist: "Keynesian Economics"
   • A concise explanation of Keynesian economics and its relevance to modern economic policy.
   • https://www.youtube.com/watch?...

These videos provide a range of perspectives and levels of depth, from introductory overviews to more detailed explorations, making them valuable resources for students studying Keynesian economics.