Keynesianism
A reform of liberalism
Developed by John Maynard Keynes
In response to economic problems of the Classical Liberal model
Particularly the Great Depression which followed the Stock Market crash of 1929
Keynesian reforms
Greater State role
The State should act to counter economic downturns (recessions or depressions)
Through spending, particularly Deficit spending
Also through taxation and interest rate policies
The purpose is to shore up Demand
Many classical economists believed ‘Say’s Law’, which states that supply generates its own demand
Keynes refuted this, and the conditions of the Great Depression seemed to prove his claim
In severe downturns, the psychological response of economic decision makers is effected
People tend to become extremely cautious and avoid spending money
Businesses would avoid investing even in a low price environment
Aggregate demand would be reduced
Prices would fall, and an expectation of deflation would set in, further reducing demand and investment
Excessive saving – people are too cautious to spend or invest their funds, even though interests rates in a depression are very, very low
Motivation for saving more due to fear than desire for return or profit
Downward spiral of falling prices (deflation), falling investment, and falling wages
Keynes propose ‘counter cyclical’ State actions, including:
Infrastructure spending
A social safety net such as unemployment payments and pensions
These kick in during bad times, and the government borrows money (runs a deficit) to get money into the hands of spenders and soak up savings)
It was important to Keynes that deficit spending by the State then be reduced when ‘good times’ or ‘full employment’ returned
Otherwise these demand-supporting policies could be inflationary.
Keynes preferred to see State expenditures go to the lower classes, because he believed they would spend, rather than the rich, who would save.
Keynesianism became the dominant system of economic thought and public policy in most European social democracies after WWII
It was also dominant in the US from about 1930s to about 1980
The Reagan Revolution and ‘Supply Side Economics’ was a return to Neo-Liberalism and rejection of Keynes