What is Keynesian economics in simple terms?

Keynesian economics is a demand side policy and it explains how the changes of aggregate demand (aggregate expenditure) impact to output, inflation and unemployment of an economy.

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What is the Aggregate Expenditure Model in Economics?

According to Keynesian economics, when the economy is in a recession with unemployment, the government should apply expansionary fiscal policy. To learn more, kindly click here

Keynes contended that prolonged periods of high unemployment could result from a lack of overall demand. Consumption, investment, government purchases, and net exports (the difference between what a country sells to and buys from foreign countries) are the aggregate of four factors that determine an economy’s output of goods and services. One of these four factors must be the source of any growth in demand.

However, as expenditure decreases during a recession, powerful forces frequently depress demand. For instance, during economic downturns uncertainty frequently undermines consumer confidence, leading people to cut spending, particularly on luxuries like a home or a car. Businesses may spend less on investments as a result of customers spending less because there is less of a need for their products.

Role of the government

As a result, the government is now responsible for raising output. Keynesian economics holds that government intervention is required to control the business cycle or the ups and downs in economic activity. In other words, when the economy is in a recession with unemployment, the government should apply expansionary fiscal policy.

Keynesian theory emphasis on the fiscal policy. So, Keynesian theory is a demand side economic theory that impact to the aggregate demand of the AD-AS model.

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AD-AS model

AD-AS model : What happened in a recession?

Multiplier effect

A multiplier effect is another feature of Keynesian theory of economic activity; it states that production varies by a factor of the rise or fall in spending that generated the change. A dollar increase in government spending would result in a dollar rise in output if the fiscal multiplier was larger than one.

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What is the Multiplier Effect in Economics? – Complete Lesson

What is the Keynesian Multiplier? – With Examples

Founder of the Keynesian economics

Founder of the Keynesian economics is John Maynard Keynes.

Keynesian economics and great depression

Existing economic theory was unable to adequately explain the causes of the severe global economic collapse during the Great Depression of the 1930s or to offer a public policy solution to jump-start output and employment.

So, Keynes has introduced a new theory “Keynesian economics” on his of “The General Theory of Employment, Interest, and Money”. Keynes has released in February 1936. In this revolutionary book, Keynes has presented two key points. The first was that government spending constituted a crucial component of aggregate demand. This implied that demand would rise in tandem with rising spending. Keynes’ second claim was that government spending was essential to preserving full employment.

Pre- Keynesian Economics: Which theory is usually applied?

Keynesian economics vs classical economics

Before the introduction of Keynesian economics, economists usually applied the classical theory of economics. Classical economic theory encouraged the Laissez-faire economics. According to this idea, in a free market, the laws of supply and demand control the business cycle. The expansion of businesses helps the economy. Instead of focusing on consumers, the government should prioritize businesses, and its total function should be limited.

But Keynesian economics emphasized that government spending on infrastructure, unemployment insurance, and education results in an increase in consumer demand. Government spending is required to keep the labor force at full capacity.

Why did Keynesian economics end?

After World War II, Keynesian economics dominated economic theory and policy until the 1970s, when many industrialized nations experienced “stagflation,” or inflation and poor growth. Because Keynesian theory lacked a suitable policy response to stagflation at that time, it lost favor.

Post-Keynesian Economics: Which theory is usually applied?

Keynesian economics vs monetary economics

After 1970, economists usually applied the monetary economics.To read more about monetary policy, kindly click here

Monetarist economists claimed that prudent use of monetary policy (basically controlling the supply of money to affect interest rates) could help to resolve the crisis because they questioned whether governments could control the business cycle through fiscal policy.

The monetarist school of thought likewise argued that money can affect output in the short term. But an expansionary monetary policy only results in inflation over the long term. The long-run neutrality of money, which holds that changes in the money supply only affect nominal economic variables like prices and wages and have no impact on real economic variables like employment and output, was largely adopted by Keynesian economists, who improved the original theory by better integrating the short and long runs.

Keynesian economics examples

There is little doubt that John Maynard Keynes would be the economist you look to in order to grasp the issues facing the economy, Harvard professor N Gregory Mankiw stated in the New York Times. Although Keynes passed away more than fifty years ago, his analysis of recessions and depressions continues to serve as the cornerstone of contemporary macroeconomics. 

Examples

1. Australia’s economic thought during the war was significantly influenced by the work of British economist John Maynard Keynes.The Australian government’s response to the war’s economic issues was the first significant use of Keynesian economic theory in Australian public policy. The Reserve Bank of Australia heavily influenced on both of its plans for post-war reconstruction and its wartime economic policies
2. Through government expenditure on initiatives to create jobs, President Roosevelt embraced Keynesian ideas to put an end to the Great Depression. Roosevelt established Social Security, the U.S. minimum wage, and rules against child labor. He also established the Federal Deposit Insurance Corporation, which protects deposits against bank runs.
3. Bill Clinton’s expansionary economic policies, which generated more employment than those of any other US president, contributed to a decade of prosperity. While homeownership increased to its greatest level ever measured at 67.7%, the poverty rate decreased to 11.8%.

Is Keynesian economics used today?

1. Many countries (specially European and American countries) have applied Keynesian theory during the 2008 -2009 financial crisis. Governments have increased their expenditure and cut taxes.
2. The Economic Stimulus Act, sponsored by President Barack Obama, helped to end the Great Recession. $224 billion was spent on healthcare, education, and prolonged unemployment benefits as a result of the Economic Stimulus Act. By awarding $275 billion in federal grants, loans, and contracts, it also generated a large number of jobs. Moreover, this law reduced taxes by $288 billion. Obamacare also slowed the rate at which healthcare expenditures increased.

Governments can apply Keynesian Economics to solve the problems in the economies.

What are the criticisms of keynesian economics?

1. Supply-side economists contend that increasing company expansion, not increased consumer demand, is what stimulates the economy. These economists do agreed that the government helps to stimulate the economy. But they think fiscal policy should concentrate on businesses. Deregulation and tax reductions are important to supply-side economists. To read more about supply side economic policies, Kindly click here
2. Monetarists, who believe that monetary policy is the true cause of the business cycle, are among the other opponents of Keynesian economic theory. The Great Depression was attributed on excessive interest rates by Milton Friedman and other monetarists. They hold that increasing the money supply spurs economic growth and prevents recessions.