Keynesian Economics

The School of Keynesian Economics

Introduction

Keynesian economics is a school of thought that emerged in the early 20th century, primarily associated with the work of British economist John Maynard Keynes. It revolutionized economic theory and policy, particularly in response to the Great Depression of the 1930s. Keynesian economics emphasizes the role of aggregate demand in determining overall economic activity and argues that active government intervention is essential for stabilizing the economy. This article explores the historical context, key concepts, prominent figures, critiques, and lasting impact of Keynesian economics.

Historical Context

1. The Great Depression

The onset of the Great Depression in 1929 was a turning point in economic thought. Classical economics, which emphasized self-regulating markets and the importance of long-term growth, struggled to explain the severe unemployment and economic stagnation that characterized the era. The traditional belief that markets would correct themselves faltered, prompting economists to search for new theories to address the crisis.

2. Keynes’s ‘The General Theory of Employment, Interest, and Money’

In 1936, John Maynard Keynes published his seminal work, The General Theory of Employment, Interest, and Money. This book fundamentally challenged classical economic thought by focusing on the importance of aggregate demand in determining employment and production levels. Keynes argued that inadequate demand could lead to prolonged periods of unemployment and economic stagnation, necessitating government intervention.

Key Concepts of Keynesian Economics

1. Aggregate Demand

At the heart of Keynesian economics is the concept of aggregate demand, which refers to the total demand for goods and services in an economy at a given price level. Keynes argued that fluctuations in aggregate demand are the primary drivers of economic cycles, with inadequate demand leading to unemployment and economic downturns.

2. The Multiplier Effect

The multiplier effect is a key mechanism in Keynesian economics, illustrating how an initial change in spending can lead to a larger overall impact on the economy. For example, when the government increases spending on infrastructure projects, it not only creates jobs for construction workers but also generates income for those workers, who then spend their earnings on goods and services. This ripple effect can stimulate further economic activity and boost overall demand.

3. Government Intervention

Keynesian economics advocates for active government intervention in the economy, especially during periods of recession. Keynes argued that governments should use fiscal policy—changes in government spending and taxation—to influence aggregate demand. During economic downturns, increasing government spending or reducing taxes can stimulate demand and help the economy recover.

4. The Liquidity Preference Theory

Keynes introduced the liquidity preference theory to explain interest rates. According to this theory, individuals prefer to hold liquid assets (cash or easily convertible assets) over illiquid investments, especially during uncertain economic times. As a result, when people demand liquidity, interest rates may rise, which can further dampen investment and consumption.

5. Demand-Driven Output

Keynes emphasized that output and employment levels are primarily driven by demand rather than supply. In times of economic downturn, firms may reduce production and lay off workers due to insufficient demand, leading to a vicious cycle of unemployment and reduced consumption.

Prominent Figures in Keynesian Economics

1. John Maynard Keynes (1883-1946)

As the founder of Keynesian economics, John Maynard Keynes is best known for his groundbreaking ideas on macroeconomic policy and the role of government in stabilizing the economy. His work laid the foundation for a new approach to understanding economic fluctuations and provided a framework for policy interventions.

2. Paul Samuelson (1915-2009)

Paul Samuelson was a prominent economist who helped formalize and popularize Keynesian economics in the United States. His influential textbook, Economics, introduced Keynesian concepts to a wider audience and integrated them into modern economic theory.

3. John Hicks (1904-1989)

John Hicks contributed to the development of Keynesian economics through his work on the IS-LM model, which illustrates the relationship between interest rates (I) and output (S) in the goods market and money market (LM). This model became a fundamental tool for analyzing Keynesian principles and their implications for policy.

4. Alfred Marshall (1842-1924)

While Marshall is primarily associated with the neoclassical school, his ideas on market equilibrium and the importance of demand influenced Keynesian economics. His concepts of consumer surplus and elasticity provided a foundation for understanding consumer behavior in the context of aggregate demand.

Critiques of Keynesian Economics

While Keynesian economics has significantly influenced economic thought and policy, it has also faced various critiques:

1. Classical Counterarguments

Classical economists argue that Keynesian policies can lead to inflation and distortions in market mechanisms. They emphasize the importance of supply-side factors and argue that government intervention can create inefficiencies in the economy.

2. New Classical Economics

New classical economists, led by figures like Robert Lucas, argue that expectations play a crucial role in economic decision-making. They contend that individuals and firms adjust their behavior based on anticipated policy changes, which can render government intervention ineffective.

3. Long-Term vs. Short-Term Focus

Critics argue that Keynesian economics primarily addresses short-term fluctuations and may neglect long-term growth factors. They advocate for policies that enhance productivity and encourage investment in the supply side of the economy.

4. The Role of Money Supply

Monetarists, led by Milton Friedman, criticize Keynesian economics for underestimating the role of money supply in determining economic activity. They argue that controlling the money supply is essential for managing inflation and stabilizing the economy.

The Legacy of Keynesian Economics

1. Post-World War II Consensus

Following World War II, Keynesian economics gained widespread acceptance among policymakers and economists. Many countries adopted Keynesian principles to manage their economies, leading to significant government involvement in economic planning, public works projects, and welfare programs.

2. Stagflation and the 1970s Crisis

The rise of stagflation (a combination of stagnant economic growth and high inflation) in the 1970s challenged the effectiveness of Keynesian policies. The limitations of Keynesian economics became apparent as traditional tools failed to address the complexities of the economic landscape.

3. New Keynesian Economics

In response to critiques and changing economic conditions, New Keynesian economics emerged in the late 20th century, integrating elements of microeconomic foundations and rational expectations into Keynesian models. New Keynesians seek to address some of the shortcomings of traditional Keynesian theory while maintaining the core emphasis on demand management.

4. Ongoing Relevance

Keynesian economics remains relevant in contemporary economic discussions, particularly in times of economic crisis. The 2008 financial crisis and the subsequent recession led to a resurgence of Keynesian ideas, with many governments implementing stimulus packages and expansive fiscal policies to boost aggregate demand.

Post-Keynesian economics

Post-Keynesian economics is a school of economic thought with its origins in The General Theory of John Maynard Keynes, with subsequent development influenced to a large degree by Michał Kalecki, Joan Robinson, Nicholas Kaldor, Sidney Weintraub, Paul Davidson, Piero Sraffa and Jan Kregel. Historian Robert Skidelsky argues that the post-Keynesian school has remained closest to the spirit of Keynes' original work. It is a heterodox approach to economics.

Neoclassical Synthesis (NCS), Neoclassical–Keynesian Synthesis, or Neo-Keynesianism (Neo-Keynesian Economics)

Neoclassical Synthesis (NCS), Neoclassical–Keynesian Synthesis,  or just Neo-Keynesianism (Neo-Keynesian Economics) was a post-World War II academic movement and paradigm in economics that worked towards reconciling the macroeconomic thought of John Maynard Keynes with neoclassical economics. Being Keynesian in the short run and neoclassical in the long run, neoclassical synthesis allowed the economy to adjust via fiscal and monetary policies in the short run (especially focusing on fiscal policies that were considered to be more effective than monetary ones) whilst predicting that equilibrium in the long run will be reached without state intervention. The synthesis, formulated by a group of economists (most notably John Hicks, Franco Modigliani and Paul Samuelson), dominated economics in the post-war period and formed the mainstream of macroeconomic thought in the 1950s, 1960s and 1970s.

A series of developments occurred that shook the neoclassical synthesis in the 1970s as the advent of stagflation and the work of monetarists like Milton Friedman cast doubt on neo-Keynesian conceptions of monetary theory. The conditions of the period proved the impossibility of maintaining sustainable growth and low level of inflation via the measures suggested by the school. The result would be a series of new ideas to bring tools to macroeconomic analysis that would be capable of explaining the economic events of the 1970s. Subsequent new Keynesian and new classical economists strived to provide macroeconomics with microeconomic foundations, incorporating traditionally Keynesian and neoclassical characteristics respectively. These schools eventually came to form a « new neoclassical synthesis », analogous to the neoclassical one, that currently underpins the mainstream of macroeconomic theory.

New Keynesian Economics

New Keynesian Economics is a school of macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroeconomics.

Two main assumptions define the New Keynesian approach to macroeconomics. Like the New Classical approach, New Keynesian macroeconomic analysis usually assumes that households and firms have rational expectations. However, the two schools differ in that New Keynesian analysis usually assumes a variety of market failures. In particular, New Keynesians assume that there is imperfect competition in price and wage setting to help explain why prices and wages can become « sticky », which means they do not adjust instantaneously to changes in economic conditions.

Wage and price stickiness, and the other market failures present in New Keynesian models, imply that the economy may fail to attain full employment. Therefore, New Keynesians argue that macroeconomic stabilization by the government (using fiscal policy) and the central bank (using monetary policy) can lead to a more efficient macroeconomic outcome than a laissez faire policy would.

New Keynesianism became part of the new neoclassical synthesis - which is now usually referred to simply as New Keynesian economics - that incorporated parts of both it and new classical macroeconomics, and forms the theoretical basis of mainstream macroeconomics today.

Conclusion

The School of Keynesian Economics represents a transformative shift in economic thought, emphasizing the importance of aggregate demand and government intervention in stabilizing the economy. John Maynard Keynes’s pioneering ideas laid the foundation for modern macroeconomic theory and policy, shaping how economists and policymakers understand and address economic fluctuations. Despite facing critiques and evolving in response to changing economic conditions, Keynesian economics continues to play a vital role in contemporary economic discourse and practice. Its legacy is evident in the ongoing debates about the appropriate balance between market forces and government intervention in achieving economic stability and growth.

Here is a list of influential and notable economists from the School of Keynesian Economics, along with their key contributions:

1. John Maynard Keynes (1883–1946)

• Key Works: The General Theory of Employment, Interest, and Money (1936)

• Contribution: Founder of Keynesian economics, Keynes revolutionized macroeconomic thought by emphasizing the importance of aggregate demand in determining economic output. His theory challenged classical economics by arguing that markets do not always clear and that government intervention is necessary to smooth out the business cycle, particularly during recessions.

2. Joan Robinson (1903–1983)

• Key Works: The Economics of Imperfect Competition (1933), Essays in the Theory of Economic Growth (1962)

• Contribution: Robinson was a key figure in post-Keynesian economics and worked closely with Keynes at Cambridge. She is known for her contributions to imperfect competition and her analysis of economic growth and capital theory. Robinson was also critical of neoclassical economics and developed theories in line with Keynesian thought on unemployment and economic dynamics.

3. Paul Samuelson (1915–2009)

• Key Works: Foundations of Economic Analysis (1947), Economics: An Introductory Analysis (1948)

• Contribution: Samuelson played a pivotal role in merging Keynesian economics with neoclassical microeconomic theory, creating the ‘neoclassical synthesis.’ He also developed mathematical models for Keynesian economics and is credited with popularizing Keynesian ideas in American economics education.

4. Alvin Hansen (1887–1975)

• Key Works: A Guide to Keynes (1953), Fiscal Policy and Business Cycles (1941)

• Contribution: Often called the ‘American Keynes,’ Hansen was instrumental in bringing Keynesian economics to the U.S. He developed the theory of secular stagnation, which suggests that mature economies may experience long-term stagnation without sufficient government intervention and investment.

5. Richard Kahn (1905–1989)

• Key Works: The Relation of Home Investment to Unemployment (1931)

• Contribution: Kahn introduced the concept of the multiplier effect, a key element of Keynesian economics, which explains how initial increases in spending lead to larger overall increases in income and economic activity. This concept is central to understanding fiscal stimulus and its impact on the economy.

6. James Tobin (1918–2002)

• Key Works: Tobin’s q (1969), Asset Accumulation and Economic Activity (1980)

• Contribution: Tobin contributed to the theory of investment and monetary economics, with his concept of Tobin’s q— the ratio of market value to replacement cost of physical assets—being an important tool in assessing investment behavior. He also advocated for Keynesian monetary policies and argued for using fiscal policy to manage economic cycles.

7. Robert Solow (1924–present)

• Key Works: A Contribution to the Theory of Economic Growth (1956)

• Contribution: Though known for his work in neoclassical growth theory, Solow incorporated Keynesian ideas into his work on long-term economic growth. His famous Solow-Swan growth model showed how capital accumulation and technological progress drive economic growth, and he emphasized the importance of government policies in managing economic fluctuations.

8. Hyman Minsky (1919–1996)

• Key Works: Stabilizing an Unstable Economy (1986), John Maynard Keynes (1975)

• Contribution: Minsky developed the financial instability hypothesis, which builds on Keynesian ideas to explain how financial markets contribute to economic cycles. He argued that periods of financial stability lead to increasing risk-taking, which can culminate in financial crises. His work became particularly influential during the 2008 financial crisis.

9. Nicholas Kaldor (1908–1986)

• Key Works: Causes of the Slow Rate of Economic Growth in the United Kingdom (1966), Essays on Economic Stability and Growth (1960)

• Contribution: Kaldor contributed significantly to the theory of distribution, growth, and development. He proposed Kaldor’s growth laws, which focus on the role of manufacturing in driving economic growth, and criticized mainstream economic models for neglecting issues of increasing returns and sectoral dynamics.

10. Abba P. Lerner (1903–1982)

• Key Works: The Economics of Control (1944), Essays in Economic Analysis (1953)

• Contribution: Lerner developed the concept of functional finance, which argues that government fiscal policy should aim to manage aggregate demand, full employment, and inflation, without being constrained by budgetary balance. His ideas are central to modern Keynesian thought on fiscal policy and public debt management.

11. John Kenneth Galbraith (1908–2006)

• Key Works: The Affluent Society (1958), The New Industrial State (1967)

• Contribution: Galbraith critiqued the power of large corporations and their influence on both the economy and society. His work emphasized the role of government in regulating economic power and maintaining full employment, drawing heavily from Keynesian principles of economic management.

12. Lawrence Klein (1920–2013)

• Key Works: The Keynesian Revolution (1947), An Econometric Model of the United States (1950)

• Contribution: Klein was a pioneer in the field of econometrics and macroeconomic modeling, using Keynesian principles to develop models that forecast economic activity. His work in developing large-scale macroeconomic models had a profound impact on economic policy and planning, and he won the Nobel Prize in 1980 for his contributions.

13. Joseph Stiglitz (1943–present)

• Key Works: Whither Socialism? (1994), Globalization and Its Discontents (2002)

• Contribution: Stiglitz is a leading advocate of Keynesian economics in modern times. He has contributed to information economics and criticized neoliberal economic policies. Stiglitz argues that market imperfections and asymmetries justify government intervention to promote stability and equity.

14. Paul Krugman (1953–present)

• Key Works: The Return of Depression Economics (1999), End This Depression Now! (2012)

• Contribution: Krugman is a strong proponent of Keynesian economics, particularly in the context of managing financial crises. He has emphasized the importance of fiscal stimulus and government intervention to combat recessions and criticized austerity measures that exacerbate economic downturns.

15. Michal Kalecki (1899–1970)

• Key Works: Essays in the Theory of Economic Fluctuations (1939)

• Contribution: Kalecki independently developed many ideas similar to Keynes’s, particularly regarding aggregate demand and economic cycles. His analysis of the role of investment and profits in driving economic fluctuations contributed to Keynesian and post-Keynesian economic thought.

16. Wynne Godley (1926–2010)

• Key Works: Macroeconomics (1983), Monetary Economics (2006, with Marc Lavoie)

• Contribution: Godley is known for his work on stock-flow consistent models, which track the interactions between the real economy and financial sectors. His work emphasized the importance of accounting for sectoral balances, public debt, and financial stability, aligning with Keynesian concerns over demand management and macroeconomic stability.

17. Axel Leijonhufvud (1933–2022)

• Key Works: On Keynesian Economics and the Economics of Keynes (1968)

• Contribution: Leijonhufvud provided important critiques of the neoclassical interpretation of Keynes’s work, highlighting that Keynes’s original ideas about economic instability and disequilibrium were often misunderstood. He argued for a more dynamic understanding of Keynesian economics, focusing on macroeconomic disequilibria.

18. George Akerlof (1940–present)

• Key Works: The Market for Lemons (1970), Animal Spirits (2009, with Robert Shiller)

• Contribution: Akerlof is best known for his work on asymmetric information, but his book Animal Spirits (with Robert Shiller) applies Keynesian concepts to modern economic challenges, emphasizing the role of psychological and social factors in economic decision-making and cycles.

19. Robert Shiller (1946–present)

• Key Works: Irrational Exuberance (2000), Animal Spirits (2009, with Akerlof)

• Contribution: Shiller’s work on behavioral economics integrates Keynesian insights into financial markets. He emphasizes the importance of psychological factors, bubbles, and market instability in economic fluctuations, advocating for government intervention to mitigate economic crises.

20. Thomas Piketty (1971–present)

• Key Works: Capital in the Twenty-First Century (2013)

• Contribution: Piketty's work focuses on income and wealth inequality, demonstrating through extensive historical data that wealth concentration tends to increase in capitalist societies. He argues that the return on capital often outpaces economic growth, leading to persistent inequality. Piketty advocates for progressive taxation and global wealth taxes as essential measures to mitigate this trend, emphasizing the need for policy interventions to address the economic imbalances created by capitalism. His research has significantly influenced public discourse on inequality and economic policy.

Conclusion

The legacy of Keynesian economics is profound and enduring, shaped by a diverse array of influential economists who have expanded and adapted its principles over the decades. From John Maynard Keynes, who laid the foundation for modern macroeconomic thought, to contemporary figures like Thomas Piketty, who addresses pressing issues of inequality, these economists have contributed significantly to our understanding of economic dynamics, market behaviors, and the critical role of government intervention. Their collective insights challenge traditional economic theories and advocate for policies aimed at fostering stability, growth, and equity. As we navigate the complexities of today’s global economy, the lessons from Keynesian economics remain vital, offering essential frameworks for addressing economic challenges and ensuring sustainable development in an ever-changing world.