Keynesianism

Keynesianism is an economic theory developed by John Maynard Keynes in the 20th century that emphasizes government intervention in the economy to stabilize the economic cycle.

This approach argues that, in times of recession, the government should increase public spending and reduce taxes to stimulate aggregate demand and, thus, promote employment and economic growth. On the other hand, in periods of high inflation , the government must adopt fiscal restraint policies to prevent the economy from overheating.

Origin of Keynesianism

Keynesianism originated in the United Kingdom, in the context of the Great Depression of the 1930s , which followed the 1929 Crisis in the USA . It was developed by John Maynard Keynes, a British economist, whose work The General Theory of Employment, Interest and Money , published in 1936, laid the foundations of the theory.

At the height of the depression, Keynes argued that markets did not self-regulate efficiently and that mass unemployment could persist without government intervention. His theory emphasized the importance of effective demand in determining employment and advocated active fiscal and monetary policies to stabilize the economy.

The first practical application of Keynesianism occurred in the United States , during the government of Franklin D. Roosevelt, with the New Deal , which included a series of fiscal stimulus measures to combat the Great Depression. This approach also became the basis for the post-war economic policy of many other countries and played a key role in the post-World War II economic recovery.

How does Keynesianism work?

John Maynard Keynes’ main work that underpins Keynesianism is The General Theory of Employment, Interest, and Money , published in 1936. In this book, Keynes presents his theory and describes the functioning of the economy according to Keynesian scientific method  and the way in which we can make conjectures. However, it is sometimes difficult to understand the logic.

In the work, Keynes argues that the economy can become trapped in equilibria of involuntary unemployment, when markets are unable to adjust quickly to reach full employment. It introduces key concepts, such as “effective demand” — which represents aggregate demand in the economy, made up of consumption, investments, public spending and net exports. Keynes argues that effective demand is fundamental in determining the level of production and employment in an economy.

Keynes also discusses the concept of “marginal propensity to consume” — which refers to the additional portion of income that people spend. He states that the marginal propensity to consume can vary and that, in times of economic crisis, people tend to save more, which can lead to a drop in effective demand. This, in turn, can result in unemployment and underutilization of resources.

Furthermore, the author addresses the importance of fiscal and monetary policy for managing effective demand. He argues that, in times of recession, the government should increase public spending and/or reduce taxes to stimulate demand and reverse unemployment. It also highlights the central bank’s ability to influence interest rates and the money supply to affect investment and consumption.

Characteristics

Among the main characteristics of Keynesianism, the following can be highlighted:

1. Government intervention: The need for active government intervention in the economy to combat economic fluctuations such as recessions and depressions is emphasized. This includes fiscal and monetary policies to stimulate or contain aggregate demand depending on economic conditions.
2. Economic cycles: the existence of economic cycles is recognized, with natural fluctuations in employment and production. The government must intervene to smooth these cycles, preventing high unemployment rates during recessions.
3. Monetary and fiscal policy: the use of monetary (control of money supply and interest rates) and fiscal (spending and taxes) policies is recommended as tools to achieve macroeconomic objectives, such as full employment and price stability.
4. Countercyclical role: It is suggested that the government adopts countercyclical policies, increasing spending during recessions and reducing it during periods of high inflation to maintain economic stability.
5. Short-term focus: focuses mainly on the short term, on managing immediate economic fluctuations, in contrast to some economic theories that are more long-term oriented.
6. Criticism of laissez-faire: the idea of ​​laissez-faire, typical of liberalism , which defends government non-intervention in the economy, was challenged , arguing that the free market will not necessarily lead to full employment and economic stability.

Who was Keynes?

John Maynard Keynes (1883-1946) was a British economist known for his contributions to economic theory and his innovative economic policies. He was born in Cambridge, United Kingdom, and studied at the University of Cambridge, where he received degrees in mathematics and economics.

He later taught at the same university and held important government positions during both World Wars, including the team negotiating the Treaty of Versailles after the First World War. His most influential work, The General Theory of Employment, Interest and Money , published in 1936, had a great impact on economic thought by highlighting the importance of effective demand and government intervention in the economy.

Application of Keynesianism

Keynesianism was applied in different countries and contexts throughout the 20th century. His most significant influence occurred during the Great Depression , following the Crash of 1929.

In the United States, the New Deal, implemented by President Franklin D. Roosevelt in the 1930s, was one of the first practical applications of Keynesianism. This program involved a series of fiscal stimulus policies, such as the creation of public jobs and investments in infrastructure, to combat economic depression.

In Great Britain, the home country of John Maynard Keynes, Keynesianism was also adopted as part of post-World War II reconstruction policies . The British government implemented social welfare policies, investment in housing and public services, and adopted a Keynesian approach to dealing with unemployment and promoting full employment.

In addition to the United States and the United Kingdom, many other Western countries, including Canada, Australia, France, and Germany, also adopted Keynesian policies after World War II. These policies included increasing public spending, regulating the financial sector, and promoting employment.

Keynesianism also played an important role in developing countries , where industrialization and economic modernization were crucial goals. For example, in Japan after World War II, the government adopted Keynesian policies to rebuild the economy and promote industrial growth.

However, over the decades, Keynesianism has undergone adaptations and changes in response to different economic contexts, such as the stagflation of the 1970s. The rise of neoliberalism in the 1980s and 1990s led to a reversion in many countries to policies more market-oriented economies.

Advantages and Disadvantages

Throughout the history of recent economic thought, several authors have dedicated themselves to studying Keynesianism. Many have published works that defend it and point out its advantages; Many others have published works that criticize it, pointing out disadvantages. This discussion can be summarized with the main points below.

Advantages of Keynesianism

1. Paul Samuelson, in Economics (1948): the American economist emphasized the importance of Keynesianism for economic stabilization. He argued that Keynesian policies such as fiscal stimulus can help avoid prolonged recessions and mass unemployment, making the economy more resilient.
2. James Tobin, in Liquidity Preference as Behavior Towards Risk (1958): the American economist developed Keynes’ theory of liquidity preference. He argued that government intervention to reduce interest rates can stimulate private investment and boost economic growth, contributing to a more stable economy.

Disadvantages of Keynesianism

1. Milton Friedman, in A Theory of the Consumption Function (1957): the American economist criticized Keynesianism for its excessive focus on demand-side policies, arguing that these policies could lead to inflation if not are well calibrated. He promoted the idea that control of the money supply and price stability are key to avoiding economic crises.
2. Robert Lucas, in Expectations and the Neutrality of Money (1972): the American economist questioned the government’s quality of life. These patients are limited in their ability to predict and respond effectively to economic fluctuations. He argued that the rational expectations of economic agents can render Keynesian policies ineffective as people adjust their behavior in anticipation of government actions, thus undermining the success of these policies.

Criticisms of Keynesianism

Keynesianism has also faced significant criticism over time, especially from economists who advocate more market-oriented economic approaches. Among the main criticisms of the Keynesian model, we can mention:

1. Inflation and stagflation: Milton Friedman, in his work A Theory of the Consumption Function (1957) and other works, criticized Keynesianism for its tendency to generate inflation when governments adopt uncontrolled expansionist policies. Furthermore, the stagflation of the 1970s, characterized by high inflation and economic stagnation, led to criticism that Keynesian policies were inadequate to deal with this scenario.
2. Rational expectations: Economists such as Robert Lucas, in Expectations and the Neutrality of Money (1972), argued that Keynesian policies were often ineffective because of people’s ability to anticipate government actions. If the rational expectations of economic agents are taken into account, Keynesian policies may be less effective in affecting economic behavior.
3. Cost of Unemployment: Friedrich Hayek, author of The Road to Serfdom (1944), criticized Keynesianism for its emphasis on reducing unemployment at any cost. He argued that excessive government intervention in the economy could undermine individual freedom and lead to inefficient economic outcomes.
4. Long-term effects: Some critics argue that Keynesianism tends to focus too much on the short term, ignoring the long-term implications of government stimulus policies. They claim that the accumulation of public debt and market distortions can harm sustainable economic growth.