Learning the Basics of Keynesian Economics
Keynesian economics was developed by John Maynard Keynes. It is an economic theory that believes on the government influence on certain economic factors rather than limiting itself while letting the free market take its course. His main theory is further expounded in his book “The General Theory of Employment, Interest and Money”. Published in 1936, it has become the influential book that started other schools of thought in economics related to Keynesian theory.
“Priming the Pump”
One of the most popular concepts on Keynesian economics is the “priming the pump”. This is an aid to countries or states that have economic problems. Through this concept, the government should initiate actions that would increase spending – eventually stimulating the economy as demands would rise.
This concept is infamous because it is a direct reaction to the economic theory popular during its proposition: Austrian economics which supports free market and limited government intervention. However, the idea of priming the pump is believed to be supported by the events during the Great Depression. Among the reasons why the US economy slowly regained its standing was due to President Roosevelt’s increased spending on defense system.
Excessive Saving
Another concept proposed by Keynes is the idea of excessive saving that can cause recession. He believes that the biggest reason why a state or country experiences recession was due to money hoarding. A person may start saving in a constantly increasing amount. This is caused by various economic factors or it is simply human behavior to save as much as they can. If one person hoards money successfully on their savings account, another person may emulate the action. Soon, everyone is afraid to spend. This will have a ripple effect on the economy as businesses will have fewer customers.
His solution to this problem is very simple: stimulate the economy by expanding the available supply of money. It’s like the concept of priming the pump but instead of government spending, the government creates actions that would lead people to spend. By stimulating the economy, people would have the confidence to buy again which will start the motion of slow but sure economic progress.
The idea of excessive saving provides a good framework on how recession and depression starts. When people start to hoard money or when funds are held because of fear, the economy will eventually suffer because money is no longer circulating.
Active Government Policy
This is probably the gist of Keynesian economics: government should always have active participation in the country’s economy. He even goes to imply that budget and deficit problems of the government should not be a priority as they have to focus on the state’s economy to maintain balance. The government should never hesitate to spend excessively when the country is in recession in order to encourage spending. Conversely, they should also quell inflation by increasing taxes. The latter proposition believes that the increase of demand when the economy is strong could cause inflation as supply is not as strong as demand.
Since any state or country is constantly facing challenges and triumphs in their economy, the government should not just wait for events to happen. They should be active in learning the progress and react accordingly. This ensures stability recession will be prevented and inflation is controlled before they could even happen. Like his other theories, Keynes’ critics are opposed to the idea of allowing the government direct influence on how the economy will work. They argued that increased government intervention would eventually take its toll on business as their earnings decrease and this will also have negative ripple effect on the economy.
IS/LM Model and Philips Curve
These two theories were developed with the help of Keynes original proposition for government economic intervention. The IS/LM means Investment Savings over Liquidity preference Money supply. This theory provides a concrete solution for government on the actual actions that should be considered. The model illustrates the relationship of investment and output while considering other factors that may affect the relationship. This model was proposed in 1936 and although many acknowledge its limitation because not every factor is considered, it does provide a fine example of macroeconomic behavior.
The Philips Curve on the other hand, deals with the relationship of inflation with unemployment. This was developed by William Philips in 1958. In gist, the curve shows that inflation could rise when unemployment is low. This is a very popular theory because it was considered a trend since the end of WWII until the 70s. The theory lost its popularity during the 70s because unemployment rate increased even without the inflation. While this theory is no longer popular, it also shows a potential relationship of inflation and employment.
Keynesian economics is one of the most groundbreaking schools of thought in economics. Its basic idea of government intervention has spawned other theories that try to explain current economic conditions.