Clarifying Keynesian Economics

May 10th, 2013 by Rick Drain

British Economist John Maynard Keynes has been hugely influential because of ideas he developed while studying the Great Depression, which was then ongoing.

His key observation was that when an economy has been dealt a severe blow, such that there’s mass unemployment and shuttered factories, then the economy if left to itself could take a very long time to recover. That’s simply because unemployed people spend as little as possible, and businesses only re-open factories or build new ones to meet rising demand for goods. Even if, as theory recommended at the time, wages and interest rates dropped to the point where many more people would be hired, those workers’ spending power would be too low to drive growth in the short or medium term.

Keynes proposed that in such a case, government could speed the recovery immensely by borrowing money (interest rates were low and business were not borrowing to build) and funding productive work. Workers would have money to spend for current consumption, and roads, bridges, schools, etc. would be built to make future growth more efficient.  When the recovery came around, the special projects would wind down and the government would use the increased tax revenues to pay down the debt.

Some people hated the idea, not least because it gave a very big role in the economy to government. Arguments have raged, and good and bad points have been raised.

Seven of the most common bad points are discussed by Mark Thoma in The Fiscal Times:

Seven Myths about Keynesian Economics