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Keynesians - Introduction
Keynesian economists are, not surprisingly, so named because they are advocates of the work of John Maynard Keynes (if only all economics was that easy!). Much of his work took place at the time of the Great
Depression in the 1930s, and perhaps his best known work was the 'General Theory of
Employment, Interest & Money' which was published in 1936.
In this section we look more generally at the work of Keynesian economists. Follow the links below or at the foot of the page to find out more detail about what they believed in and the policies they proposed.
* Beliefs
* Theories
* AS & AD
* Policies
* Virtual Economy policies
Keynesians - Beliefs
Keynes didn't agree with the Classical economists!! In fact the easiest way to look at
Keynesian theory is to see the arguments he gave for Classical theory being wrong. In essence
Keynes argued that markets would not automatically lead to full-employment equilibrium, but in fact the economy could settle in equilibrium at any level of unemployment. This meant that Classical policies of non-intervention would not work. The economy would need prodding if it was to head in the right direction, and this meant active intervention by the government to manage the level of demand. Follow the links in the navigation bar at the foot of the page or in the side panel to find out more detail on the sort of policies this may involve.
Keynesian beliefs can be illustrated in terms of the circular flow of income. If there was disequilibrium between leakages and injections, then classical economists believed that prices would adjust to restore the equilibrium. Keynes, however, believed that the level of output (in other words National Income) would adjust. Say, for example, that there was for some reason an increase in injections (perhaps an increase in government expenditure). This would mean an imbalance between leakages and injections.
As a result of the extra aggregate demand firms would employ more people. This would mean more income in the economy some of which would be spent and some saved (or paid in tax). The extra spending would prompt the firms in the economy to produce even more, which leads to even more employment and therefore even more income. This process would go on, and on, and on, and on until it stopped! It would eventually stop because each time income increased, the level of leakages (savings, tax and imports) also increased. Once leakages and injections were equal again, equilibrium was restored. This process is called the Multiplier effect. Keynesians - Theories
Keynes argued that relying on markets to get to full employment was not a good idea. He believed that the economy could settle at any equilibrium and that there would not be automatic changes in markets to correct this situation. The main Keynesian theories used to justify this view were:
* The labour market
* The market for loanable funds (money market)
* The Multiplier
* Keynesian inflation theory
Monetarist
The labour market
Keynes didn't have the same confidence in the labour market as Classical economists. He argued that wages would be 'sticky downwards'. In other words workers would not be happy about taking wage cuts and would resist this. This would mean that wages would not necessarily fall enough to clear the market and unemployment would linger. We can see this in the diagram below:
[The labour market]
When the demand for labour falls from D1 to D2 (maybe due to the onset of a recession), the wage rate should fall, so that the market clears. However,
Keynes argued that because wages were sticky downwards, this would not happen and unemployment of ab would persist. This unemployment he termed demand deficient unemployment.
The market for loanable funds (money market)
Classical economists were of the view that savings would need to be increased to provide more funds for investment. Keynes disputed this assumption - once again because he had less faith in markets as the economics 'miracle cure'. He argued that any increase in savings would mean that people spent less. This would mean a decrease in aggregate demand. This would just make things worse and firms would be even less inclined to invest because they would find the demand for their products decreasing. He felt that investment depended much more on business expectations.
The Multiplier
Any increase in aggregate demand in the economy would result, according to Keynes, in an even bigger increase in
National Income. This process came about because any increase in demand would lead to more people being employed. If more people were employed, then they would spend the extra earnings. This in turn led to even more spending, which led to even more employment which led to even more income which then led to even more spending which then led to ................. The length of time this process went on for would depend on how much of the extra income was spent each time. If the initial recipients of the extra income saved it all, then the process would stop very quickly as no-one else would get their hands on the extra income. However, if they spent it all the knock-on effects of the extra spending would carry on for some time.
Therefore the higher the level of leakages, the lower the Multiplier would be.
The precise formula for calculating the multiplier is:
Multiplier = 1
-------------------------------------------------
1 - Marginal propensity to consume
Keynesian view of inflation
The key to the classical view of inflation was the Quantity Theory of Money
. This theory revolved around the Fisher Equation of Exchange :
MV = PT where: M is the amount of money in circulation
V is the velocity of circulation of that money
P is the average price level and
T is the number of transactions taking place
Keynes once again rejected this theory (you may be getting the idea that he didn't agree much with classical economics!!). He argued that increases in the money supply would not inevitably lead to increases in inflation. Increasing M may instead lead to a decrease in V. In other words the average speed of circulation of money would fall because there was more of it about.
Alternatively, the increase in M may lead to an increased in T (number of transactions), because as we have seen Keynes disputes the assumption that the economy will find its own equilibrium. It may be in a position where there is insufficient demand for full-employment equilibrium
, and in that case increasing the money supply will fund extra demand and move the economy closer to full employment. Keynesians tend to argue that inflation is more likely to be cost-push inflation or from excess levels of demand. This is usually termed demand-pull inflation.