Keynesian economics is an economic theory and macroeconomic policy approach named after the British economist John Maynard Keynes. It emerged in response to the Great Depression of the 1930s and became influential in shaping economic policies, particularly during the mid-20th century. Keynesian economics advocates for active government intervention in the economy to achieve full employment and stabilise economic growth.
Keynesian economics is based on several key principles:
- Aggregate Demand: Keynesian economics emphasises the role of aggregate demand (total spending in the economy) as the primary driver of economic activity. When aggregate demand falls short of the economy's potential output, it can lead to recessions and unemployment.
- Economic Slumps and Unemployment: Keynes argued that during economic downturns, private sector investment and consumer spending tend to decline, leading to a reduction in economic output and an increase in unemployment. In such situations, he proposed that the government should step in to boost demand through fiscal and monetary policies.
- Fiscal Policy: Keynes advocated for the use of fiscal policy, which involves government spending and taxation, to stimulate or control the economy. During periods of economic downturn, the government can increase spending on public projects, welfare programs, and infrastructure to boost aggregate demand and create jobs. Conversely, during periods of high inflation and economic overheating, the government can reduce spending or increase taxes to cool down the economy.
- Monetary Policy: Keynes also acknowledged the importance of monetary policy, which involves the control of the money supply and interest rates by the central bank. Lowering interest rates and increasing the money supply can encourage borrowing and spending, thus stimulating economic activity. Conversely, raising interest rates can help control inflation by reducing spending.
- Government Intervention: In contrast to classical economic theories that advocated for minimal government intervention and a laissez-faire approach, Keynesian economics argued that active government involvement in the economy was necessary to address fluctuations in economic activity and stabilize the business cycle.
Keynesian economics had a significant influence on economic policy during the post-World War II era, particularly in Western countries. Many governments adopted Keynesian policies, and the approach remained dominant until the 1970s when stagflation (a combination of stagnant economic growth and high inflation) challenged some of its core assumptions.
Since then, economic thinking has evolved, and various economic theories, including neoclassical and monetarist approaches, have emerged. Modern economic policies often combine elements from different theories to address complex economic challenges. However, Keynesian principles, particularly the use of fiscal and monetary policies to stabilize the economy, remain relevant and continue to shape economic policy discussions.