In a deep slump with mass unemployment, what did Keynes say a government should do?
Keynes argued that full employment could be restored only with help from government spending, and that a budget deficit in a downturn was the remedy. Balancing the budget was the standard practice of the time.
- Began
- 1936, with John Maynard Keynes's The General Theory of Employment, Interest and Money
- Founder
- John Maynard Keynes (1883 to 1946), a British economist at Cambridge
- Later figures
- Abba Lerner, Arthur Okun and Robert Solow
- Where it guided policy
- Economic policy in most Western governments, until the 1970s
- Main rivals
- Monetarism and new classical economics
What it was reacting to
Keynes wrote The General Theory in response to the long spell of high unemployment in Britain between the two world wars. Governments of the time aimed to balance their budgets, and wage cuts were a common proposed cure for unemployment.
Keynes rejected that cure. He argued that a general cut in wages would cut workers' incomes and spending, so firms would sell less and hire no more.
The key ideas
Can you name the four key ideas of Keynesian economics?
Total spending in an economy: consumption, investment and government spending. Keynesians hold that it decides how much is produced, and how many people are employed, in the short run.
Can you think of an example?
Firms grow gloomy about the future and cut investment. Companies that make machines lay off staff, even though nothing has changed in what the economy could produce.
Wages and prices adjust slowly, so a fall in spending cuts output and jobs before it cuts prices.
Can you think of an example?
Pay is often fixed in yearly agreements. If sales collapse in March, a firm cannot cut pay until the agreement ends, so it lays workers off instead.
A change in spending goes on to change total income as it passes from person to person, because one person's spending is another's income. Keynesians hold that the effect is positive, though not always larger than the first change.
Can you think of an example?
A government pays a firm to build a road. The builders spend part of their wages in local shops, whose owners then spend part of theirs.
Using government spending, taxes and interest rates to support demand in a slump and hold it back in a boom.
Can you think of an example?
In a recession a government cuts taxes and raises spending, running a deficit, then reverses course once unemployment has fallen.