Brad Cartwright

Keynesian Economics is one of the most transformative ideas in the history of economic thought.  For those of you who have purchased the Macroeconomics course, this may be familiar to you.

It emerged during the depths of the Great Depression, at a time when traditional economic models were failing to explain the massive economic collapse.

John Maynard Keynes, an English economist, challenged the prevailing neoclassical views and offered a new way of thinking about how governments could—and should—respond to economic crises.

The Context: Before Keynes

Before Keynes, the dominant economic model was the neoclassical model, which focused almost exclusively on the supply side of the economy.

The role of the government, according to this model, was minimal: create infrastructure, enforce laws, and establish a system where businesses could thrive. Economists believed that free markets were self-correcting and that the economy, if left alone, would allocate resources efficiently and recover from downturns naturally.

But then came the Great Depression of the 1930s, a global economic crisis so severe that it shattered confidence in the self-correcting nature of markets. Factories closed, businesses went bankrupt, and unemployment skyrocketed. People stopped spending, which led to even more businesses failing—a downward spiral that the neoclassical model had no tools to address.

Enter John Maynard Keynes

Keynes observed this economic devastation and argued that the traditional approach wasn’t working.

In fact, he believed that during times of severe economic crises, the only entity capable of turning things around was the government.

Why? Because in such situations, the government is often the only player with the resources and authority to act boldly enough to stabilize the economy.

Keynes shifted the focus from supply-side economics to demand-side economics. He argued that governments had a responsibility not just to support businesses but also to stimulate demand by increasing spending.

According to Keynes, during a crisis, governments should:

1. Spend More: Increase government expenditures on public projects to create jobs and inject money into the economy.
2. Lower Taxes: Reduce taxes to put more money in people’s pockets, encouraging them to spend.
3. Run Deficits: If necessary, governments should spend more than they collect in taxes, even if it means going into debt. Keynes believed that the short-term benefits of stimulating the economy outweighed the long-term costs of debt.

The Keynesian Revolution

Keynes’ ideas revolutionized economic thought and policy. His approach became the foundation of macroeconomics, which studies the economy as a whole rather than focusing on individual markets or firms.

Keynes’ theories also redefined the role of the government in the economy. Under Keynesian economics, the government wasn’t just a referee ensuring fair play; it became an active participant responsible for maintaining economic stability and growth.

Real-World Examples of Keynesian Economics

During the Great Depression, Keynesian ideas were put into practice in the United States through massive public works programs. Consider the following:

• The Empire State Building: Built during the 1930s with government funding, it created thousands of jobs during construction.
• The Golden Gate Bridge: Another monumental project funded by government spending.
• Mount Rushmore: A government jobs program that paid workers to carve the faces of U.S. presidents into a mountain.
• The Hoover Dam: Built to create jobs and stimulate economic activity.

These projects weren’t just about building infrastructure; they were about putting people back to work and restoring confidence in the economy.

Fiscal and Monetary Policy

Keynes also introduced the idea of using fiscal policy and monetary policy as tools to manage the economy:

• Fiscal Policy: Governments can adjust spending and taxation to influence demand.
• Monetary Policy: Central banks can manipulate interest rates and the money supply to impact economic activity.

Together, these tools gave policymakers new ways to respond to economic challenges.

Keynesian Economics Today

Keynes’ ideas dominated economic thought and policy from the 1930s to the 1970s.

However, during the 1970s, a phenomenon known as stagflation—simultaneous high unemployment and high inflation—posed challenges that Keynesian economics couldn’t fully address. This led to a resurgence of neoclassical ideas, but Keynesian principles didn’t disappear.

In fact, Keynesian economics remains highly relevant.

During the 2008 financial crisis, governments around the world implemented massive stimulus packages based on Keynesian principles. The idea that governments should step in to stabilize economies during crises continues to influence economic policy today.

Why Keynesian Economics Matters

Keynesian economics reshaped our understanding of the government’s role in managing the economy.

It emphasized that markets aren’t always self-correcting and that active government intervention is sometimes necessary to prevent economic collapse.

Keynes didn’t just change economic theory; he changed the way we think about economic policy and the responsibilities of governments.

So, as you continue your studies, remember that Keynesian economics isn’t just about abstract models or theories. It’s a practical approach to addressing real-world problems—a way of thinking that has shaped the modern world and continues to do so today.

Start thinking about it…you’ll see Keynesian principles popping up everywhere in modern economic policy.