Notesale: Turn your study into money

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KEYNESIANISM: (1930s – 1970s)
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Keynes developed his theories in response to the Great Depression and was highly critical
of classical economic arguments that natural economic forces and incentives would be
enough to help the economy recover
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It is a theory that says the government should increase aggregate demand as it strongly
influences economic output in the short run, to boost growth
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As a result, the theory supports
expansionary fiscal policy
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→ overdoing causes inflation
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In this
book he maintained that during recessions structural rigidities and certain characteristics
of market economies would exacerbate economic weakness and cause aggregate demand
to plunge further
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Second, Keynes argued that government spending was necessary to maintain full
employment
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Instead, he argued that once an economic downturn sets in, for whatever reason, the fear
and gloom that it engenders among businesses and investors will tend to become selffulfilling and can lead to a sustained period of depressed economic activity and
unemployment
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Commented [OA1]: Along with U
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Treasure official
Harry Dexter White, Keynes is considered the intellectual
founding father of the IMF and the World Bank, which were
created at Bretton Woods
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During he 1973 oil crisis, Keynesian policy
responses did not reduce unemployment instead leading to
a period of high inflation and stagflation
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It says the free market allows the
laws of supply and demand to self-regulate the business cycle
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It will enable private entities to own the factors of
production – entrepreneurship, capital goods, natural resources and labour
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The government should have a balanced budget and incur little debt
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In his “General Theory of Employment, Interest and Money” he clarified the point – the
size of effective demand determines the amount of employment
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Consumption propensity: the ratio of consumption expenditure to income
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Commented [OA3]: 1
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2
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3
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The stronger the liquidity preference, the greater the
demand for money
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Keynesian economists justify government intervention through public
policies that aim to achieve full employment and price stability
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Short-term demand increases initiated by interest rate cuts reinvigorate the economic
system and restore employment and demand for services
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Without intervention, Keynesian theorists
believe, this cycle is disrupted, and market growth becomes more unstable and prone to
excessive fluctuation
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When borrowing is encouraged,
businesses and individuals often increase their spending
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Interest rate manipulation may no longer be enough to generate new economic activity if
it cannot spur investment, and the attempt at generating economic recovery may stall
completely
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Furthermore, the classical economic theory proposes 3 main reasons for unemployment:
1
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(depend on welfare payments)
2
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3
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Classical economists consider that in a pure
capitalist free market economy the third situation cannot occur, because the invisible
hand can automatically regulate the labor market and that the wages will be
automatically fixed at a level that will encourage both the workers to work and the
employers to employ
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He believed that unemployment was caused
by a lack of demand
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The government’s job is to create demand (investing in big public works that would employ
many people) even if that meant creating a deficit in the budget
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The country should reduce their spending in
case of a recession or economic crises, just like a household
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Commented [OA4]: when monetary policy becomes
ineffective due to very low interest rates combined with
consumers who prefer to save rather than invest in
higher-yielding bonds or other investments
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Keynes denied this, arguing that interest rates depended on
people’s liquidity preferences and the money supply
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Main tenets of Keynesianism:
1
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Nearly all Keynesians
and monetarists now believe that both fiscal and monetary policies effect aggregate
demand
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According to Keynesian theory, changes in aggregate demand, whether anticipated or
unanticipated, have their greatest short-run effect on real output and employment, not
on prices
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Keynesians put
more emphasis on the short run
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Otherwise, an injection of new money would
change all prices by the same percentage
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Keynesian models of economic activity
also include a multiplier effect; that is, output increases by a multiple of the original change
in spending that caused it
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Keynesians believe that prices, and especially wages, respond slowly to changes in supply
and demand, resulting in periodic shortages ad surpluses, especially of labour
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4
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In fact, Keynesians typically see unemployment
as both too high on average and too variable
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They have concluded that the costs of low inflation are small
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This is based on the belief that macroeconomic fluctuations significantly
reduce economic well-being ad the government is knowledgeable and capable enough to
improve in the free market
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They agree the government has a role to play, but fiscal policy should
target companies
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Commented [OA5]: -The Keynesian multiplier
represents how much demand each dollar of government
expenditure generates
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Monetarists claim that monetary policy is the real driver of the business cycle
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They believe the
expansion of the money supply will end recessions and boost growth
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Monetarist economists doubted the
ability of governments to regulate the business cycle with fiscal policy and argued that
judicious use of monetary policy could alleviate the crisis
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They believe the
government should take a more active role to protect the common welfare
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Communists believe the government should own everything
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New Keynesian Theory:
The brief debate between Keynesians and new classical economists in the 1980s was fought
primarily over the first three tenets of Keynesianism
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New classical theory (originated in the early 1970s) emphasizes the ability of a market economy
to cure recessions by downward adjustments in wages and prices
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The label “new Keynesian” describes those economists who, in the 1980s, responded to
this new classical critique with adjustments to the original Keynesian tenets
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The primary disagreement between new classical and new Keynesian economists is over
how quickly wages and prices adjust
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They believe
that prices “clear” markets—balance SUPPLY and DEMAND—by adjusting quickly
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New Keynesian theories rely on this stickiness of wages and prices to explain why
involuntary UNEMPLOYMENT exists and why MONETARY POLICY has such a strong
influence on economic activity
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According
to this view, if the money supply falls, people spend less money and the demand for goods
falls
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New classical economists
criticized this tradition because it lacks a coherent theoretical explanation for the sluggish
behavior of prices
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In new Keynesian theories recessions are caused by some economy-wide market
failure
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In particular, New Keynesians assume that there is imperfect competition[1] in price and
wage setting to help explain why prices and wages can become "sticky", which means they
do not adjust instantaneously to changes in economic conditions
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Therefore, New Keynesians
argue that macroeconomic stabilization by the government (using fiscal policy) and
the central bank (using monetary policy) can lead to a more efficient macroeconomic
outcome than a laissez faire policy would

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