What Is Keynesian Economics?
Keynesian economics is an economic theory that argues that governments should spend heavily on infrastructure projects and unemployment benefits during economic downturns in order to stimulate consumer and business spending, growth and job creation.
The theory was developed by British economist John Maynard Keynes in his 1936 book, The General Theory of Employment, Interest, and Money. It was published during the Great Depression, when nothing seemed to work to promote consumer spending, business investment and employment growth.
Keynes argued that during such times, the government needed to adopt an expansionary fiscal policy, even if it meant creating large government budget deficits. He believed policy would stimulate demand because businesses and consumers either could not or would not spend money.
FDR's New Deal
Probably the best-known example of a country putting Keynesian economics to work is the New Deal programs launched by the administration of U.S. President Franklin Roosevelt during the 1930s. They created numerous government agencies and programs that spent enormous sums of money to build projects and create benefits designed to put people to work and money in their hands.
Among the projects and programs enacted and built during the New Deal were Social Security, the Tennessee Valley Authority, the Civilian Conservation Corps, the Public Works Administration, the Works Progress Administration, and the Rural Electrification Administration. Some of these agencies still exist in 2019.
Keynes and his followers believe that government spending like this would give people money to spend, which would stimulate demand for goods. This would then would boost business growth and job creation, and the cycle would thus feed on itself, creating economic growth. Conversely, once the economy has begun to grow again, Keynesians believe that governments should pull back on spending and increase taxes in order to avoid inflation.
As a result, Keynesian economics is a countercyclical theory, calling for governments to spend heavily during economic contractions and reduce spending during recoveries. However, many governments continue to use stimulative fiscal policies even during expansions.
While Keynesian economics is still very much a part of government fiscal policies around the world, other competing theories and policies have been developed since Keynes propounded his ideas during the Great Depression.
For example, during the "stagflation" of the 1970s, when many Western economies suffered from both stagnant economic growth and high inflation at the same time—thought to be an oxymoron—Keynesian economic solutions proved ineffective.
Under U.S. President Ronald Reagan and others, "supply-side" economics ruled the day, as opposed to Keynesians, who emphasized the demand side of the economy. Supporters of this theory argue that business investment, not consumer demand, drives economic growth. As a result, they instituted tax cuts and deregulation to stimulate business investment, which would incent hiring and then consumer spending. This would then drive continued business expansion.
The Rise Of Monetarism
Advocates of monetary policy appear to be in the ascendency, especially in the wake of the Great Recession that followed the global financial crisis of 2008. This thinking calls for central banks to manipulate the supply of money and the level of interest rates to create the ideal economic environment, meaning moderate inflation, low interest rates and full employment.
For example, the U.S. Federal Reserve, the European Central Bank, the Bank of England, the Bank of Japan and others generally follow the same policies. They include very low—if not actually negative—interest rates and other accommodative monetary policies in order to stimulate business demand and job growth.
Keynesian economics was devised by the British economist John Maynard Keynes during the Great Depression of the 1930s. It's an economic theory that argues that governments should spend heavily during economic downturns in order to stimulate spending, which will ignite economic growth and employment.
Once the recovery begins, governments should pull back on spending in order to avoid causing inflation. Keynesianism has been a dominant macroeconomic theory ever since. However, in more recent years it has been somewhat eclipsed by monetarism, in which central banks manipulate interest rates and monetary policy in order to promote economic growth while keeping inflation under control.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…