By Aidan Hackett. Edited by Arjun Chandrasekar.
Overview
As the Great Depression set in around the world, John Maynard Keynes’ home, the UK, was particularly ill affected. Keynesian economics is often referred to as “depression economics” because of the time in which Keynes was inspired to start creating this theory. He began noticing that the theory of his contemporaries, classical economics, just was not cutting it in a world where the economy seemed to be feeding back into itself in an endless negative spiral. More or less, he noticed that businesses cannot look out for their shareholders when everyone is too afraid to spend their money.
Keynes’ Background
The Right Honourable 1st Baron Keynes was born John Maynard Keynes in Cambridge to an upper-middle-class family of intellectuals. From a young age, he was noted for being “head and shoulders above all the other boys in the school”, especially in arithmetic, and was encouraged to apply for a King’s Scholarship to Eton College. Successfully achieving this distinction, Keynes developed his talents in mathematics, eventually getting a scholarship to King’s College Cambridge to study mathematics. Keynes received a degree with first-class honours, and was active in many student societies, becoming president of the Cambridge Union Society. However, apart from sometimes sitting in on lectures, Keynes had no formal economic education.
Keynes’ Theories
Keynes’ basic theory was formulated counter to classical economic theory, the philosophy of Adam Smith and the people he inspired, and the theory of the invisible hand. While most other economists of the time argued that the self-interest of businesses would eventually bring an end to the Great Depression, Keynes did not see this as viable in the short term, and waiting for the economy to kick itself into gear again would either lead to greater economic loss in the near term or would never actually happen. What Keynes proposed instead, was government intervention through spending or other initiatives aimed at increasing the cash people had so that aggregate demand, and therefore spending, would increase.
Basically, what Keynes was saying is that once a recession of the scale of the Great Depression set in, the doom and gloom of the whole situation will lead to a self-fulfilling prophecy – people prepare for the worst by spending less and saving more, meaning businesses don’t have as many sales, meaning they have to lay off workers, meaning people are confirmed in their ideas that there is a financial struggle, and then the cycle continues. The only way to get out of this, according to Keynes, was for the government to step in, take control of the situation and encourage spending.
But how will the government afford all of this? Keynes proposed that the government should not raise taxes at the time it was spending the money, instead saying that taxes should be cut, and these tax cuts make sense, as the government should be doing anything they can to increase spending. Instead, the government should increase taxes when the times are good, when the economy is growing, and when people are spending a lot of money. During this time, the taxes wouldn’t be felt as much, as the economy is doing well; there are jobs, people are getting raises, and overall, there is much more prosperity. What this system of taxing when times are good and spending when times are bad does is decrease the amplitude of the business cycle. While traditionally the business cycle was an upward trend, the peaks were very high because the government didn’t intervene, and then the troughs were incredibly low because the government did intervene. With more intervention, Keynes claimed that the trend would still be an upwards one, but the public would have to trade the extreme highs of the good times for more protection against the lows of the bad times. A perfect historical example of this is the excess of the 1920s vs the poverty of the 1930s, compared to the period between 2005 and 2015 where governments around the world stepped in and pumped economies full of cash in wake of the GFC.
Criticisms of Keynes’ Theories
Broken Window Fallacy
- A child breaks a window of a shop owner, meaning the owner has to pay the window installer, who has to buy a window, who has to pay their workers, who all have families that they need to feed so they buy groceries, so on and so forth. This initial spending by the shop owner to get a new window created more spending throughout the economy, and the child is a hero for stimulating the economy. That is the Keynesian view. Critics would say “hey wait, the shop owner probably would have spent that money anyway, so you are just forcing him to spend it on something unproductive for his business, actually hurting him and the economy in the long run.” Also, there is the matter of where the owner is going to get the money in the first place if we are indeed in a recession. Keynes would argue that the shop owner would not have spent the money in the first place out of fear, so needed an incentive – the broken window.
“Where does all this money come from?”
- While taxing in the good times covers some of the spending in the bad times, it rarely covers all of it, and oftentimes “emergency recession measures” will hang around after the recession has ended, as it is a habit of governments to try and get as much power as possible. This causes countries to go into debt or print more money, neither of which are good for the public long term as they cause higher interest rates and inflation respectively.
Conclusion
Keynes was, without a doubt, one of the most influential thinkers of the 20th century, and after Smith and Marx, is often cited as being the preeminent theorist in economics. His philosophy, which was so different from anything else mainstream at the time, has been responsible for keeping recessions short and non-crippling, for almost a century now. While Keynes has come in and out of fashion over the years, in these times of Covid, he has once again come to the forefront of government policy discussion. Whether or not all the spending leads to inflation or not, why worry, because as Keynes said, “In the long run, we are all dead”.
For more information on this subject, we recommend watching this video!
