The Keynesian School of Economics an Overview Essay Example

The Keynesian School of Economics: an Overview Essay What was the historical background of the school? Answer: The Keynesian school, proponents of the branch of economics now termed as Keynesian economics had come into existence towards the beginning of the twentieth century. This school was arguably the first viable alternative to the Classical school of thought. The school argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and therefore advocates active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle. These theories were based on the ideas of 20th-century British economist John Maynard Keynes (1883- 1946). The premise forming the basis of Keynesian economics were first presented in ‘The General Theory of Employment, Interest and Money’ (1936). Roots of Keynes’s ideas can be traced back to before 1929 and he adopted a macroeconomic approach. World War I and the economic controls acted out requiring an overall view of the economy. The growth of large-scale industrial production and trade made the economy more susceptible to statistical measurement and control, making the inductive, aggregate approach more feasible than the past. In fact, this approach was increasingly necessary as the public became more eager for the government to deal actively with unemployment. He represented the British Treasury at the Treaty of Versailles—was appalled at the conditions of the peace treaty as he observed that nations had failed to look at the case from a macroeconomic point of view. The Great Depression of the 1930’s also had a profound effect in the development of Keynes’s ideas. In fact his ideas materialized when he was trying to analyze the problems of trade cycle (recessions and booms), one of the greatest problems of the classical economists. We will write a custom essay sample on The Keynesian School of Economics: an Overview specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on The Keynesian School of Economics: an Overview specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on The Keynesian School of Economics: an Overview specifically for you FOR ONLY $16.38 $13.9/page Hire Writer Furthermore the economic thinking of the period was concerned with the problems of secular stagnation (globally declining growth rate) of the capitalist society. Some speculated that as the national income increased, consumption expenditures rose less rapidly than total income, and savings increased more rapidly. Wages were recognized as a source of demand for goods as well as a cost of production, and cutting wages was frequently opposed as providing no real remedy for unemployment; this was the macroeconomic thinking. The mature private-enterprise economies of the Western world were less vigorous after World War I. The population growth was declining; most of the world had already been colonized; there seemed no more room for geographic expansion; consumption appeared to outrun production as incomes and savings rose; less resources were allotted for the purpose of research and development as a result there were no new inventions like the steam engine, electricity, etc to stimulate vast capital investments. Also, the decline of vigorous price competition reduced the rate of replacement of old machinery with new and more efficient ones, and the economy was being dragged downward furthermore when the growing accumulated of depreciation funds from the past investments were not spent quickly enough. Question- 02: What were the major tenets of the school? Answer: The complete doctrine of the Keynesian economists was set as a better option than those provided by the classical economists. Keynes argued that the economy had moved towards The Great Depression only because of the flawed notion that the economy would adjust to the prevailing market conditions and move towards equilibrium. He proposed the government should take a more ‘hands on’ approach. Some of the major tenets include: 1) The school put forward the Keynesian Theory of Employment which began with the principle of effective demand. That is, total employment depends on total demand (aggregate effective demand) and unemployment rose due to a shortage of effective demand (thus they’re agreeing to Malthus’s remark that there was a need for unproductive consumption and government investment). In the calculation of a country’s output which consisted of consumption, investment and government expenditure(Y= C + I + G). Keeping G constant it can be noted that the immediate determinants of Income and thus employment are consumption and investment spending. The money spent on final gods and services, let it be consumption or investment generated income. 2) The Keynesian economists pointed out that there was a tendency for savings to exceed investment (which might reduce AD and lead to unemployment) which is why they supported government intervention to close this gap. It was this school which appealed for the end of lassiez- faire (minimum role of government). For instance, the government should stimulate the economy by lowering interest rates and adopting a deficit budget during imes of economic depression. 3) The government may increase the marginal propensity to consume (and thereby stimulating the economy) through the redistribution of income by adopting a progressive taxation policy (as MPC is higher for lower income earners). 4) The Keynesians stated that the marginal efficiency of capital (expected rate of profit of a new investment) will have a tendency to decline (as more and more investments compete against each other; increas ed supply price of capital goods). They thought that it was difficult to maintain full employment in a Capitalist economy unless the rate of interest was low enough. 5) In periods of falling aggregate demand for goods and services, firms respond to lower sales by reducing production and discharging or laying off workers, not by insisting on wage cuts. This is because prices are sticky downwards. Any decline in effective demand initially cause reductions in output and employment rather than decline in the price level. Deflation occurs only under conditions of extremely severe depression. This wage and price rigidity is also a major tenet on this school 6) Keynesians believe that, because prices are somewhat rigid, fluctuations in any component of spending-consumption, investment, or government expenditures-cause output to fluctuate. If government spending increases, for example, and all other components of spending remain constant, then output will increase. Keynesian models of economic activity also include the multiplier effect (increase in output by a multiple of the original change in spending that caused it). Thus, a ten-billion-dollar increase in government spending could cause total output to rise by fifteen billion dollars (a multiplier of 1. 5) or by five billion (a multiplier of 0. 5). Contrary to what many people believe, Keynesian analysis does not require that the multiplier exceed 1. 0. For Keynesian economics to work, however, the multiplier must be greater than zero. Question- 03: Who did the School benefit or seek to benefit? Answer: The Keynesian School was successful mainly because it focused on painful problems such as unemployment and depression, which were present at that time. It offered something almost to everyone and rationalized what was already being out of necessity. The school’s stress on labor and emphasis on job creation amidst the great depression gained widespread recognition. Business interests benefited from government contracts and government incentives to get the economy out of depression/ recession. When bankers had extensive excess reserves in the 1930s, they found a vast and profitable area for investment in government bonds, and government controls gave the banking system liquidity, security and stability. Reformers and intellectuals enjoyed vastly increased employment in government service that had grown out of Keynesian thinking with less risks of being laid off. Farmers long had favored easy monetary policies and low interest rates. They also came to rely heavily on government spending programs for agriculture. Such forms of government expenditures seemed to bear more than proportionate benefits due to the multiplier effect. Question- 04: How was the school valid, useful or correct in its time? Answer: The introduction of Keynes ideas in the world stage was nothing short of revolutionary. They were perhaps the first group of economists to consider economic theory during policymaking. World wars, The Great depression and the growing impediments of modern life had already weakened the foundations of lassiez- faire. Simply waiting for the ‘markets to stabilize’ was too painful for many to agree to. Keynes had provided both an explanation of fluctuations and a program to tackle it. The role of economists and economic analysis in shaping the direction of government policy was thus greatly increased. It might be interesting to note that the Keynesian approach became immensely useful even to those who did not accept Keynes’s policy conclusions. It established a new set of analytical tools through which to view the economy, encouraged the further development of national income accounting and stimulated a vast and productive effort at empirical studies of the real world which was almost non- existent before their arrival. Question- 05: Which tenets of the school became lasting contributions? Answer: Many say that the founder of the Keynesian School of thought, J. M. Keynes was the one who had contributed the most in the twentieth century. His book ‘The General Theory of Employment, Interest and Money’ influenced economic theory as well as public policy. One of Keynes’s chief contributions was to tie economic to the great economic problems of the day (depression). The impact of the ‘General Theory’ had a dynamic effect n economic study as several tools had been added under this category namely consumption function (marginal propensity to consume); saving function (marginal propensity to save); liquidity preference (transaction, precautionary, speculative demand); marginal efficiency of capital; multiplier effects and the IS- LM analysis. Another important input made by Keynes was in the use of expectations. His integration of expectation with his theory of money and mar ginal efficiency made notable advances in economic investigation. While Classical economists assumed full employment, Keynes and therefore the Keynesian School emphasized on under- employment equilibrium (equilibrium at less than full employment). This meant that increase in the quantity of money does not necessarily mean increase in the price levels (inflation) as long as there is spare capacity in the economy. Towards the end of the school’s long list of contributions it would be fair to mention that the school had critics from several circles. Despite the fact that many of the Keynesian policy prescriptions have been discredited, Keynesian tools of analysis still dominate macroeconomic theory. These theorists were successful in demonstrating the inadequacies of Classical economics, and in the process established a system that is not, itself, without flaws. The importance of their contribution is not its degree of precision, but its role in advancing the debate—in stimulating the argument and in providing the framework for that debate. Source: V. Lokhnathan. ; A History of Economic Thought, 9th ed. The Keynesian School of Economics an Overview Essay Example The Keynesian School of Economics: an Overview Essay What was the historical background of the school? Answer: The Keynesian school, proponents of the branch of economics now termed as Keynesian economics had come into existence towards the beginning of the twentieth century. This school was arguably the first viable alternative to the Classical school of thought. The school argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and therefore advocates active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle. These theories were based on the ideas of 20th-century British economist John Maynard Keynes (1883- 1946). The premise forming the basis of Keynesian economics were first presented in ‘The General Theory of Employment, Interest and Money’ (1936). Roots of Keynes’s ideas can be traced back to before 1929 and he adopted a macroeconomic approach. World War I and the economic controls acted out requiring an overall view of the economy. The growth of large-scale industrial production and trade made the economy more susceptible to statistical measurement and control, making the inductive, aggregate approach more feasible than the past. In fact, this approach was increasingly necessary as the public became more eager for the government to deal actively with unemployment. He represented the British Treasury at the Treaty of Versailles—was appalled at the conditions of the peace treaty as he observed that nations had failed to look at the case from a macroeconomic point of view. The Great Depression of the 1930’s also had a profound effect in the development of Keynes’s ideas. In fact his ideas materialized when he was trying to analyze the problems of trade cycle (recessions and booms), one of the greatest problems of the classical economists. We will write a custom essay sample on The Keynesian School of Economics: an Overview specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on The Keynesian School of Economics: an Overview specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on The Keynesian School of Economics: an Overview specifically for you FOR ONLY $16.38 $13.9/page Hire Writer Furthermore the economic thinking of the period was concerned with the problems of secular stagnation (globally declining growth rate) of the capitalist society. Some speculated that as the national income increased, consumption expenditures rose less rapidly than total income, and savings increased more rapidly. Wages were recognized as a source of demand for goods as well as a cost of production, and cutting wages was frequently opposed as providing no real remedy for unemployment; this was the macroeconomic thinking. The mature private-enterprise economies of the Western world were less vigorous after World War I. The population growth was declining; most of the world had already been colonized; there seemed no more room for geographic expansion; consumption appeared to outrun production as incomes and savings rose; less resources were allotted for the purpose of research and development as a result there were no new inventions like the steam engine, electricity, etc to stimulate vast capital investments. Also, the decline of vigorous price competition reduced the rate of replacement of old machinery with new and more efficient ones, and the economy was being dragged downward furthermore when the growing accumulated of depreciation funds from the past investments were not spent quickly enough. Question- 02: What were the major tenets of the school? Answer: The complete doctrine of the Keynesian economists was set as a better option than those provided by the classical economists. Keynes argued that the economy had moved towards The Great Depression only because of the flawed notion that the economy would adjust to the prevailing market conditions and move towards equilibrium. He proposed the government should take a more ‘hands on’ approach. Some of the major tenets include: 1) The school put forward the Keynesian Theory of Employment which began with the principle of effective demand. That is, total employment depends on total demand (aggregate effective demand) and unemployment rose due to a shortage of effective demand (thus they’re agreeing to Malthus’s remark that there was a need for unproductive consumption and government investment). In the calculation of a country’s output which consisted of consumption, investment and government expenditure(Y= C + I + G). Keeping G constant it can be noted that the immediate determinants of Income and thus employment are consumption and investment spending. The money spent on final gods and services, let it be consumption or investment generated income. 2) The Keynesian economists pointed out that there was a tendency for savings to exceed investment (which might reduce AD and lead to unemployment) which is why they supported government intervention to close this gap. It was this school which appealed for the end of lassiez- faire (minimum role of government). For instance, the government should stimulate the economy by lowering interest rates and adopting a deficit budget during imes of economic depression. 3) The government may increase the marginal propensity to consume (and thereby stimulating the economy) through the redistribution of income by adopting a progressive taxation policy (as MPC is higher for lower income earners). 4) The Keynesians stated that the marginal efficiency of capital (expected rate of profit of a new investment) will have a tendency to decline (as more and more investments compete against each other; increas ed supply price of capital goods). They thought that it was difficult to maintain full employment in a Capitalist economy unless the rate of interest was low enough. 5) In periods of falling aggregate demand for goods and services, firms respond to lower sales by reducing production and discharging or laying off workers, not by insisting on wage cuts. This is because prices are sticky downwards. Any decline in effective demand initially cause reductions in output and employment rather than decline in the price level. Deflation occurs only under conditions of extremely severe depression. This wage and price rigidity is also a major tenet on this school 6) Keynesians believe that, because prices are somewhat rigid, fluctuations in any component of spending-consumption, investment, or government expenditures-cause output to fluctuate. If government spending increases, for example, and all other components of spending remain constant, then output will increase. Keynesian models of economic activity also include the multiplier effect (increase in output by a multiple of the original change in spending that caused it). Thus, a ten-billion-dollar increase in government spending could cause total output to rise by fifteen billion dollars (a multiplier of 1. 5) or by five billion (a multiplier of 0. 5). Contrary to what many people believe, Keynesian analysis does not require that the multiplier exceed 1. 0. For Keynesian economics to work, however, the multiplier must be greater than zero. Question- 03: Who did the School benefit or seek to benefit? Answer: The Keynesian School was successful mainly because it focused on painful problems such as unemployment and depression, which were present at that time. It offered something almost to everyone and rationalized what was already being out of necessity. The school’s stress on labor and emphasis on job creation amidst the great depression gained widespread recognition. Business interests benefited from government contracts and government incentives to get the economy out of depression/ recession. When bankers had extensive excess reserves in the 1930s, they found a vast and profitable area for investment in government bonds, and government controls gave the banking system liquidity, security and stability. Reformers and intellectuals enjoyed vastly increased employment in government service that had grown out of Keynesian thinking with less risks of being laid off. Farmers long had favored easy monetary policies and low interest rates. They also came to rely heavily on government spending programs for agriculture. Such forms of government expenditures seemed to bear more than proportionate benefits due to the multiplier effect. Question- 04: How was the school valid, useful or correct in its time? Answer: The introduction of Keynes ideas in the world stage was nothing short of revolutionary. They were perhaps the first group of economists to consider economic theory during policymaking. World wars, The Great depression and the growing impediments of modern life had already weakened the foundations of lassiez- faire. Simply waiting for the ‘markets to stabilize’ was too painful for many to agree to. Keynes had provided both an explanation of fluctuations and a program to tackle it. The role of economists and economic analysis in shaping the direction of government policy was thus greatly increased. It might be interesting to note that the Keynesian approach became immensely useful even to those who did not accept Keynes’s policy conclusions. It established a new set of analytical tools through which to view the economy, encouraged the further development of national income accounting and stimulated a vast and productive effort at empirical studies of the real world which was almost non- existent before their arrival. Question- 05: Which tenets of the school became lasting contributions? Answer: Many say that the founder of the Keynesian School of thought, J. M. Keynes was the one who had contributed the most in the twentieth century. His book ‘The General Theory of Employment, Interest and Money’ influenced economic theory as well as public policy. One of Keynes’s chief contributions was to tie economic to the great economic problems of the day (depression). The impact of the ‘General Theory’ had a dynamic effect n economic study as several tools had been added under this category namely consumption function (marginal propensity to consume); saving function (marginal propensity to save); liquidity preference (transaction, precautionary, speculative demand); marginal efficiency of capital; multiplier effects and the IS- LM analysis. Another important input made by Keynes was in the use of expectations. His integration of expectation with his theory of money and mar ginal efficiency made notable advances in economic investigation. While Classical economists assumed full employment, Keynes and therefore the Keynesian School emphasized on under- employment equilibrium (equilibrium at less than full employment). This meant that increase in the quantity of money does not necessarily mean increase in the price levels (inflation) as long as there is spare capacity in the economy. Towards the end of the school’s long list of contributions it would be fair to mention that the school had critics from several circles. Despite the fact that many of the Keynesian policy prescriptions have been discredited, Keynesian tools of analysis still dominate macroeconomic theory. These theorists were successful in demonstrating the inadequacies of Classical economics, and in the process established a system that is not, itself, without flaws. The importance of their contribution is not its degree of precision, but its role in advancing the debate—in stimulating the argument and in providing the framework for that debate. Source: V. Lokhnathan. ; A History of Economic Thought, 9th ed.