BY: RAHUL ROKKAM, CONTRIBUTOR
Near the top of a list entitled “The Top 100 Most Influential People You Have Never Heard of” would be John Maynard Keynes (pronounced “canes”), an English economist who fundamentally altered the course of contemporary macroeconomics by advising governments to utilize fiscal policy to moderate the “boom and bust” periods of the business cycle. Keynes argued that aggregate demand (the total demand for goods and services in an economy at a given time) determined the rate of economic activity and vice versa, insufficient aggregate demand would contribute to high levels of unemployment. The Keynesian school of thought, ubiquitous today, prevailed in the 1950s-60s when virtually all capitalist governments adopted his policy. During the recession of 2008-09, the Federal Reserve under the Obama administration orchestrated several stages of quantitative easing (monetary policy enacted by a central bank when standard monetary policy has become ineffective), essentially Keynesian economics on steroids. The merits of this stimulus are disputed, however, there is a burgeoning quantity of literature arguing the benefits of fiscal expansion on an economy in the short run. The Keynesian school of thought is arguably the most influential—and likewise complex and convoluted. Here are Keynes’ fundamentals:
- Keynes identified that if investment exceeds saving, inflation will ensue. Alternatively, if saving exceeds investment, recession will arise. Subsequently, he advised that optimal macroeconomic policy during an economic downturn should encourage spending rather than saving. This belief ran contrary to the popular belief that saving is necessary during economic crises, which was engrained in the minds of hundreds of millions worldwide following the Great Depression which decreased worldwide GDP by 15% (the recession of 2008-09 decreased worldwide GDP by 1%). Furthermore, international trade plummeted by 50% and unemployment skyrocketed to 25% in the United States. Spending was the last option for economically decimated individuals, but Keynes argued the unprecedented – that consumer spending was the “oxygen” for an economy to function. He laid out the groundwork for this fiscal policy in The General Theory of Employment, Interest and Money, published in 1936. As Keynes artfully described, “For the engine which drives enterprise is not thrift, but profit.”
- Keynes argued against Say’s Law, which stated that aggregate production creates an equal quantity of aggregate demand, whereas Keynes stated the opposite. In other words, Say’s Law held that supply creates demand, whereas Keynes believed the opposite – that output is created by demand. Say’s Law was de facto accepted in Keynes’ time but is now widely rejected by modern economists. New York Times op-ed columnist and Nobel Prize winner, American economist Paul Krugman articulates the scholarly consensus: “not only doesn’t supply create its own demand; experience since 2008 suggests, if anything, that the reverse is largely true — specifically, that inadequate demand destroys supply. Economies with persistently weak demand seem to suffer large declines in potential as well as actual output.” Talk about being ahead of the game.
- Full employment can not always be reached by making wages sufficiently low. An economy, by definition, comprises of aggregate output resulting from aggregate expenditure. The bottom line is that unemployment is caused if people don’t spend enough money.
- Keynes argued that to boost aggregate demand during a recession, governments should borrow money and boost demand by injecting money into the economy. After the economy was growing sufficiently, the government could pay back the loans.
- Keynes reasoned that government should play a major role in the economy; this notion challenged Adam Smith’s laissez-faire economics, which stated that economies functioned best when markets are free of state intervention.
- Keynes argued that economically and socially ideal economies should be assisted by substantial contributions from both public and private sectors.
The Bancor: During World War II, Keynes suggested a supranational currency called the “Bancor,” to act as a world reserve currency. It would effectively stabilize commodity prices as it would be fixed to 30 commodities. Furthermore, it would achieve trade balance because it would act as a unit of account. Surplus countries with an excess of bancor-based assets and deficit countries with excessive bancor-based liabilities would both be charged, in an effort to restore balanced trade. This proposal was ultimately rejected in the Bretton Woods Conference (1944) in favor of an pegged exchange rate system tied to physical gold, establishing the US dollar as the world reserve currency.
The World Bank and the IMF: As World War II came to a close, Keynes championed the Bretton Woods negotiations, advocating for the creation of an international central bank and an international currency regulation body. Consequently the World Bank and the International Monetary Fund (IMF) were created, both playing a significant role in securing the stability of developing nations’ economies in the status quo.
The American Jobs Act (2011): Jared Bernstein, a Senior Fellow at the Center on Budget and Policy Priorities, as well as Chief Economic Adviser to Joe Biden from 2009-11, cited the American Jobs Act as a paragon of the Obama administration’s hold to Keynesian thought. He argues “That’s a $447 billion stimulus program, and they may not want to label it that, because of political reasons, but certainly the measures in there would be very recognizable to Keynes as precisely the right way to help temporarily offset the contraction in private-sector demand.” He was referring to Keynes’ aforementioned belief that a government should intervene in its economy during a recession, when private-sector demand is too low and thus aggregate demand, the determinant for overall economic activity, drops.
On his deathbed, John Maynard Keynes is to have proclaimed that his only regret in life was that he did not drink more champagne. For Keynes, consumption (economic or alcoholic) was what made the world go round.
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