Keynesian Economics

John Maynard Keynes argued that the fundamental cause of the 1929 Great Depression was insufficient aggregate demand and contended that these deficiencies could only be remedied through expansionary fiscal policies by the public sector. In his 1936 work, "The General Theory of Employment, Interest and Money", Keynes challenged the prevailing Classical and Neoclassical views, introducing a new approach to economics that was revolutionary in nature. For this reason, Keynes’s ideas are also referred to as the Keynesian Revolution.

Keynesian economics played a dominant role in world economies from the 1929 Great Depression until the 1970s. However, the experience of stagflation exposed the limitations of this approach and led to the strengthening of Monetarist (Monetary Policy) and Neoclassical views. Today, Keynesian policies are still applied, particularly during periods of economic stagnation, and continue to serve as one of the foundational pillars of still economic models.

Key Principles of Keynesian Economics

• Keynes argued that when spending by households, firms, and the external sector declines, the public sector must step in to close this gap. The state can achieve this intervention by increasing public spending or cutting taxes. The replacement of private sector spending by public sector action is known as Counter-Cyclical Fiscal Policy. In the case of inflation, total spending must be reduced, and the state should balance the market by decreasing expenditures or raising taxes. Hence, Keynesian economics is also called demand-side economics.
• Keynes introduced the multiplier mechanism into aggregate demand analysis, asserting that expenditures generate increased income in the economy through a multiplied effect.
• He rejected the classical assertion that wages and prices are always flexible. According to Keynes, wages and prices are flexible upward but rigid downward. This rigidity prevents unemployment and economic imbalances from self-correcting, making government intervention necessary.
• Keynes opposed the classical notion that "supply creates its own demand". If this were true, the 1929 Great Depression would never have occurred. He also argued that savings, when held as idle balances rather than invested, reduce aggregate demand.
• While classical economists claimed that money is held only for transaction purposes and that money demand is insensitive to interest rates, Keynes proposed that money can be held for transaction, precautionary, and speculative purposes.
• Keynes maintained that full employment is rarely achieved and underemployment can be persistent. In the labor market, workers consider nominal wages while employers consider real wages. Therefore, the market cannot automatically reach full employment.
• While classical economics advocates for a small and balanced budget, Keynes argued that the budget can be used as a tool of fiscal policy.