John Maynard Keynes (1883-1946) was a British economist whose ideas on how to deal with unemployment, inflation, recession and depression have had lasting impact on the world. In his book, General Theory of Employment, Interest and Money (1936) Keynes outlined his understanding of what causes unemployment, interest rate issues and money supply issues. His causal analysis is routine economic analysis; his point of departure is what he recommended to solve those problems. His recommendation was not particularly original for in one form or another, governments have been doing what he recommended. However, he was the first to systematize these ideas on how to cope with economic cycles.
Keynes recommendations were radical departure from classical economics. Classical economists like Adam Smith, David Ricardo etc had preached Governments hands off the economy but Keynes preached the exact opposite. He accepted that built into the free enterprise economic system are periods of boom and burst, inflation and recession and depression and stagflation. If you do nothing to cope with these problems, in time, no doubt, they would correct themselves, but the price would be stiff.
If nothing is done to correct depression many persons would be out of work as businesses collapse. The impact would be systemic: marriages would be affected, how children are raised would be affected (unemployed folk tend to be angry folk; domestic violence would rise, child beating would rise etc), crime rates would rise, homicides and suicides would rise, and we are not talking about the economic effects yet.
Do you want to have all these to occur so that you remain a purist to the gospel of free enterprise? Economics is a social construct, an idea hatched and propagated by man, an idea not part of nature (economics is strictly socially constructed ideas, not natural ideas, as in physics).
Keynes recommended doing certain things to tackle economic downturns and upturns. In depression he recommended massive public spending, such as on building roads, airports, bridges, etc, so as to pour money into the economy, create jobs, even if they are make belief jobs.
If people are employed, receive monthly checks and have money in their pockets their behaviors tend to improve. They spend money and that means that businesses are patronized and that has multiplier effect on the economy. People buy things and businesses produce what people buy and the economy looks up.
The economy is grown when people demand the goods and services produced by businesses. This way unemployment, recession and depression are tackled.
But how does government obtain the money to spend on anti depression measures? Ordinarily, governments obtain money through taxation but in periods of depression taxation revenue dip as people do not have money to pay up.
Keynes recommends that if need be that governments should borrow the money they expend on economic stimulus package. Borrow the money from those who have it and when you stimulate the economy and folk start making money and paying taxes you would have the money to pay off that debt.
As I write, the US economy appears to be in recession. The Bush administration and Congress has just approved nearly $ 160 billion in economic stimulus plan. The idea is to give tax payers some money ($600 per tax payer), money that they would go spend and thus create demand for goods and services and this would hopefully result in increase production. (I would think that such money is best spent on rebuilding America’s dilapidated Highways and bridges, education and other infrastructure.)
Additionally, the Federal Reserve has reduced the interest rate it charges borrowers from it (prime rate) with the hope of generating demand for loans, and lending to the public hence stimulate the economy. Lastly, the Federal Reserve has made $200 billion available for commercial banks to borrow from, which would make them able to lend to the public.
Keynes suggested that governments actively intervene in the economy and do something about economic downturns and upturns (during inflationary periods governments can withdraw money from the economy via raising taxes, raising lending rates to slow borrowing etc).
The various recommendations made by Keynes are now called fiscal and monetary policies (of the government).
Apparently, President Franklyn Delano Roosevelt applied some of Keynes suggestion in his New Deal Programs and seems to have reduced the depression of the 1930s. (Actually, the Second World War has something to do with the end of the depression …wars create employment.)
With the acceptance of his economic ideas, the United States Government and other countries held the Breton Woods economic conference in1944 (in Rhode Island) with the goal of figuring out how to apply Keynes economic ideas to the international sphere. Inflation, depression and recession in one economy affect other economies.
The conference set up the so-called Breton woods institution: The World Bank, International Monetary Fund, International Bank of Reconstruction (to reconstruct destroyed European economies). Members agreed to contribute certain amounts of money to these institutions and have them available for member economies to borrow from.
A country suffering recession may borrow from the IMF to stimulate its economy before it exports it to the world wide economy. A country could generate domestic employment by borrowing from the World Bank to build big ticket items like dams, roads etc. The World Bank offers long term loans and the IMF offers short term loans.
The whole idea is to make money available to struggling economies. In the 1990s the IMF rescued the collapsing Mexican Pesos and economy and averted its multiplier effects on US banks that had lent heavily to Mexican business. As the Millennium ended the IMF rescued the sputtering Indonesian economy and averted damage to the world economy. What happens in one country affects other countries, so it is in the best interests of all countries to solve each others economic problems.
As would be expected, there has not been a shortage of criticisms of Keynes economic Theory. Most of these criticisms can be summarized as a call to return to Adam Smith’s hands off approach to economic issues. Milton Friedman is probably the most vocal opponent of Keynesian economics.
It is a good thing that folk criticize Keynes’ economic approach, for every good thing has in it bad. Allowing government to become too big risks it becoming a totalitarian government. It is in small, limited government, as John Locke pointed out, lies our liberty.
Be that as it may, any one who thinks that we can return to total government’s hands off the economy is dreaming and not dealing with reality. Balance between doing too much and doing too little is what is called for.
John Maynard Keynes. The General Theory of Employment, Interest and Money. (1936).