In the history of macroeconomics, the figure of John Maynard Keynes remains one of the most prominent ones. Likewise, the Keynesian model of economics presents an interesting perspective on the complex economic process and the role of government in them. Since the 1930s, the model of the economy proposed by Keynes has been the subject of acute professional debates. Today, the Keynesian model of economics represents a valid counterargument to the classical (monetarist) view on the economy. The crisis of 2008-2011 became a relevant proof to the validity of Keynes’s macroeconomic assumptions. The recent financial and economic crises have proved the viability of the model in the current economic environment, restoring the spirit of uncertainty that guided the development, implementation, and prominence of the Keynesian model.
The history of the Keynesian model of economics dates back to the times of the Great Depression. According to Vroey and Malgrange, “without the Great Depression, Keynes’s The General Theory of Employment, Interest, and Money (1936) would not have seen the light of day” (1). Keynes wrote his famous book, in order to understand the causes of mass unemployment at the end of the 1920s (Vroey & Malgrange 1). He sought to understand the nature of the failed deflationary mechanisms and, at the same time, define the best fix to ail the sore economy of the day. Almost immediately, Keynes’s vision of macroeconomics became the central driver of theoretical and practical developments in the field of economics. Today, Keynes is often held responsible for the birth of the macroeconomic theory and the rapid evolution to its current state.
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In essence, the Keynesian model of economics treats the economy as a highly unstable system. Keynes viewed the economy as a complex combination of short-term fluctuations that repeated but could not correct themselves automatically (Tragakes 259). One of the chief benefits of the model is that it empowers the public sector to act in defense of the country’s macroeconomic interests. In this sense, Keynes’s macroeconomic thinking is in stark contrast to the classical, or monetarist, perspective that treats the economy as inherently stable and capable of achieving a long-term equilibrium without any external support (Tragakes 259). The basic flaw of the classical model is that it fails to account for the multiple external influences on the stability of the economy and markets. Moreover, it creates an excessively optimistic picture of the economy and markets, even when a serious recessionary gap continuous to persist.
Aggregate demand is at the center of the Keynesian model, and it needs to be fixed and stabilized to keep the economy running. Aggregate demand comprises three elements – private investment, consumer expenditures, and government spending (Mahdjoubi 2). Keynes also suggested three different ways in which aggregate demand could be corrected. Such corrections are necessary to foster continuous growth in the economy. First, lower taxes will release more funds, making them available to consumers and increasing consumer spending (Mahdjoubi 2). Second, lower interest rates will encourage business and individual borrowing, thus contributing to the flow of aggregate demand (Mahdjoubi 2). Third, new government expenditures that exceed tax receipts will increase the flow of aggregate demand in the economy (Mahdjoubi 2). The goal of all these activities is clear: the society must maintain the level of aggregate demand in the economy high enough to provide jobs to all available workers. The Keynesian model of economics is based on the assumption that macroeconomic fluctuations are caused by the spontaneous actions of customers and firms. Business cycles emerge from the changes in consumer and investment spending, which are closely related to individuals’ and firms’ expectations about the future (Tragakes 259). As the optimism about the economic future increases, individuals and firms increase their spending, and the AD curve shifts to the right. With the growing pessimism about the future, investment spending shrinks, causing a leftward shift of the AD curve. In the Keynesian model of economics, these changes in expectations about the future are called “animal spirits” (Tragakes 259).
One of the most controversial elements of the Keynesian model is the role of government in the economy. Given Keynes’s commitment to uncertainty, it comes as no surprise that government plays one of the chief roles in maintaining macroeconomic stability. Keynes believed that product prices and wages could not fall easily and remain low over a long period of time (Tragakes 259). In Keynes’s view, maintaining the full employment equilibrium is impossible without a wise government policy. It is government that can help raise real GDP to the levels of potential GDP, in order to avoid recessionary gaps (Tragakas 259). Still, the Keynesian model of economics is not without flaws.
Inflation is one of the biggest concerns, since any action on lowering interest rates is likely to speed up inflationary trends in the economy. Furthermore, lower taxes are not always effective in boosting aggregate demand – at the times of depression and high unemployment rates, lower taxes will hardly motivate individuals and firms to increase their spending (Mahdjoubi 2). Even if lower taxes help to release additional funds, they will not necessarily increase consumer spending and investment. Nevertheless, the principles and assumptions of the Keynesian model have become relevant during the recent financial crisis.
For years, the Keynesian model was criticized for treating markets as inherently unstable. Keynes always believed that markets had to be supported and controlled by government. The 2008-2011 global crises have proved that markets can fail, while market agents may not be able to achieve equilibrium without external support. Some economists, including Paul Krugman, even suggested that “Keynesian economics remains the best framework we have for making sense of recessions and depressions” (Vroey & Malgrange 20). The recent market failures have confirmed that Keynes was right when he said that the economic future was unknown and even the most sophisticated estimates were simply disguising common ignorance (Hiltzik). Financial markets are not stable, and government interventions do not always lead to inefficiency. The Keynesian model of economics can still be used to achieve a reasonable balance of independence and government support that will benefit the economy in a long-term perspective.
In conclusion, the Keynesian model of economics is based on the assumption that the economy and markets are inherently unstable. As a result, government plays one of the central roles in bringing the economy to the desired equilibrium. The recent economic crises have confirmed the relevance of Keynes’s macroeconomic beliefs. Today, the Keynesian model of economics can be successfully used to benefit the economy in the long run.
- Hiltzik, Michael. “The World Still Can Learn from Keynesian Economics.” Los Angeles Times, 23 Nov 2009. Web. 10 Oct 2013.
- Mahdjoubi, Darius. “Keynesian Economics and the Linear Model of Innovation.” The University of Texas at Austin, 1997. Web. 10 Oct 2013.
- Tragakes, Ellie. Economics for the IB Diploma. Cambridge: Cambridge University Press, 2011. Print.
- Vroey, M. and P. Malgrange. “The History of Macroeconomics from Keynes’s General Theory to the Present.” Louvain University, 2011. Web. 10 Oct 2013.
