John Maynard Keynes is a British economist whose theory revolutionized economic thinking in the early 20th century and helped to overcome one of the greatest economic crises in history. His major ideas and suggestions concerning the necessity of spending and the government’s intervention were adopted by Franklin D. Roosevelt to battle the Great Depression. Even now, Keynes’ diagnosis of recessions remains the basis of modern macroeconomics and is used by modern economists to predict severe economic challenges. In general, the focus on investments and the necessity of the government’s intervention in economy for its stabilization may be regarded as the main elements of Keynes’ theory.
Before a stock market crash and subsequent severe global economic depression started in 1029, a capitalist economy was believed to have an automatic mechanism of the regulation of the free market and full employment (Ghosh & Ghosh, 2020). In turn, Keynes argued the existence of this mechanism and identified several factors that, along with unemployment, may lead to recessions. First of all, according to the economist, insufficient aggregate demand and focus on saving instead of investing are the major causes of downturns. In other words, when people start to save money instead of spending, the demand for services and goods inevitably declines, and businesses’ sales fall off as well. Therefore, saving causes lower national income that, in turn, prevents households from new saving goals’ achievement. As a result, lower sales lead to limited production, declining profits, a rise in unemployment, and an economic slowdown. Thus, prevailing investment rates are associated with business growth and economic development, while prevailing rates of savings will inevitably cause recessions. Moreover, it does not supply but demand that drives production and guarantees a healthy economy.
Keynes defined the role of the government in fixing economic crises as the most important. He believed that the government should interfere in the economy for its regulation and stabilization as there are no natural and independent mechanisms for these processes. Facing recessions, governments should lower taxes and increase spending to increase consumer buying power and create jobs. Investments may be stimulated through the monetary policy by lowering interest rates. In addition, government’s monetary stimulus in a form of spending is highly essential to provide full employment (Skidelsky, 2017). In the case of a recession, it may go into debt, however, this strategy will be expedient. Keynes advocated even deficit spending on various labor-intensive infrastructure projects to stabilize wages and stimulate employment. For instance, the federal government may invest in building roads, public construction, infrastructure. In the present day, its investments will include the development of alternative energy and the space program. Thus, when the government invests, it encourages others and leads to increasing demand and production. In other words, consumption is regarded as a key to recovery.
However, with the government’s spending, the phenomenon of “crowding out” may occur. It implies the situation when the government fails to increase total aggregate demand through its spending as it causes a fall in the spending and investment of the private sector. Keynes argued that “crowding out” does not occur in the case of a recession as the government will spend unused resources, and its spending will not increase interest rates. In turn, due to previous excessive savings, the private sector will have idle resources. Thus, the possibility of “crowding out” is more essential during the country’s economic growth and when it is already close to its full capacity. In this case, expansionary fiscal policy will inevitably cause “crowding out.”
References
Ghosh, C., & Ghosh, A. N. (2020). John Maynard Keynes and stabilization measures. In An Introduction to Economics (pp. 95-104). Palgrave Pivot. Web.
Skidelsky, R. (2017). Chapter 9: How would Keynes have analysed the Great Recession of 2008 and 2009? In T. Congdon (Ed.), Money in the Great Recession (pp. 208-232). Buckingham Studies in Money, Banking and Central Banking. Web.