Keynesian Economics in a Nutshell

  • Keynes stated that if Investment exceeds Saving, there will be inflation. If Saving exceeds Investment there will be recession. One implication of this is that, in the midst of an economic depression, the correct course of action should be to encourage spending and discourage saving. This runs contrary to the prevailing wisdom, which says that thrift is required in hard times. In Keynes’s words, “For the engine which drives Enterprise is not Thrift, but Profit.”
  • Keynes took issue with Say’s Law – one of the economic “givens” of his era. Say’s Law states that supply creates demand. Keynes believed the opposite to be true – output is determined by demand.
  • Keynes argued that full employment could not always be reached by making wages sufficiently low. Economies are made up of aggregate quantities of output resulting from aggregate streams of expenditure – unemployment is caused if people don’t spend enough money.
  • In recessions the aggregate demand of economies falls. In other words, businesses and people tighten their belts and spend less money. Lower spending results in demand falling further and a vicious circle ensues of job losses and further falls in spending. Keynes’s solution to the problem was that governments should borrow money and boost demand by pushing the money into the economy. Once the economy recovered, and was expanding again, governments should pay back the loans.
  • Economically and socially successful economies have significant contributions from both the government and the private sectors.
  • Keynes’s view that governments should play a major role in economic management marked a break with the laissez-faire economics of Adam Smith, which held that economies function best when markets are left free of state intervention.