Microeconomics: John Maynard Keynes Assignment

Amanda Flores

Swathi Aare

March 22, 2015        

Microeconomics: John Maynard Keynes Assignment

Summary: This article discusses and supports the views of Economist John Maynard Keynes in today’s economic scenario of high unemployment, inflation and low economic growth. The article states that whatever measures are being taken by modern economists and governments of major economies of the world are not working: the income of a median household in US is 3 percent lower than that during the 2007-09 recession, the economy is facing symptoms of the Great Depression and we need apply insights from Keynes during these times.

The basic principle of Keynes’ work was that in a recession, there are wasted resources due to falling private sector investment and spending. Therefore, the government should step in and by increasing government spending making the unemployed resources, lying idle become used. Keynes advocated increased government expenditures and lower taxes to stimulate demand and pull the global economy during the times recession/stagflation. Keynes advises that if government cuts back on the spending during low economic growth phase, companies also don’t want to invest and consumers don’t want to spend, the overall income in the economy shrinks, everyone is forced to cut back on their spending and this results in decrease in savings instead of rise.  This creates a condition of low economic growth and mass unemployment.

During the 2008, U.S government stimulus to the economy helped it recover and grew faster when compared to European economies which took austerity measures.  

According to Keynes once the economy is in a recovery phase, monetary policy, i.e. reduction in interest rates after interest rates hit zero is ineffective and he recommends fiscal policy - tax cuts and spending hikes. Furthermore, he said, interest rate cut works well during ordinary times.

Accomplishments of Keynes: He wrote the Economic Consequences of the Peace in 1919, accurately predicting the difficulties Germany would have and the consequent political resentment. His ground breaking work – The General theory of Employment, Interest and Money (1936) provided a framework for macroeconomics. He led Britain’s delegation in the founding of International Monetary Fund and World Bank. President Kennedy endorsed and adopted Keynesian approach and proposed tax cut to boost demand.

Another accomplishment is that, Keynes’ theories explains the short-term fluctuations on Wall Street.

He was a statesman, a philosopher, lover of ballet and the member of intellectual Bloomsbury Group

Two economic view points after the stagflation of 1970s:

1. Rational expectations, a theory which said that government could not possibly stimulate the economy through deficit spending because foresighted consumers would rationally expect that the stimulus would have to be paid for through future tax hikes and save on spending.
2. Supply side economists said that Keynes’ theories missed explaining on how low taxes could stimulate long-term growth.

Arguments against Keynes’ policy approach: Keynes faced many challenges to his economic policy both in life and in death. Keynes saw adoptions of his theories through the 1960s, however in the 1970s there was a shift. According to Eswar Prasad, a Cornell University economist, Keynes’ theories apply when there are good domestic policies and heavy dose of international cooperation, which lack in current scenario.  The emergence of stagflation, the simultaneous rise in unemployment and inflation, lead to a shift in thinking toward “rational expectations”. This states that the government would be ineffective at stimulating the economy because consumers would expect that it would need to be paid back eventually, and would start saving now; offsetting the stimulus. Keynes also saw opposition from Harry Dexter White, concerning international trade balance. Keynes advocated for a international clearing union to keep countries from either over importing their goods and stalling the domestic economy, or from seizing to import all together, while exporting their goods to other nations.  He was beat out by White developing the less powerful International Monetary Fund and the World Bank which act as more of a band-aide fix for the problems than a systematic overhaul. We are finding that these institutions lack the level of authority to effectively balance the worlds trade in a fair way to all.