Keynes’ Economic Theory: A Historic Solution to our Modern Crisis?
by Efin Advisor | October 21, 2008
History is a great teacher.
Over 70 years ago, economist John Maynard Keynes lived through the troubles of the Great Depression and came up with a solution for such a crisis. What did Keynes’ figure out?
During the Great Depression, monetary policy became ineffective and institutional failures were triggered by falling asset prices. Keynes opposed the conventional wisdom of the time. He was not content to think that the economy would self-correct. Instead, Keynes realized that during economic downturns, people and businesses alike have a propensity to save.
In a time of financial crisis, the great irony is that saving can have a negative effect on a poor economy. When individuals save, they aren’t buying products from businesses, and businesses lose revenue. The same is true for businesses: if organizations save their money, instead of investing in new technology, materials products and labor, other companies lose revenue. It is a vicious cycle that tends to exacerbate the problems of an economic downturn.
As an economist, Keynes studied incentives in an effort to understand how to overcome the tendency to save. What he realized is that instead of attempting to keep people from saving, the government should inject money into the economy to compensate for the absence of regular investment. Thus, during recessions, Keynes recommended the government “deficit spend.” If the government worries about receiving enough revenue, he posited, then it will be highly inhibited in how it loosens capital, and therefore will not be able to stimulate the economy out of trouble.
This should be positive news for those who are worried today. Not only do we seem to have the knowledge as to how to get out of this potential recession, but the solution has already begun to be implemented. The bailout package, while it may have its flaws, represents the fundamentals of Keynes’ theory. The infusion of capital is an attempt to stimulate us out of this crisis.
This helps alleviate my worried mind, but I just hope Mr. Keynes is right. I’d hate for the economy to take a long time to self-correct, and it would be even worse if the economy didn’t and he were wrong. I guess a lot of people have invested a lot of time in questioning these theories, and it probably does hold true to some extent.
I do agree that the parallels to the Great Depression are fairly strong, but I never really knew how much economics got us out of the Depression. I always thought that it was the war that helped us make that jump and, gosh, we really should avoid having another war. Heck, this war seems to be a big cause of our economic crisis, so who knows. Can anyone explain what we actually did to get out of the Great Depression? That will probably help me understand this problem/answer more.
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I am so glad that somebody has brought this point up. I have been saying for a while now that we should protect our economy through government spending. Although some people may be concerned about the idea of more deficit spending, it is what I like to call a “drop in the bucket” kind of problem. With a multi-trillion dollar national debt and a growing deficit, the situation will not be that much worse if we continue to borrow for a little while to stabilize our economy. Personally, I believe that we should restart the Works Progress Administration, use government money to decrease unemployment, inject money directly into the economy, where it is needed most, and best of all- improve our infrastructure. It seems to me that this is the best way to deal with the “confidence” issue in the economy. Even though I do not believe that confidence is the biggest issue today, I think that a strong show from the government that the economy is a priority, and that people are not alone, will go a long way towards a resolution.
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The question is not about whether the government should pump money into the economy, it’s where it should put it. The government just put $700 billion into one single sector of the economy. That’s a pretty poor way to spread out your resources, even though it had to be done to keep things from collapsing. The bailout package is absolutely not the sort of solution Keynes would have advocated. A stimulus package could work, but with this economy, people will be far more likely to save the money than spend it. This might help out the banks, but I think $700 billion is enough for them. So what do we do? Should the government go down to the local mom and pop bakery and buy 500 loaves of bread to supplement the sales that aren’t being made due to the economy? Should it give tax breaks to big businesses to alleviate their expenditures, thus perpetuating the same cycle it’s trying to avoid? We don’t have the capital nor the economic structure to make such decisions at this point in our nation’s history, I’m afraid. Keynsian economics won’t work here.
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I think that this is an interesting theory. If the government is capable of saving the economy just by putting a little money into the market, they should definitely take that route. I wonder how effective it will be, however, since people have already started to save money. Unless somehow people can be convinced to spend their money instead of saving it, this plan could be doomed to fail.
Does anyone know of any effective economic theories for jump-starting business confidence, so that people will be more likely to spend their money? It seems that if this can be accomplished, a Keynes style solution could work, or maybe the market would correct its self on its own so that the government would not have to invest the capital.
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I completely disagree with this notion. Due respect to Mr. Keynes, but we are so far in debt right now that it would be utterly irresponsible to take any action which would put us more in debt. We are already facing the notion of passing this incredible burden onto our children, and I do not care to think about the fact that now, in addition to this incredible debt, we could pass on a failing economy. Reckless policies are what got us to this point in the first place, we can not spend ourselves out of the problem, and it would be a huge mistake to try.
I think that our situation is different from that of Keynes. Fist of all, we already have a massive national debt the likes of which we have not seen before. Second, one of the key factors that helped our economy during the great depression was the war. Given current circumstances it is doubtful that this would help the economy.
Overall, I am generally opposed to more government intervention, especially when it would adversely affect our situation, and our future. The economy will rebound eventually regardless of government action, we should let it. We do not need to artificially inflate the economy. It will be better in the long run if the economy stabilizes its self, and recovers independently.
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I vaguely remember reading about Keynes in my intro to econ class in college. This was a long time ago, so don’t take my word as gospel. I remember that there was a long period where people thought of Keynes’ theory as gospel, but then during the 70s, stagflation (I dont remember what stagflation is but i remember the word because its an odd word) somehow disproved his theories. Has anyone heard of this? Does this only apply in times of stagflation or does Keynes’ theory still apply equally today?
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Sally: I can’t tell if you’re being sarcastic. Did you really not realize that economics got us out of the Depression? Obviously the war helped to stimulate the economy because we were lucky enough to have been industrialized, but the New Deal is what saved us from total ruin.
Greg: You’re looking at things WAY too literally. That $700 billion will allow people to continue spending their own money as usual because the economy will be stabilized. It actually plays right into Keynsian economics. It’s not about spreading out resources, it’s about investing your resources in the sectors that will most help your economy stabilize, and in this case they’ve put money exactly where it needs to be to encourage stimulation and growth.
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Isn’t it GOOD for people to save in this economic climate? I mean, if people are saving, it means they’re putting their money in banks. If banks have more money, they have more capital that they can use to keep themselves afloat. If banks are staying afloat, confidence in the market is restored and stock prices begin to go up again. If stock prices begin to go up again, people are making more money and thus can afford to spend more to stimulate the economy. Am I missing something here?
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Keynes is too liberal. Of course someone like him is going to talk about pumping money into the economy, he would probably advocate all kinds of welfare programs to help us get out of this mess. Conservative economics have never been more important than they are right now. Help out the big companies so they can create more jobs. With more jobs, people can EARN their money, this stimulating the economy while also serving public good. Don’t let people freeload just because some investors and homeowners made some mistakes.
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Keynes is definitely wrong. We shouldn’t be giving more money to the government so they can spend it inefficiently. Aside from the government redistributing it to people who haven’t earned the money, they also just waste a lot of it. Taxes should be cut and people should be given more tax rebates, so they can spend more money on their own and help the businesses that deserve helping. Nothing good can come from giving the government more money
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I really admire Keynes: he defied the thoughts of the time and really helped us in America’s time of need. I wish we could claim him as an American economist, because he certainly saved our butts during the Great Depression. We need more free thinkers like him. Bernake and Paulson clearly aren’t cut out to be a men like Keynes, considering how poorly they have led this country of late. We should talk more with other nations to see what they are thinking, since this does affect everyone and, if Keynes proved anything, we can find talent from abroad that helps us extensively here
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How can you trust Keynes’ economic theories? He changed his mind every other week about what he believed, and whenever someone criticized him he just claimed that he no longer believed in the principles he was being criticized for. As Winston Churchill once said: “If you put two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions.”
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So, the market is still in a terrible situation event though Paulson has given billions and billions of dollars for banks to lend. They do not seem to be lending the money, they are just buying up other banks for themselves and not handing out it. This is a classic example of economic theories failing. Government spending will only help if the spending is being injected into the market, and buying up other companies does not do this. It does not free up capital for people to spend. Unless we put provisions about how the companies have to spend the money, then there is no chance that we are going to be in better situation soon.
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