*noun*; a school of economic thought prevalent after World War 2; around 1980, Keynesianism was supposedly superseded by monetarism, and then by the rational expectations hypothesis. Theory is named for John M. Keynes (1881-1946), who argued against the then-
mainstream view that the economy was "self correcting." Keynes' book introducing his economic theory was The General Theory of Employment, Interest, and
Money (1936).
*
Basic Concept*
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The
basic concept of Keynesianism is that each economy has a level of aggregate demand, which does not respond to price or income levels in the same
way that classical economics says it should. Rising income, for example, *does not* lead to a matching increase in consumption or
business investment.
Business investment is driven by investment opportunity, not {only] by interest rates. Savings is driven by liquidity preference, not only by interest rates.
Keynes suggested that, for any economy, there was a marginal propensity to consume that was less than one. Hence, if the national income rose by 10%, consumption would rise by
something less than 10%. This would lead to some production not being consumed, waste, and unemployment.
*What Keynesianism Says We Should Do*
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In 1936, when Keynes wrote *The General Theory*, most of the world was suffering from the Great
Depression. Keynes recommended that the national
government stimulation aggregate demand through a policy of deficit stimulus. In other
words, the country should create adequate levels of aggregate demand by spending more than it took in as taxes (fiscal policy).
Also, Keynesianism held that aggregate demand could be stimulated *up to a point* by lowering interest rates (monetary policy).
*Application*
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In the USA and other large industrial countries, fiscal and monetary policy has been attempted often. After 1980, the Federal Reserve chair (
Paul Volcker) was a monetarist, who claimed to
reject Keynesianism. Nobel laureates in economics almost unanimously attacked Keynesianism as outmoded and wrong-headed, but governments continue to use fiscal stimulus and interest rate cuts in response to recessions.
