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'''Keynesian Economics''' was "the dominant economic paradigm from the 1940s to the 1970s."<ref>[http://www.thefreemanonline.org/featured/the-great-depression-according-to-milton-friedman/ The Great Depression According to Milton Friedman] </ref>
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{{Economics sidebar}}
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It is associated with the ideas of the [[British]] economist [[John Maynard Keynes]].  
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'''Keynesian economics''' (also called '''Keynesianism''' ({{pronEng|ˈkeɪnziən}}) and '''Keynesian Theory''') is a [[macroeconomics|macroeconomic]] theory based on the ideas of 20th-century British economist [[John Maynard Keynes]]. Keynesian economics argues that [[private sector]] decisions sometimes lead to [[Pareto efficiency|inefficient]] macroeconomic outcomes and therefore advocates active policy responses by the [[public sector]], including [[monetary policy]] actions by the [[central bank]] and [[fiscal policy]] actions by the government to stabilize output over the [[business cycle]].<ref>{{cite book |last=Sullivan | first = Arthur | coauthors = Steven M. Sheffrin | title = Economics: Principles in action | publisher = Pearson Prentice Hall  | date = 2003 | location = Upper Saddle River | doi = | isbn = 0130630853}}</ref> The theories forming the basis of Keynesian economics were first presented in ''[[The General Theory of Employment, Interest and Money]],'' published in 1936; the interpretations of Keynes are contentious, and [[Keynesian economics#Postwar Keynesianism|several schools of thought]] claim his legacy.
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"Keynes thought there is no self-corrective mechanism (or [[invisible hand]]) in a [[free-market economy]]."<ref name=milton>[http://www.thefreemanonline.org/featured/the-great-depression-according-to-milton-friedman/ The Great Depression According to Milton Friedman] </ref>
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Keynesian economics advocates a [[mixed economy]]—predominantly private sector, but with a large role of government and public sector—and served as the economic model during the latter part of the [[Great Depression]], [[World War II]], and the post-war [[Golden Age of Capitalism]], 1945–1973, though it lost some influence following the [[stagflation]] of the 1970s. As a [[middle way]] between ''[[laissez-faire]]'' [[capitalism]] and [[socialism]], it has been and continues to be attacked from both the right and the left.<ref>
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Marx and Keynes: The Limits of the Mixed Economy, Paul Mattick 1969 </ref><ref>
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The Critics of Keynesian Economics. ed. Henry Hazlitt, Foundation for Economic Education; 2nd edition (March 1995)</ref>
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The advent of the [[Financial crisis of 2007–2009|global financial crisis]] in 2007 has caused a [[2008–2009 Keynesian resurgence|resurgence in Keynesian thought]]. Keynesian economics has provided the theoretical underpinning for the plans of President [[Barack Obama]], Prime Minister [[Gordon Brown]] and other global leaders to, allegedly, rescue the world economy.<ref>
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{{cite news
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|url= http://www.ft.com/cms/s/0/c4cf37f4-d611-11dd-a9cc-000077b07658.html
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|title= The undeniable shift to Keynes
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|publisher= The Financial Times
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|author= Chris Giles in London, Ralph Atkins in Frankfurt and Krishna Guha in Washington |accessdate=2009-01-23}}
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</ref>
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"An unfettered [[market economy]] results in [[depression (economics)]]s, [so Keynes] recommended that the government engage in massive [[deficit spending]]."<ref name=milton />
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== Overview ==
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In Keynes's theory, there are some [[microeconomics|micro-level]] actions of individuals and firms that can lead to aggregate [[macroeconomics|macroeconomic]] outcomes in which the economy operates below its [[potential output]] and growth.  Some [[classical economics|classical economists]] had believed in [[Say's Law]], that supply creates its own demand, so that a "[[general glut]]" would therefore be impossible.  Keynes contended that [[aggregate demand]] for [[good (economics)|goods]] might be insufficient during economic downturns, leading to unnecessarily high [[unemployment]] and losses of potential output.  Keynes argued that government policies could be used to increase aggregate demand, thus increasing economic activity and reducing unemployment and [[deflation (economics)|deflation]].  
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According to Keynes, economic slumps are the result of too little [[demand]] (see also [[aggregate demand]]). The government can stimulate demand by cutting taxes and increasing spending even if this results in growing deficits. During times of economic boom the government can increase taxes and/or cut spending. This will reduce the risk of [[Inflation]] and also reduce government deficits. Keynesian economics influenced [[FDR]]'s [[New Deal]] programs during the [[Great Depression]].
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Keynes argued that the solution to depression was to stimulate the economy ("inducement to invest") through some combination of two approaches: a reduction in interest rates and government investment in infrastructure. Investment by government injects income, which results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so forth. The initial stimulation starts a cascade of events, whose total increase in economic activity is a multiple of the original investment.<ref>{{Citation |last=Blinder |first=Alan S. |authorlink= |date=2002 |title=Keynesian Economics |encyclopedia=The Concise Encyclopedia of Economics |url=http://www.econlib.org/library/Enc/KeynesianEconomics.html |accessdate=2008-04-09 }}</ref>
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Keynes also felt that [[inflation]] and [[unemployment]] were opposites. This was proven false by the "[[stagflation]]" of the 1970s.
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A central conclusion of Keynesian economics is that, in some situations, no strong automatic mechanism moves output and employment towards [[full employment]] levels. This conclusion conflicts with economic approaches that assume a general tendency towards an [[economic equilibrium|equilibrium]]. In the '[[neoclassical synthesis]]', which combines Keynesian macro concepts with a micro foundation, the conditions of [[general equilibrium]] allow for price adjustment to achieve this goal.
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While Keynes supported government intervention and government programs, he intended that they only be active during poor economic situations, unlike the modern [[welfare state]]. Many believe that FDR agreed, though FDR had died before these programs could be repealed.
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The [[new classical macroeconomics]] movement, which began in the late 1960s and early 1970s, criticized Keynesian theories, while [[New Keynesian economics]] have sought to base Keynes's idea on more rigorous theoretical foundations.
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While liberal in nature, Keynesian economics also had an influence on conservatives - the [[Laffer curve]], a key component of [[supply-side economics]] and the basis for the Reagan and Bush II tax cuts, was based on Keynesian concepts.
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More broadly, Keynes saw this as a ''general'' theory, in which utilization of resources could be high or low, whereas previous economics focused on the ''particular'' case of full utilization.
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==Notes==
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Some interpretations of Keynes have emphasized his stress on the international coordination of Keynesian policies, the need for international economic institutions, and the ways in which economic forces could lead to [[war]] or could promote peace.<ref>{{citation |last=Markwell |first=Donald |authorlink= |chapter= |title=John Maynard Keynes and International Relations: Economic Paths to War and Peace |year=2006 |publisher=Oxford University Press |location=New York |isbn=0198292368 }}</ref>
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<references />
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[[Category:United States Government]]
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== Precursors ==
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Keynes's work was part of a long-running debate within economics over the existence and nature of [[general glut]]s. While a number of the policies Keynes advocated (notably government deficit spending) and the theoretical ideas he proposed (effective demand, the multiplier, the paradox of thrift) were advanced by various authors in the 19th and early 20th century, Keynes's unique contribution was to provide a ''general theory'' of these, which proved acceptable to the political and economic establishments.
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=== Schools ===
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{{See also|Underconsumption|Stockholm school (economics)}}
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An intellectual precursor of Keynesian economics was [[underconsumption]] theory in [[classical economics]], dating from such 19th century economists as [[Thomas Malthus]] to the American economists [[William Trufant Foster]] and [[Waddill Catchings]], who were influential in the 1920s and 1930s. Underconsumptionists were, like Keynes after them, concerned with failure of [[aggregate demand]] to attain [[potential output]], calling this "underconsumption" (focusing on the demand side), rather than "[[overproduction]]" (which would focus on the supply side), and advocating [[economic interventionism]]. Keynes specifically discussed underconsumption (which he wrote "under-consumption") in the ''General Theory,'' in [http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch22.htm#iv Chapter 22, Section IV] and [http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch22.htm#vii Chapter 23, Section VII].
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Numerous concepts were developed earlier and independently of Keynes by the [[Stockholm school (economics)|Stockholm school]] during the 1930s; these accomplishments were described in a 1937 article, published in response to the 1936 ''General Theory,'' sharing the Swedish discoveries.<ref>{{citation|authorlink=Bertil Ohlin|first=Bertil|last=Ohlin|year=1937|journal=Economic Journal|title=Some Notes on the Stockholm Theory of Savings and Investment}}</ref>
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=== Concepts ===
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The [[multiplier (economics)|multiplier]] dates to work in the 1890s by the Australian economist [[Alfred De Lissa]], the Danish economist [[Julius Wulff]], and the [[German American]] economist [[Nicholas Johannsen]],<ref>{{citation |last=Dimand |first=Robert William |title=The origins of the Keynesian revolution |year=1988 |publisher=Stanford University Press |location=Stanford |isbn=0804715254 |page=117 |url= }}</ref> the latter being cited in a footnote of Keynes.<ref>{{citation |last=Keynes |first=John Maynard |authorlink= |title=Treatise on Money |year=1930 |publisher=Macmillan |location=London |isbn= |page=90 |url= }}</ref> Nicholas Johannsen also proposed a theory of [[effective demand]] in the 1890s.
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The [[paradox of thrift]] was stated in 1892 by [[John M. Robertson]] in his ''The Fallacy of Savings,'' in earlier forms by [[mercantilist]] economists since the 16th century, and similar sentiments date to antiquity:<ref name="neglect">{{cite journal
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|title=A Neglected Early Statement the Paradox of Thrift
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|first1=Robert T.
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|last1=Nash
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|first2=William P.
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|last2=Gramm
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|journal=History of Political Economy
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|year=1969
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|volume=1
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|number=2
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|pages=395–400
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|url=http://hope.dukejournals.org/cgi/pdf_extract/1/2/395
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|doi=10.1215/00182702-1-2-395
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}}</ref><ref>{{cite book
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|first=John M.
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|last=Robertson
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|authorlink=J. M. Robertson
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|title=The Fallacy of Saving
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|year=1892
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|url=http://www.archive.org/stream/fallacyofsavings00robe/fallacyofsavings00robe_djvu.txt
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}}</ref>
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{{quote|There is that scattereth, and yet increaseth; and there is that withholdeth more than is meet, but it tendeth to poverty.<br/>
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The liberal soul shall be made fat: and he that watereth shall be watered also himself.
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|[[s:Bible (King James)/Proverbs#11:24|Proverbs 11:24–25]]}}
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Today these ideas, regardless of provenance, are referred to in academia under the rubric of "Keynesian economics", due to Keynes's role in consolidating, elaborating, and popularizing them.
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==Keynes and the Classics==
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{{capitalism}}
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Keynes sought to distinguish his theories from "classical economics," by which he meant the economic theories of [[David Ricardo]] and his followers, including [[John Stuart Mill]], [[Alfred Marshall]], [[Francis Ysidro Edgeworth]], and [[Arthur Cecil Pigou]].  A central tenet of the classical view, known as [[Say's law]], states that “supply creates its own demand.”  Say's Law can be interpreted in two ways.  First, the claim that the total value of output is equal to the sum of income earned in production is a result of a national income accounting identity, and is therefore indisputable.  A second and stronger claim, however, that the "''costs'' of output are always covered in the aggregate by the sale-proceeds resulting from demand" depends on how consumption and saving are linked to production and investment.  In particular, Keynes argued that the second, strong form of Say's Law only holds if increases in individual savings exactly match an increase in aggregate investment.<ref>cf. ''General Theory'', Ch.1,2</ref>
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Keynes sought to develop a theory that would explain determinants of saving, consumption, investment and production.  In that theory, the interaction of aggregate demand and aggregate supply determines the level of output and employment in the economy.
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Because of what he considered the failure of the “Classical Theory” in the 1930s, Keynes firmly objects to its main theory&mdash;adjustments in prices would automatically make demand tend to the full employment level.
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Neo-classical theory supports that the two main costs that shift demand and supply are labor and money. Through the distribution of the monetary policy, demand and supply can be adjusted. If there were more labor than demand for it, wages would fall until hiring began again. If there was too much saving, and not enough consumption, then interest rates would fall until people either cut their savings rate or started borrowing.
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=== Wages and spending ===
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During the Great Depression, the classical theory defined economic collapse as simply a lost incentive to produce. Mass [[unemployment#Classical unemployment|unemployment]] was caused only by high and rigid real wages.  {{Citation needed|date=November 2009}}
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To Keynes, the determination of wages is more complicated.  First, he argued that it is not [[real vs. nominal in economics|''real'' but ''nominal'']] wages that are set in negotiations between employers and workers, as opposed to a [[barter (economics)|barter]] relationship. Second, nominal wage cuts would be difficult to put into effect because of laws and wage contracts. Even classical economists admitted that these exist; unlike Keynes, they advocated abolishing minimum wages, unions, and long-term contracts, increasing labor-market flexibility. However, to Keynes, people will resist nominal wage reductions, even without unions, until they see  other wages falling and a general fall of prices.
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He also argued that to boost employment, ''real'' wages had to go down: nominal wages would have to fall ''more than'' prices.  However, doing so would reduce [[consumption (economics)|consumer demand]], so that the [[aggregate demand]] for goods would drop. This would in turn reduce business sales revenues and expected profits. Investment in new plants and equipment&mdash;perhaps already discouraged by previous excesses&mdash;would then become more risky, less likely. Instead of raising business expectations, wage cuts could make matters much worse.
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Further, if wages and prices were falling, people would start to expect them to  fall. This could make the economy spiral downward as those who had money would simply wait as falling prices made it more valuable&mdash;rather than spending. As [[Irving Fisher]] argued in 1933, in his ''Debt-Deflation Theory of Great Depressions'', [[deflation (economics)|deflation]] (falling prices) can make a depression deeper as falling prices and wages made pre-existing nominal debts more valuable in real terms.
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=== Excessive saving ===
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<div style="float:right;margin:0 0 0 0.5em;text-align:center;">[[Image:CLASSIX.png|Right|Classics on Saving and Investment.]]</div>To Keynes, excessive saving, i.e. saving beyond planned investment, was a  serious problem, encouraging [[recession]] or even [[depression (economics)|depression]]. Excessive saving results if investment falls, perhaps due to falling consumer demand, over-investment in earlier years, or pessimistic business expectations, and if saving does not immediately fall in step, the economy would decline.
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The [[classical economics|classical economists]] argued that interest rates would fall due to the excess supply of "[[loanable funds]]". The first diagram, adapted from the only graph in ''The General Theory'', shows this process. (For simplicity, other sources of the demand for or supply of funds are ignored here.) Assume that fixed investment in capital goods falls from "'''old I'''" to "'''new I'''" (step '''a'''). Second (step '''b'''), the resulting excess of saving causes interest-rate cuts, abolishing the excess supply: so again we have saving ('''S''') equal to investment. The interest-rate ('''i''') fall prevents that of production and employment.
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Keynes had a complex argument against this ''[[laissez-faire]]'' response. The graph below summarizes his argument, assuming again that fixed investment falls (step '''A'''). ''First'', saving does not  fall much as interest rates fall, since the [[income effect|income]] and [[substitution effect]]s of falling rates go in conflicting directions. ''Second'', since planned [[fixed investment]] in plant and equipment is mostly based on long-term expectations of future profitability, that spending does not rise much as interest rates fall. So '''S''' and '''I''' are drawn as steep (inelastic) in the graph.  Given the [[elasticity (economics)|inelasticity]] of both demand and supply, a ''large'' interest-rate fall is needed to close the saving/investment gap. As drawn, this requires a ''negative'' interest rate at equilibrium (where the '''new I''' line would intersect the '''old S''' line). However,  this negative interest rate is not necessary to Keynes's argument.
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<div style="float:left;margin:0 0.5em 0 0;text-align:center;">[[Image:KEYNES.png|Keynes on Saving and Investment.]]</div>''Third'', Keynes argued that saving and investment are not the main determinants of interest rates, especially in the short run. Instead, the supply of and the demand for the stock of ''[[money]]'' determine interest rates in the short run. (This is not drawn in the graph.) Neither changes quickly in response to excessive saving to allow fast interest-rate adjustment. 
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Finally, because of fear of capital losses on assets besides money, Keynes suggested that there may be a "[[liquidity trap]]" setting a floor under which interest rates cannot fall. While in this trap, interest rates are so low that any increase in money supply will cause bond-holders (fearing rises in interest rates and hence capital losses on their bonds) to sell their bonds to attain money (liquidity). In the diagram, the equilibrium suggested by the '''new I''' line and the '''old S''' line cannot be reached, so that excess saving persists.  Some (such as [[Zero interest rate policy|Paul Krugman]]) see this latter kind of liquidity trap as prevailing in [[Japan]] in the 1990s. Most economists agree that [[real vs. nominal in economics|nominal interest rates]] cannot fall below zero, however, some economists (particularly those from the [[Chicago school]]) reject the existence of a liquidity trap.
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Even if the liquidity trap does not exist, there is a ''fourth'' (perhaps most important) element to Keynes's critique. Saving involves not spending all of one's income. It thus means insufficient demand for business output, unless it is balanced by other sources of demand, such as fixed investment. Thus, ''excessive'' saving corresponds to  an unwanted accumulation of inventories, or what classical economists called a [[general glut]].<ref>{{Citation |last= |first= |authorlink= |date= |title=The General Glut Controversy |url=http://cepa.newschool.edu/het/essays/classic/glut.htm }}</ref>  This pile-up of unsold goods and materials encourages businesses to decrease both production and employment. This in turn lowers people's incomes&mdash;and saving, causing a leftward shift in the '''S''' line in the diagram (step '''B'''). For Keynes, the fall in income did most of the job by ending excessive saving and allowing the loanable funds market to attain equilibrium. Instead of interest-rate adjustment solving the problem, a [[recession]] does so. Thus in the diagram, the interest-rate change is small.
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Whereas the classical economists assumed that the level of output and income was constant and given at any one time (except for short-lived deviations), Keynes saw this as the key variable that adjusted to equate saving and investment.
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''Finally'', a recession undermines the business incentive to engage in [[fixed investment]]. With falling incomes and demand for products, the desired demand for factories and equipment (not to mention housing) will fall. This [[accelerator effect]] would shift the '''I''' line to the left again, a change not shown in the diagram above. This recreates the problem of excessive saving and encourages the recession to continue.
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In sum, to Keynes there is interaction between excess supplies in different markets, as [[unemployment]] in labor markets encourages excessive saving&mdash;and ''vice-versa''. Rather than prices adjusting to attain equilibrium, the main story is one of [[quantity adjustment]] allowing recessions and possible attainment of [[underemployment equilibrium]].
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=== Active fiscal policy ===
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{{Unreferenced section|date=March 2009}}
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As noted,{{Clarify|date=October 2008}}<!-- where noted? please provide specific section link or expand if necessary --> the classicals wanted to balance the government budget. To Keynes, this would exacerbate the underlying problem: following either policy{{Clarify|date=October 2008}}<!-- which two policies? laissez-faire and balancing the budget? or increasing budget deficit and something else? --> would ''raise saving'' (broadly defined) and thus lower the demand for both products and labor. For example, Keynesians see [[Herbert Hoover]]'s June 1932 tax increase as making the Depression ''worse''.{{Citation needed|date=January 2008}}{{Clarify|date=October 2008}}<!-- even with a cite this needs expansion to explain in what way they saw that: did the tax balance an existing deficit or did it create a surplus? -->
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Keynes′ ideas influenced [[Franklin D. Roosevelt]]'s view that insufficient buying-power caused the Depression. During his presidency, Roosevelt adopted some aspects of Keynesian economics, especially after 1937, when, in the depths of the Depression, the United States suffered from recession yet again following fiscal contraction. But to many the true success of Keynesian policy can be seen at the onset of [[World War II]], which provided a kick to the world economy, removed uncertainty, and forced the rebuilding of destroyed capital. Keynesian ideas became almost official in [[social democracy|social-democratic]] Europe after the war and in the U.S. in the 1960s.
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Keynes′ theory suggested that active government policy could be effective in managing the economy. Rather than seeing unbalanced government budgets as wrong, Keynes advocated what has been called [[countercyclical]] fiscal policies, that is policies which acted against the tide of the [[business cycle]]: [[deficit spending]] when a nation's economy suffers from [[recession]] or when recovery is long-delayed and unemployment is persistently high&mdash;and the suppression of inflation in boom times by either increasing taxes or cutting back on government outlays. He argued that governments should solve problems in the short run rather than waiting for market forces to do it in the long run, because "in the long run, we are all dead."<ref>{{cite book | last = Keynes | first = John Maynard | title = A Tract on Monetary Reform | date = 1924 | chapter = The Theory of Money and the Foreign Exchanges}}</ref>
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This contrasted with the [[classical economics|classical]] and [[neoclassical economics|neoclassical]] economic analysis of fiscal policy. Fiscal stimulus ([[deficit spending]]) could actuate production. But to these schools, there was no reason to believe that this stimulation would outrun the side-effects that "[[Crowding out (economics)|crowd out]]" private investment: first, it would increase the demand for labor and raise wages, hurting [[rate of profit|profitability]]; Second, a government deficit increases the stock of government bonds, reducing their market price and encouraging high [[interest rate]]s, making it more expensive for business to finance [[fixed investment]]. Thus, efforts to stimulate the economy would be self-defeating.
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The Keynesian response is that such fiscal policy is only appropriate when unemployment is persistently high, above what is now termed the Non-Accelerating Inflation Rate of Unemployment, or "[[NAIRU]]". In that case, crowding out is minimal. Further, private investment can be "crowded in": fiscal stimulus raises the market for business output, raising cash flow and profitability, spurring business optimism. To Keynes, this [[accelerator effect]] meant that government and business could be ''[[complement good|complements]]'' rather than [[substitute good|substitutes]] in this situation. Second, as the stimulus occurs, [[gross domestic product]] rises, raising the amount of [[saving]], helping to finance the increase in fixed investment. Finally, government outlays need not always be wasteful: government investment in [[public goods]] that will not be provided by profit-seekers will encourage the private sector's growth. That is, government spending on such things as basic research, public health, education, and [[infrastructure]] could help the long-term growth of [[potential output]].
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A Keynesian economist might point out that classical and neoclassical theory does not explain why firms acting as "special interests" to influence government policy are assumed to produce a negative outcome, while those same firms acting with the same motivations outside of the government are supposed to produce positive outcomes. [[Libertarianism|Libertarians]] counter that because both parties consent, free trade increases net happiness, but government imposes its will by force, decreasing happiness. Therefore firms that manipulate the government do net harm, while firms that respond to the free market do net good.
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In Keynes' theory, there must be significant [[unemployment#Cyclical unemployment|slack in the labor market]] before [[deficit spending|fiscal expansion]] is justified. Both conservative and some [[neoliberalism|neoliberal]] economists question this assumption, unless labor unions or the government "meddle" in the [[free market]], creating persistent supply-side or [[unemployment#Classical unemployment|classical unemployment]].{{Clarify|date=October 2008}}<!-- please make that sentence make grammatical sense; is there a missing word or incorrect punctuation there? --> Their solution is to increase labor-market flexibility, e.g., by cutting wages, busting unions, and deregulating business.
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[[Deficit spending]] is not Keynesianism.{{Citation needed|date=March 2009}} Keynesianism recommends counter-cyclical policies to smooth out fluctuations in the [[business cycle]].{{Citation needed|date=March 2009}} An example of a counter-cyclical policy is raising taxes to cool the economy and to prevent inflation when there is abundant demand-side growth, and engaging in deficit spending on labor-intensive infrastructure projects to stimulate employment and stabilize wages during economic downturns.{{Citation needed|date=March 2009}} Classical economics, on the other hand, argues that one should ''cut'' taxes when there are budget surpluses, and cut spending&mdash;or, less likely, increase taxes&mdash;during economic downturns.{{Citation needed|date=March 2009}} Keynesian economists believe that adding to profits and incomes during boom cycles through tax cuts, and removing income and profits from the economy through cuts in spending and/or increased taxes during downturns, tends to exacerbate the negative effects of the business cycle.{{Citation needed|date=March 2009}} This effect is especially pronounced when the government controls a large fraction of the economy, and is therefore one reason fiscal conservatives advocate a much smaller government.{{Citation needed|date=March 2009}}
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=== "Multiplier effect" and interest rates ===
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{{Main|Spending multiplier}}
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Two aspects of Keynes' model had implications for policy:
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First, there is the "Keynesian [[Multiplier (economics)|multiplier]]", first developed by [[Richard Ferdinand Kahn|Richard F. Kahn]] in 1931. [[Exogenous]] increases in spending, such as an increase in government outlays, increases total spending by a multiple of that increase. A government could stimulate a great deal of new production with a modest outlay if:
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#The people who receive this money then spend most on consumption goods and save the rest.
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#This extra spending allows businesses to hire more people and pay them, which in turn allows a further increase consumer spending.
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This process continues. At each step, the increase in spending is smaller than in the previous step, so that the multiplier process tapers off and allows the attainment of an equilibrium. This story is modified and moderated if we move beyond a "closed economy" and bring in the role of taxation: the rise in imports and tax payments at each step reduces the amount of induced consumer spending and the size of the multiplier effect.
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Second, Keynes re-analyzed the effect of the interest rate on investment. In the classical model, the supply of funds (saving) determined the amount of fixed business investment. That is, since all savings was placed in banks, and all business investors in need of borrowed funds went to banks, the amount of savings determined the amount that was available to invest.  To Keynes, the amount of investment was determined independently by long-term profit expectations and, to a lesser extent, the interest rate. The latter opens the possibility of regulating the economy through [[money supply]] changes, via [[monetary policy]]. Under conditions such as the [[Great Depression]], Keynes argued that this approach would be relatively ineffective compared to fiscal policy. But during more "normal" times, monetary expansion can stimulate the economy.{{Citation needed|date=July 2009}}
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== Postwar Keynesianism ==
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{{Main|Neo-Keynesian economics|New Keynesian economics|Post-Keynesian economics}}
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<!-- Post-Keynesian criticisms are mentioned here because they trace their legacy to Keynes: these are debates within Keynesianism, not from external schools -->
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In the post-[[World War II|WWII]] years, Keynes's policy ideas were widely accepted. Governments prepared good quality economic statistics on an ongoing basis and tried to base their policies on the Keynesian theory that had become orthodoxy. In the early era of [[new liberalism]] and [[social democracy]], most western [[capitalism|capitalist]] countries enjoyed low, stable unemployment and modest inflation.
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Through the 1950s, moderate degrees of government demand leading industrial development, and use of fiscal and monetary counter-cyclical policies continued, and reached a peak in the "go go" 1960s, where it seemed to many Keynesians that prosperity was now permanent.  In 1971, Republican US President [[Richard Nixon]] even proclaimed "we are all Keynesians now".<ref name=Keyn2>{{Citation |last=Lewis |first=Paul |authorlink= |date=August 15, 1976 |title=Nixon's Economic Policies Return to Haunt the G.O.P. |newspaper=[[New York Times]] |url=http://select.nytimes.com/gst/abstract.html?res=FB0717FE345E1A738DDDAC0994D0405B868BF1D3 }}</ref> However, with the oil shock of 1973, and the economic problems of the 1970s, modern liberal economics began to fall out of favor. During this time, many economies experienced high and rising unemployment, coupled with high and rising inflation, contradicting the [[Phillips curve]]'s prediction. This [[stagflation]] meant that the simultaneous application of expansionary (anti-recession) and contractionary (anti-inflation) policies appeared to be necessary, a clear impossibility. This dilemma led to the end of the Keynesian near-consensus of the 1960s, and the rise throughout the 1970s of ideas based upon more classical analysis, including [[monetarism]], [[supply-side economics]]<ref name=Keyn2 /> and [[new classical economics]].  At the same time Keynesians began during the period to reorganize their thinking (some becoming associated with [[New Keynesian economics]]); one strategy, utilized also as a critique of the notably high unemployment and potentially disappointing GNP growth rates associated with the latter two theories by the mid-1980s, was to emphasize low unemployment and maximal economic growth at the cost of somewhat higher inflation (its consequences kept in check by indexing and other methods, and its overall rate kept lower and steadier by such potential policies as Martin Weitzman's [[Martin Weitzman#Research|share economy]]).<ref>{{cite book |title= Hard Heads, Soft Hearts: Tough Minded Economics for a Just Society |last= Blinder |first= Alan S. |authorlink= Alan Blinder |coauthors= |year= 1987 |publisher=Perseus Books |location=New York |isbn= 0201145197 |pages=65–66 }}</ref>
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Currently, there exists multiple [[schools of economic thought]] that trace their legacy to Keynes, notably [[Neo-Keynesian economics]], [[New Keynesian economics]], and [[Post-Keynesian economics]]. Keynes' biographer [[Robert Skidelsky]] writes that the post-Keynesian school has remained closest to the spirit of Keynes' work in following his monetary theory and rejecting the [[neutrality of money]].<ref>{{Harvnb|Skidelsky|2009}}</ref><ref>Financial markets, money and the real world, by Paul Davidson, [http://books.google.com/books?id=88XA6OHxVAcC&pg=PA88&q=post-keynesian pp. 88–89]</ref>
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In the postwar era Keynesian analysis was combined with neoclassical economics to produce what is generally termed the "[[neoclassical synthesis]]", yielding [[Neo-Keynesian economics]], which dominated [[mainstream economics|mainstream macroeconomic thought]]. Though it was widely held that there was no strong automatic tendency to full employment, many believed that if government policy were used to ensure it, the economy would behave as neoclassical theory predicted. This post-war domination by Neo-Keynesian economics was broken during the [[stagflation]] of the 1970s. There was a lack of consensus among macroeconomists in the 1980s. However, the advent of  [[New Keynesian economics]] in the 1990s, modified and provided microeconomic foundations for the neo-Keynesian theories. These modified models now dominate mainstream economics.
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[[Post-Keynesian economics|Post-Keynesian economists]] on the other hand, rejects the neoclassical synthesis, and more generally, neoclassical economics applied to the macroeconomy. Post-Keynesian economics is a [[heterodox economics|heterodox school]] which holds that both Neo-Keynesian economics and New Keynesian economics are incorrect, and a misinterpretation of Keynes's ideas. The Post-Keynesian school encompasses a variety of perspectives, but has been far less influential than the other more mainstream Keynesian schools.
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=== Main theories ===
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The two key theories of mainstream Keynesian economics are the IS-LM model of John Hicks, and the Phillips curve; both of these are rejected by Post-Keynesians.
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It was with [[John Hicks]] that Keynesian economics produced a clear [[model (economics)|model]] which policy-makers could use to attempt to understand and control economic activity. This model, the '''[[IS-LM model|IS-LM]]''' model is nearly as influential as Keynes' original analysis in determining actual policy and economics education. It relates aggregate demand and employment to three [[exogenous]] quantities, i.e., the amount of [[money]] in circulation, the government budget, and the state of business expectations. This model was very popular with economists after [[World War II]] because it could be understood in terms of [[general equilibrium]] theory. This encouraged a much more static vision of macroeconomics than that described above.{{Citation needed|date=February 2007}}
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The second main part of a Keynesian policy-maker's theoretical apparatus was the [[Phillips curve]]. This curve, which was more of an empirical observation than a theory, indicated that increased employment, and decreased [[unemployment]], implied increased [[inflation]]. Keynes had only predicted that falling unemployment would cause a higher price, not a higher [[inflation rate]]. Thus, the economist could use the '''IS'''-'''LM''' model to predict, for example, that an increase in the money supply would raise output and employment&mdash;and then use the Phillips curve to predict an increase in inflation. {{Citation needed|date=February 2007}}
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==Criticism==
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{{criticism-section}}
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===Monetarist criticism===
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One school began in the late 1940s with [[Milton Friedman]]. Instead of rejecting macro-measurements and macro-models of the economy, the [[monetarism|monetarist school]] embraced the techniques of treating the entire economy as having a supply and demand equilibrium. However, because of [[Irving Fisher]]'s [[equation of exchange]], they regarded [[inflation]] as solely being due to the variations in the [[money supply]], rather than as being a consequence of [[aggregate demand]]. They argued that the "crowding out" effects discussed above would hobble or deprive fiscal policy of its positive effect. Instead, the focus should be on [[monetary policy]], which was largely ignored by early Keynesians.
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[[Monetarism]] had an ideological as well as a practical appeal: monetary policy does not, at least on the surface, imply as much government intervention in the economy as other measures. The monetarist critique pushed Keynesians toward a more balanced view of monetary policy, and inspired a wave of revisions to Keynesian theory.
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===New classical macroeconomics criticism===
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{{See also|Lucas critique}}
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Another influential school of thought was based on the [[Lucas critique]] of Keynesian economics. This called for greater consistency with [[microeconomic]] theory and rationality, and particularly emphasized the idea of [[rational expectations]]. Lucas and others argued that Keynesian economics required remarkably foolish and short-sighted behavior from people, which totally contradicted the economic understanding of their behavior at a micro level.  [[New classical economics]] introduced a set of macroeconomic theories which were based on optimising [[microfoundations|microeconomic]] behavior. These models have been developed into the [[Real Business Cycle Theory]], which argues that business cycle fluctuations can to a large extent be accounted for by real (in contrast to nominal) shocks.
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===Austrian School criticism===
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[[Austrian School|Austrian]] economist [[Friedrich Hayek]] criticized Keynesian economic policies for what he called their fundamentally collectivist approach, arguing that such theories require centralized planning, which leads to totalitarian abuses. Hayek also argued that Keynes' study of the aggregate relations in an economy is fallacious, as recessions are caused by micro-economic factors. Hayek claimed that what starts as temporary governmental fixes usually become permanent and expanding government programs, which stifle the private sector and civil society. 
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Other Austrian school economists have also attacked Keynesian economics. [[Henry Hazlitt]] criticized, paragraph by paragraph, Keynes' ''[[The General Theory of Employment, Interest, and Money|General Theory]]''.<ref>{{Citation |last= |first= |authorlink= |date= |title=The Failure of the 'New Economics': An Analysis of the Keynesian Fallacies |url=http://www.mises.org/books/failureofneweconomics.pdf }}</ref> [[Murray Rothbard]] accuses Keynesianism of having "its roots deep in medieval and mercantilist thought."<ref>{{Citation |last=Rothbard |first=Murray |authorlink= |date=1947 |publisher=[[Ludwig von Mises Institute]] |title=Spotlight on Keynesian Economics |url=http://mises.org/story/2950 }}</ref>
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===Methodological Disagreement and Different Results that Emerge===
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Beginning in the late 1950s neoclassical macroeconomists began to disagree with the methodology employed by Keynes and his successors.  Keynesians emphasized the dependence of consumption on disposable income and, also, of investment on current profits and current cash flow.  In addition Keynesians posited a [[Phillips curve]] that tied nominal wage inflation to unemployment rate.  To buttress these theories Keynesians typically traced the logical foundations of their model (using introspection) and buttressed their assumptions with statistical evidence.<ref name="Akerloff2007">{{cite journal |last=Akerlof |first=George A. |authorlink=George Akerlof |coauthors= |year=2007 |month= |title=The Missing Motivation in Macroeconomics |journal=American Economic Review |volume=97 |issue=1 |pages=5&ndash;36 |doi=10.1257/aer.97.1.5 |url= |accessdate= |quote= }}</ref> Neoclassical theorists demanded that macroeconomics be grounded on the same foundations as microeconomic theory, profit-maximizing firms and utility maximizing consumers.<ref name="Akerloff2007" />
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The result of this shift in methodology produced several important divergences from Keynesian Macroeconomics:<ref name="Akerloff2007" />
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# Independence of Consumption and current Income (life-cycle [[permanent income hypothesis]])
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# Irrelevance of Current Profits to Investment ([[Modigliani-Miller theorem]])
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# Long run independence of inflation and unemployment ([[natural rate of unemployment]])
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# The inability of monetary policy to stabilize output ([[rational expectations]])
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# Irrelevance of Taxes and Budget Deficits to Consumption ([[Ricardian Equivalence]])
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==Keynesian responses to the critics==
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The heart of the [[new Keynesian economics|'new Keynesian']] view rests on microeconomic models that indicate that nominal wages and prices are "sticky," i.e., do not change easily or quickly with changes in supply and demand, so that [[quantity adjustment]] prevails. According to economist [[Paul Krugman]], "while I regard the evidence for such stickiness as overwhelming, the assumption of at least temporarily rigid nominal prices is one of those things that works beautifully in practice but very badly in theory."<ref>{{Citation |last=Krugman |first=Paul |authorlink= |date= |title=There's Something About Macro |url=http://web.mit.edu/krugman/www/islm.html }}</ref> This integration is further spurred by the work of other economists which questions rational decision-making in a perfect information environment as a necessity for micro-economic theory. Imperfect decision making such as that investigated by [[Joseph Stiglitz]] underlines the importance of management of risk in the economy.
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Over time, many macroeconomists have returned to the '''[[IS-LM model|IS-LM]]''' model and the [[Phillips Curve]] as a first approximation of how an economy works. New versions of the Phillips Curve, such as the "[[Inflation#Keynesian view|Triangle Model]]", allow for stagflation, since the curve can ''shift'' due to [[supply shock]]s or changes in [[built-in inflation]].  In the 1990s, the original ideas of "full employment" had been modified by the [[NAIRU]] doctrine, sometimes called the "natural rate of unemployment." NAIRU advocates suggest restraint in combating unemployment, in case accelerating [[inflation]] should result. However, it is unclear exactly what the value of the NAIRU should be&mdash;or whether it even exists.
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==See also==
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*[[Functional finance]]
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*[[Job guarantee]]
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*[[Keynesian formula]]
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*[[Microfoundations]]
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*[[Military Keynesianism]]
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*[[New Keynesian economics]]
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*[[Post-Keynesian economics]]
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*[[State Capitalism]]
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*[[Underconsumption]]
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*[[2008-2009 Keynesian resurgence]]
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==References==
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{{reflist|2}}
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==Further reading==
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*{{cite encyclopedia |last=Blinder |first=Alan |author= |authorlink= |coauthors= |editor= |encyclopedia=Concise Encyclopedia of Economics |title=Keynesian Economics |url=http://www.econlib.org/library/Enc/KeynesianEconomics.html |accessdate= |accessyear= |accessmonth= |edition= |date= |year= |month= |publisher= |volume= |location= |id= |isbn= |doi= |pages= |quote= }}
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*{{cite book |title=The Economic Consequences of the Peace |last=Keynes |first=John Maynard |authorlink= |coauthors= |year=2004 |origyear=1919 |publisher=Transaction Publishers |location=New Brunswick |isbn=0765805294 |pages= |url=http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/keynes/peace.htm }}
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*{{cite news |first=John Maynard |last=Keynes |authorlink= |coauthors= |title=An Open Letter to President Roosevelt |url=http://select.nytimes.com/gst/abstract.html?res=F70A11FB3C5513738DDDA80B94DA415B838FF1D3 |work=New York Times |publisher= |date=1933-12-31 |accessdate= }}
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*{{cite book |title=The General Theory of Employment, Interest and Money |last=Keynes |first=John Maynard |authorlink= |coauthors= |year=2007 |origyear=1936 |publisher=Palgrave Macmillan |location=Basingstoke, Hampshire |isbn=0230004768 |pages= |url=http://cepa.newschool.edu/het/essays/keynes/keynescont.htm }}
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*{{cite journal |last=Lindahl |first=Erik |authorlink= |coauthors= |year=1954 |month= |title=On Keynes' economic system |journal=Economic Record |volume=30 |issue= |pages=19–32, 159–171 |id= |url= |accessdate= |quote= }} Especially up to p.&nbsp;26. — This offers a compact summary of the Keynes equations and their interrelation.
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* [[Donald Markwell]], ''John Maynard Keynes and International Relations: Economic Paths to War and Peace'', Oxford University Press, 2006.
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*{{cite book |title=Problems with Economic Rationalism — Psychology, Green-issues, and Jobs |last=Traill |first=R.R. |authorlink= |coauthors= |year=2008 |origyear= |publisher=Ondwelle |location=Melbourne |isbn= |pages= |url=http://www.ondwelle.com/OSM08.pdf }} — Includes a more concise structured version of Lindahl's summary (in Section 2.1 + Appendix), — a discussion of the 2008 financial-crash, — and comments on J.L.Stein's generalization:-
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*{{cite book |title=Monetarist, Keynesian & New classical economics |last=Stein |first=Jerome L. |authorlink= |coauthors= |year=1982 |publisher=Blackwell |location=Oxford |isbn=0631129081 |pages= }}
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*{{cite journal |last=Gordon |first=Robert J. |authorlink= |coauthors= |year=1990 |month= |title=What Is New-Keynesian Economics? |journal=Journal of Economic Literature |volume=28 |issue=3 |pages=1115&ndash;1171 |doi= |url= http://www.jstor.org/stable/2727103|accessdate= |quote= }}
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*{{cite book |title=The Failure of the ‘New Economics’. An Analysis of the Keynesian Fallacies |last=Hazlitt |first=Henry |authorlink=Henry Hazlitt |coauthors= |year=1959 |publisher=Van Nostrand |location=Princeton, NJ |isbn= |pages= |url=http://www.mises.org/books/failureofneweconomics.pdf }}
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==External links==
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*[http://www.marxists.org/reference/subject/economics/keynes/general-theory/index.htm John Maynard Keynes,The General Theory of Employment, Interest and Money,1936]
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*{{gutenberg author|id=John_Maynard_Keynes|name=John Maynard Keynes}}
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*{{cite web |url=http://cepa.newschool.edu/het/essays/keynes/keynesrev.htm |title=The Keynesian Revolution |accessdate=2008-06-30 |last=Fonseca |first=Gonçalo L. |coauthors= |date= |work= |publisher=}}
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*[http://belfercenter.ksg.harvard.edu/publication/17845/why_america_must_have_a_fiscal_stimulus.html Why America Must have a Fiscal Stimulus] [[Lawrence Summers]], Harvard Kennedy School's Belfer Center
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*[http://www.time.com/time/magazine/article/0,9171,842353-1,00.html "We are all Keynesians now"] historic piece; macroeconomics in mass publications
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* [[Donald Markwell]], ''Keynes and Australia'', Reserve Bank of Australia, 2000 [http://www.rba.gov.au/PublicationsAndResearch/RDP/RDP2000-04.html]
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*[http://business.timesonline.co.uk/article/0,,16849-1823177,00.html Alan Greenspan Speech] [[Alan Greenspan]] blames Keynesian economics for debilitating the U.S. economy prior to the [[Presidency of Ronald Reagan]].
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* Family of Economics http://www.economicsfamily.com
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*{{cite web |url=http://www.southerndomains.com/SouthernBanks/p5.htm |title=Theories on the Great Depression: Harris, Sklar and Carlo: Secular Stagnation, Disaccumulation, Monopolies-Overproduction and the Long Waves |accessdate= |last=Norman |first=Reuben L., Jr. |coauthors= |date= |work= |publisher=}}
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{{Keynesians}}
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{{macroeconomics-footer}}
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{{ History of economic thought}}
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[[Category:Keynesian economics| ]]
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[[Category:Economic theories]]
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