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Conventionally, Keynesianism refers to Keynesian economic theory and its policy implications based on the ideas of British economist John Maynard Keynes (1883–1946), whose main book, The General Theory of Employment, Interest and Money, was published in 1936. Keynesian economics argues that in absence of state intervention, markets often lead to inefficient macroeconomic outcomes, such as unemployment and low economic growth, due to insufficient aggregate demand. Aggregate demand, in the simplest case of a closed economy, consists of consumption, investment, and public spending. According to Keynesianism, consumption depends on individual income level, while investment depends on the unpredictable “animal spirit” of investors. Public spending is the only variable left for governments to regulate aggregate demand, and through it, the level of economic growth and employment.

Keynes’s classical framework was later expanded in the box of tools of post–World War II macroeconomics, popularized by a new generation of textbooks. This toolbox included fiscal and monetary policies to stabilize demand and therefore output over the business cycle. Fiscal policies included public spending and taxation, while monetary policies included changes in the interest rate and the money supply. This postwar version of Keynesianism—known as the neoclassical synthesis built on analytical models first developed by John Hicks in 1937—is controversial as it is based on theoretical foundations and policy instruments that Keynes is believed to have rejected.

The Emergence Of Keynesianism

With respect to economic crises, pre-Keynesian economics was based on Say’s law, according to which the main source of demand is the flow of factor income generated through the process of production. Demand is thus generated by the increase in supply. Say’s law therefore rules out any possibility of systemic demand-deficit crises once resources are employed. In its most basic formulation, the mechanism that allows full employment of all resources is wage and pr ice flexibility, through which markets are believed to equilibrate, hence making unemployment a theoretical impossibility.

This economic theory, however, provided little insight in dealing with the persistent level of unemployment in the Great Depression. The threat of social unrest and political instability put pressures on Western governments to intervene. Classical economists’ theoretical apparatus, with its implication of laissez-faire and its prescription for nonintervention, was increasingly at odds with what Keynes termed in 1937 as “practical conclusions” and proposals of public spending to respond to the crisis.

Keynes understood that unemployment was no longer a means to retrieve profitability and, as explained by Robert Skidelsky, that wages were “downward sticky.” Hence, when profit expectations become increasingly uncertain, investors hoard money instead of lending for productive investments with an uncertain return—a phenomenon known as the liquidity trap. Thus, economic growth could not be reestablished through wage flexibility, due to the growing power of organized labor, or a fall in interest rate, due to the liquidity trap. With investors no longer investing, only the government could expand aggregate demand by expanding public spending. Keynes saw this expansionary fiscal policy as triggering a multiplier process that would expand output above the initial increase in public spending. The initial increase in output induced by public spending would increase jobs, thus also increasing consumption. This in turn would further increase output, and so on. This multiplier effect, originally discovered by Richard Kahn in his 1931 article “The Relation of Home Investment to Employment,” became the central analytical tool of postwar income determination models and modern macroeconomics.

The Spread, Crisis, And Return Of Keynesianism

Keynesianism represented an important theoretical, policy, and pedagogical rupture with previous practices. Its wide acceptance within academic and policy circles in the West war ranted the label of Keynesian revolution. This general consensus defined the economic problem as unemployment, the means for its solution as economic growth, and the set of policy instruments for managing and achieving growth as monetary and, especially, fiscal policies. To work, this consensus required a “deal” among social forces in society—namely organized labor and capital—that allowed the creation of a social and institutional context within which Keynesian policies could be implemented without threatening profitability. The principle of yearly wage increases was accepted by capital in exchange for productivity increases granted by organized labor. These productivity deals allowed the profit and wage share of total output overall to remain constant, while both wages and profit increased. Only in this context is the fiscal multiplier truly stable, which is the basic condition for Keynesian government policies to operate. The institutional arrangement making this possible is dubbed in the 2000 book Keynesianism, Social Conflict and Political Economy as the “social micro foundations of Keynesianism” (De Angelis, 37).

Keynesianism entered into crisis in the mid-1970s, through a confluence of stagflation (simultaneous high inflation and high unemployment) and pervasive social unrest, especially from social sectors previously excluded from the Keynesian deal. In the 1980s, Keynesianism as a paradigm based on the triad goal, policy means and instruments was abandoned, superseded by the monetarist critique and the advent of monetarist and supply side policies. Politicians privileged monetary policies and abandoned full employment objectives, although an ad hoc use of expansionary policy tools (e.g., military expenses in the early 1980s) remained. In the early twenty-first century, especially after the global economic crisis of 2008, there is a growing debate about returning to Keynesianism, especially a green Keynesianism, which would undertake massive public expenditure policies in renewable energy sources, promote employment policies, and increase regulation of the economy.

Bibliography:

Colander, David C., and Harry Landreth. The Coming of Keynesiansim to America: Conversations with the Founders of Keynesian Economics. Cheltenham, UK: Edward Elgar, 1996.
Davidson, Paul. John Maynard Keynes. New York: Palgrave Macmillan, 2009.
De Angelis, Massimo. Keynesianism, Social Conflict and Political Economy. London: Macmillan, 2000.
Hicks, John. “Mr. Keynes and the ‘Classics’: A Suggested Interpretation.” Econometrica 40, no. 1 (1937): 129–143.
Kahn, Richard F. “The Relation of Home Investment to Employment.” Economic Journal 41 (1931): 173–198.
Keynes, John Maynard. The General Theory of Employment, Interest, and Money. New York: Harvest/HBJ Book, 1936.
“Letter to R. F. Kahn. 20 October 1937.” In The Collected Writings of John Maynard Keynes. Vol. 14. London: Macmillan / St. Martin’s Press, 1937.
Samuelson, Paul. Economics: An Introductory Analysis. New York: McGraw-Hill, 1948.
Skidelsky, Robert. John Maynard Keynes: The Economist as Saviour, 1920–1937. London: Macmillan, 1992.

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