Keynesian Economics

This unit describes the Keynesian economic model. Keynes’s model was the most influential in economics in the twentieth century. It became widely accepted after the Great Depression, and was almost universally accepted from the 1950s through the late 1970s. Even some conservative economists and republicans, such as President Nixon, acknowledged during this time that “we are all Keynesians now.” Keynes (pictured) was born in Cambridge, England in 1883. He earned a mathematics degree from King’s College in 1905, and worked for the British Treasury, then became a teacher, a prominent journalist, and a lecturer. In 1925 he married Russian ballet dancer Lydia Lopokova. He was made a Lord in 1942. Keynes passed in 1946.

The General Theory of Employment, Interest and Money, published in 1936, was his most influential work. His ideas created the groundwork for subsequent well-known Keynesian economists such as James Tobin, Paul Samuelson, John Kenneth Galbraith, Robert Solow, Charles Schultze, Alan Blinder, Walter Heller, and Arthur Okun.

Because of the influence of Keynes, the United States government passed the Employment Act of 1946. Other industrialized countries around the world passed similar acts. It pronounced that it was the government’s responsibility to achieve full employment, stimulate the economy if necessary, and keep the price level stable. Sections 2 through 4 of this unit elaborate on Keynes’s model.

Since the 1980s, the Keynesian model has come under increasing scrutiny. Section 5 of this unit presents a critical analysis of the Keynesian model and a discussion of classical economic theories and why classical economists believe that limited government involvement in the economy is best for the country.

Classical Economics

The classical economic model is based on the famous economics book, The Wealth of Nations (1776) by Adam Smith (pictured).

Smith’s theories are the foundation for economic schools of thought, such as classical economics, the neo-classical and Austrian Schools of thought, monetarism, and rational expectations. In general, all of these models support the following:

1. Correction of economic problems by the market.
Market forces (changing prices, wages, interest rates, and economic competition) correct economic problems without government intervention.

2. Limited role of the government.
The role of the government should be limited to only the essential functions: defending the country, providing a legal system, protecting individuals’ and businesses’ properties, and providing certain public goods, such as roads, highways, and sewage systems.

Other influential classical economists include David Ricardo (1772 – 1823), Thomas Malthus (1766 – 1834), and John Stuart Mill (1806 – 1873). Neo-classical economics and the Austrian School are closely associated with classical economics and strongly support a laissez-faire, or free market, economy. Important neo-classical economists include William Stanley Jevons (1835 – 1882), Carl Menger (1840 – 1921), and Leon Walras (1834 – 1910). Famous Austrian School economists include Ludwig Von Mises (1881 – 1973), Eugen Von Bohm-Bawerk (1851 – 1914), Friedrich Hayek (1899 – 1992), and Henry Hazlitt (1894 – 1993). Another advocate of laissez-faire was the American monetarist and Nobel prize winner Milton Friedman (1912 – 2006).

For a video explanation of the differences between the Keynesian and Classical schools of thought, please watch: