Keynesian economics

Page written by AI. Reviewed internally on February 1, 2024.


Keynesian economics is an economic theory and approach to macroeconomics that was developed by the British economist John Maynard Keynes in the early 20th century.

What is Keynesian economics?

It became particularly influential during and after the Great Depression of the 1930s. Keynesian economics is characterised by several key principles:

1. Aggregate demand: Keynesians emphasise the role of aggregate demand in determining the level of economic activity. They argue that fluctuations in total spending by households, businesses, and the government have a significant impact on economic output and employment.

2. Government intervention: Keynesian economics advocates for active government intervention in the economy, especially during times of economic downturns. This intervention can take the form of fiscal policies (government spending and taxation) and monetary policies (control of the money supply and interest rates) to stimulate demand and stabilise the economy.

3. Counter-cyclical policies: Keynesian theory suggests that during a recession or depression, the government should increase its spending and reduce taxes to boost demand and create jobs. Conversely, during periods of high inflation and economic overheating, the government should reduce spending and increase taxes to cool down the economy.

4. Liquidity Trap: Keynes introduced the concept of a liquidity trap, where interest rates are so low that monetary policy alone is ineffective in stimulating demand. In such situations, fiscal policy (government spending) becomes more critical in boosting economic activity.

5. Short-Term Focus: Keynesian economics often focuses on the short-term management of the business cycle and aims to address immediate economic problems, such as unemployment and inflation.

Keynesian economics has been influential in shaping economic policies in many countries, particularly during times of economic crisis. However, it has also faced criticism, particularly from proponents of classical economics and supply-side economics, who argue for a more limited role of government in the economy and emphasise the importance of market forces.

It’s important to note that economic policies often incorporate elements from multiple economic theories, and the balance between Keynesian and other economic approaches can vary depending on the economic and political context.

Example of Keynesian economic

The economy is facing a significant downturn, marked by high unemployment, reduced consumer spending, and declining business investment. This situation indicates a lack of aggregate demand in the economy, so the government adopts a Keynesian economic approach to address the economic downturn.

In response to the economic challenges, the government introduces a stimulus package. This package includes measures such as increased government spending on infrastructure projects, tax cuts for individuals and businesses, and direct financial assistance to those most affected by unemployment. Furthermore, the government implements tax cuts for both individuals and businesses to encourage spending and investment.

The government stimulus contributes to increased consumer confidence. As people see improvements in employment, income, and overall economic conditions, they become more optimistic about the future, leading to higher spending levels.

In this example, the Keynesian economic approach involves active government intervention through a stimulus package to counteract a recession, boost demand, and initiate economic recovery.

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