Keynesian Economics

Loading the player...

What is 'Keynesian Economics'

An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed by the British economist John Maynard Keynes during the 1930s in an attempt to understand the Great Depression. Keynes advocated increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the Depression. Subsequently, the term “Keynesian economics” was used to refer to the concept that optimal economic performance could be achieved – and economic slumps prevented – by influencing aggregate demand through activist stabilization and economic intervention policies by the government. Keynesian economics is considered to be a “demand-side” theory that focuses on changes in the economy over the short run.

BREAKING DOWN 'Keynesian Economics'

Prior to Keynesian economics, classical economic thinking held that cyclical swings in employment and economic output would be modest and self-adjusting. According to this classical theory, if aggregate demand in the economy fell, the resulting weakness in production and jobs would precipitate a decline in prices and wages. A lower level of inflation and wages would induce employers to make capital investments and employ more people, stimulating employment and restoring economic growth.

The depth and severity of the Great Depression, however, severely tested this hypothesis. Keynes maintained in his seminal book, “General Theory of Employment, Interest and Money,” and other works, that structural rigidities and certain characteristics of market economies would exacerbate economic weakness and cause aggregate demand to plunge further.

For example, Keynesian economics refutes the notion held by some economists that lower wages can restore full employment, by arguing that employers will not add employees to produce goods that cannot be sold because demand is weak. Similarly, poor business conditions may cause companies to reduce capital investment, rather than take advantage of lower prices to invest in new plant and equipment; this would also have the effect of reducing overall expenditures and employment.

There is more to this economic theory - Read Can Keynesian Economics Reduce Boom-Bust Cycles?

RELATED TERMS
  1. New Keynesian Economics

    The modern macroeconomic school of thought that evolved from ...
  2. Accelerator Theory

    An economic theory that suggests that as demand or income increases ...
  3. Multiplier

    In Keynesian economic theory, a factor that quantifies the change ...
  4. Milton Friedman

    An American economist and statistician best known for his strong ...
  5. Economic Collapse

    A complete breakdown of a national, regional or territorial economy. ...
  6. Supply-Side Theory

    An economic theory holding that bolstering an economy's ability ...
Related Articles
  1. Markets

    Economist Guide: 5 Lessons John Maynard Keynes Teaches Us

    Read about the paradoxical and confusing world of John Maynard Keynes, including the lessons modern economists can still learn from the British thinker.
  2. Markets

    A Look At Fiscal And Monetary Policy

    There's a debate over which policy is better for the economy. Find out which side of the fence you're on.
  3. Markets

    Deflation and Debt: Is the United States the New Japan?

    Discover how mainstream macroeconomics has failed Japan and why the United States should take care to avoid Japan's borrow, spend and print model.
  4. Personal Finance

    Inflation for Dummies

    Inflation may seem like a straightforward concept, but it is more complex than it appears. We examine its varieties and causes.
  5. Markets

    Stagflation, 1970s Style

    Find out how Milton Friedman's monetarist theory helped bring the U.S. out of the economic doldrums.
  6. Markets

    What Causes Bubbles?

    A look at how asset bubbles are formed according to different schools of thought.
  7. Markets

    Economics 101

    Economics is the study of how individuals, governments, businesses and other organizations make choices that effect the allocation and distribution of scarce resources.
  8. Trading

    Free Market Maven: Milton Friedman

    As proponent of free market capitalism, this economist changed the way the world's economies operate.
  9. Markets

    Monetarism: Printing Money To Curb Inflation

    Learn how Milton Friedman's monetarist views shaped economic policy after World War II.
  10. Markets

    How Influential Economists Changed Our History

    Find out how these five groundbreaking thinkers laid our financial foundations.
RELATED FAQS
  1. Why is Keynesian economics sometimes called depression economics?

    Learn how in observing the effects of the Great Depression, Keynes identified flaws in classical economic theory particularly ... Read Answer >>
  2. Why do Keynesian economists focus on the lower boundary of interest rates?

    Understand the basis of Keynesian interventionism and how low interest rates are used as a policy tool. Examine Japan's Lost ... Read Answer >>
  3. How did John Maynard Keynes influence business cycle theory?

    Read about the impact of John Maynard Keynes on business cycle theory and the development of macroeconomics to study aggregate ... Read Answer >>
  4. How do changes in aggregate demand affect output?

    Find out why aggregate demand and total output are linked in macroeconomic models, and why economists disagree about the ... Read Answer >>
  5. How does macroeconomics explain "stagflation"?

    Learn about stagflation: a macroeconomic term used to describe economic turmoil. It is a time of serious inflation, slow ... Read Answer >>
  6. Where does stimulus economics come from?

    Depending on which type of economist you talk to, stimulus economics originated from the ideas of either a book published ... Read Answer >>
Hot Definitions
  1. Put Option

    An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security ...
  2. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  3. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  4. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  5. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  6. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
Trading Center