Keynesian school of economic thought introduced by the English economist John Maynard Keynes (1883-1946) and developed by his followers. The most famous work of Keynes was produced in 1936, at the height of the great depression, his groundbreaking book called “General Theory Of Employment, Interest, And Money” caused a paradigm shift for the economists. That book made the economist to suddenly replaced their emphasis on study of the economic behavior of individuals and firms (microeconomics) to the study of the behavior of the economy as a whole (macroeconomics). The main platform of Keynes’s revolutionary theory is that the aggregate demand shaped by households, businesses and the government; dynamics of free markets as the most important driving force in an economy was also dismissed by that theory. This theory also emphasize that free markets (in spite of the assertion of 18th century Scottish economist Adam Smith and other classical economists) has no self-balancing mechanisms that lead to hundred percent employment. Keynesian economists advocate and rationalize a government’s intervention in the economy through public policies that target to achieve maximum employment rate and price stability in the market. Their ideas have greatly influenced governments in many different nations around the globe and also in accepting their responsibility to provide full or near-full employment through measures (such as deficit spending) that stimulate aggregate demand. This ideology was somewhat similar with some other school of thoughts such as, classical economics, neo-classical Economics, new classical economics and supply side economics. (Blinder,2008)
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The impact on output and inflation by the economy’s total spending are the are of features Keynesian economics also known as aggregated demand. A Keynesian believes that aggregate demand is persuaded by decision of people and the government in perspective of economics that occasionally behaves inconsistently. The most prominent public decisions include those relating to money or currency and relating to public revenues , especially the revenues from taxation( fiscal) policies. A few decades ago, economists passionately emphasized on the important role of the fiscal policies and monetary policies and with some members on the side of Keynes, Keynesians did not agree on the point that monetary policy are not powerful and that fiscal policy is not a effective component(Blinder,2008). Almost all Keynesians and monetarists now think that aggregated demand is effected by the monetary policies and fiscal policies. According to the Keynesians the short run cannot be used to judge the situation in long run and the society is living in the short run. But Keynesians believe that, since prices are fairly rigid, and changes related to any part of investment, government spending expenditure or consumption can lead to fluctuation of productivity. In case for example, If all the components of government spending are not to be changed and held constant except spending by the government increases, there would more output. Professed multiplier effect, is a part of Keynesian economics; the original change by a multiple in spending leads to the increase in the output. Thus, a multiplier of 1.4 can lead to increase in total output by fourteen billion if the government spending increased by ten-billion-dollar (Blinder,2008). Multiplier should be 1.0 not more than that and neither less than zero, should be greater than zero, is now what people are believing on contrary.
Keynesians believe that prices and especially wages are slowly affected by the changes o changes in demand and supply, resulting in episodic shortages and surpluses of labor. Keynesians believe the government make decision by keeping the following perspective in play to make economy stable (a) reduction in the economic well being can be caused by the changes from high to low levels in unpredictable manner in macroeconomics (b)the experience, the network, the update inner situation of events related to the economics makes the government makes eligible knowledgeable to make appropriate decisions that would result in the improvement in free market( Blinder,2008)
In contrast, traditional economist sees an increased deficit, with government spending held constant, as an increase in aggregate demand.(Blinder, 2008) The early 1980s, in U.S. the demand was stimulated is nullified by contradictory monetary policy, the increase in the real interest rate should be seen, and Keynesian view seems to no reason to expect the saving rate to increase in the private sector.
Modern classical economic theory emphasizes the capability of a market economy to heal recessions is to make adjustments in prices and wages by downward. The mid-1970s economist of the classical economics, ascribe the cause of economic fall of the country because of the people’s misperceptions about predicting future of relative prices (for example real wages). There can be seen the increase misperception, if people are unaware of the current price level or rate of the inflation then they might argue. However such misperceptions should be transitory and certainly cannot be large in societies in which price indexes are published in a monthly basis and the typical monthly inflation rate is less than 1 percent(Blinder 2008). The early new classical view the economic downturns should be moderate and epigrammatic therefore. But still in 1980’s the long recession was faced by the world’s industrial economies. Keynesian economics may be hypothetically be chaotic, but it certainly predicts periods of persistent and involuntary unemployment.( Blinder,2008)
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Barro argues that unemployment, the real GNP, and the inflation, and real national savings should not be affected by which way the government is using economic policies, it should be a issue if the government’s spending is financed by low taxes and high deficits or higher taxes and lower deficits, it can be either way. He argues that people by being rational about the economic situation can predict the future situation, such as the higher deficit and lower future deficits can predict the future would have higher taxes for them and the coming generation. They will, Barro argues, increasing the saving by reducing the consumption by 1 dollar for the future increase in tax liability by a dollar. Thus, a rise in private saving should compensate for any increase in the government’s deficit.( Blinder,2008)
Alan S. Blinder, “Keynesian Economics.” The Concise Encyclopedia of Economics. 2008. Library of Economics and Liberty. 1 November 2010. .