Keynesian Revolution: Analysis and Criticism believe myself to be writing a book on economic theory which will largely revolutionize -- not, I suppose, at once, but in the course of the next ten years -- the way the world thinks about economic problems"
John Maynard (Keynes, Letter to G.B. Shaw, January 1, 1935)
Prior to the Keynesian Revolution, may economists and politicians viewed economics from a "micro" perspective. They saw factors such as unemployment, interest rates, profit and loss as related to individual organizations and the impact of individual transactions. In modern times, the idea of macroeconomics is much more widespread, and the impact of economic endeavors is viewed as part of an economic whole, or national/global approach. Part of the credit for this much more diverse and broad view is due to the efforts of John Maynard Keynes, through his publications and the "Keynesian Revolution."
Though Keynes is often criticized for his theories, it is most important to remember that he represents the true figure of change. Without Keynes, it is unknown whether economists of today would be considering their transactions and efforts from a national/global perspective or still from a "micro" approach, or transaction-by-transaction basis.
John Maynard Keynes was a pioneer of his time, revolutionizing economic thought and introducing the idea of macroeconomics. Prior to the time of the "Keynesian Revolution" or time when Keynes ideas were prevalent in 19th century society, classical economists considered economics from a wholly different perspective.
Most politicians felt that the government should not be heavily involved in political affairs, thus allowing individual enterprises maximum freedoms and opportunity (IEA). Keynes felt differently however, and saw the government as a key player in maintaining an equilibrium, or system of checks and balances as related to the economy as a whole.
HISTORY OF ECONOMIC THEORY
Classical Theorists," people such as Adam Smith, who opposed Keynesian Revolutionary ideas, proposed that the market was self-regulating. Classical thought rested upon the idea that the economic system pushes itself toward economic equilibrium (IEA).
Because of this, John Keynes faced must opposition from classical thinkers when he proposed the Keynesian Ideology. One of the most important points to understand when discussing Keynesian ideology is the idea that everything classical economists stood for was considered a "moot point." The whole purpose of the Keynesian Revolution was to press the point that the best government macro-economic policy was to manage the entire economy as if it were one giant enterprise.
Obviously this idea must have caused some unsettling feelings among private enterprises that valued their independence. In any given business organization of large proportions, the accounting mechanisms govern much of the policies and procedures by which the organization runs by.
Management uses accounting information to analyze operations and performance. Interestingly, Keynes macroeconomic theory came about during a time period where the development of national economic accounts was actually a realistic concept (IEA, 1997).
THE KEYNESIAN REVOLUTION: A TURNING POINT
The Keynesian Revolution marked a turning point in history, a time of new insight related to governing theories of economics. John Maynard Keynes' idea of economics as a whole, or the overall picture of economics rather than pieces of the puzzle, marks a turning point in intellectual history. He published many works related to his theories on Keynesian economics, one of which was General Theory. Since this particular publication, many people have accepted and converted to Keynesianism which has accomplished dominance in academic and political worlds.
The Keynesian Revolution basically marks the introduction of the idea of macroeconomics by Keynes in the 1930's. Keynes ideas changed thinking in several areas of macroeconomics, which included unemployment, money supply and inflation.
Macroeconomics deals with economic factors like national output and income, unemployment, rate of inflation and the balance of payments. Prior to this time in history, most economists focused on microeconomics, which studies factors like the supply and demand for individual goods and services, trade in markets and the patterns of pricing individual goods.
KEY CONCEPTS RELATED TO KEYNESIAN THEORY key concept of the Keynesian Revolution was the idea that the best policy when considering economics is to consider the entire policies and governing economic theory of one organization, group or country as one. Obviously this supports the idea of macroeconomics. Keynes believed that it was appropriate to view the whole economy like it were one huge business, and argued that the economy should be managed as one.
During the time that Keynes proposed his idea's regarding the economy, there was much criticism related to him. The reasons for this as well as history of Keynesian theory will be examined in greater detail below.
Keynesian theory puts forth two basic premises that have to be understood. The fundamental theories that Keynes proposes are as follows:
Unemployment results from inadequate demand, (2) Unemployment should be eliminated by government intervention. Governments should increase demand through adjustments in policy
Keynes viewed the economy in a circular fashion. He saw that in a market economy, demand depended upon income and expenditures. Keynes saw that demand depended on income, and income depended on expenditure. Basically, what this means is that every dollar of income received from someone depends on the expenditure that someone else makes.
Expenditure however, also depends on demand, because people won't purchase products for which there is no demand, thus possibly reducing the income of another individual. One important concept to note, is that though Keynes ideas make sense for the period in which they were developed, they may not necessarily take into consideration modern day crises such as the preponderance of credit usage among national consumers.
GENERAL IDEAS RELATED TO ECONOMIC THEORY
To understand the premise of Keynesian theory and the "revolution" surrounding this idea, it is important to understand first some general ideas about economics. In modern society and economics, some transaction typically takes place whereby money is exchanged for something of value.
The purchaser benefits by gaining something they need, want or desire and the seller benefits by gaining income. In economic language, the "expenditure" of the buyer is the "income" of the seller. Simple stuff. This actually however, forms the basis for Keynesian theory, where the following is true:
Income = Expenditure
Income = Consumption + (business) Investment + Government (spending)
Source: IEA, 1997
By this model, total spending and income should be equal in theory. John Keynes is credited with introducing the circular flow theory, where money is a "medium of exchange" that is never used up and is simply transferred from one individual to another.
CRITICISMS OF KEYNESIAN THEORY
Keynes ideas regarding macroeconomics did not come without criticism. Prior to his theories and postulations, the rigid labor market that prevents wages from falling to a level that allows equilibrium, generally explained unemployment (Winch).
Equilibrium could only be reached according to previous philosophies, when pressure from labor force members looking for work caused the wage to go down until people dropped out of the labor market, or were willing to take lower wages (Galbraith).
Keynes felt that unemployment was instead caused by a lack of demand for a particular production or services, rather than imbalance within the labor market. This makes perfect sense to modern day economic theorists, but was a huge leap at the time proposed.
Keynes argued also that there was no reason for recessions and depressions to occur. Keynes assesses that prevention of a decline in the economy relied on maintaining a balance of income and expenditures. Critics during the 1930's still felt adamantly that unemployment could only be explained by wage rates.
Some political theorists and economists such as Friedman and like- minded economists, argued that increasing demand for productions and services would only affect employment if the wage rates fell in accordance with falling prices. Others such as David Lilien argued that "sectoral shifts" accounted for half of cyclical unemployment that were have been thought to be caused by shifts in demand (Galbraith).
Some critics agreed with Keynes on the idea that unemployment may be caused by demand shifts, but they did not agree that fiscal and monetary policies instituted from the government would impact the unemployment rate, contrary to Keynes philosophies.
Some felt that such interventions would make the economy unstable because policies change with the intentions of politicians, who are only human and can make mistakes. Some also likely feared that the government would work for its own best interests, and not necessarily for the good of the public. Perhaps for example, they might take a stance simply to win an election.
RESPONSES TO CRITICISMS
Keynes knew that he faced much opposition. In his work General Theory published in 1936, he says the following of critics: "Those, who are strongly wedded to what I shall call "the classical theory," will fluctuate, I expect, between a belief that I am quite wrong and a belief that I am saying nothing new. It is for others to determine if either of these or the third alternative is right."(John Maynard