Keynesian Revolution: Analysis and Criticism Believe Myself

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

Source: Galbraith.

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

Keynes, The General Theory, 1936: p.v)

Basically, Keynes theory is simplistic. In order to keep people employed, the government should run deficits when the economy is slowing, because private sector representatives will not bother to invest in people during a slow economy.

Private companies are also less likely to invest as markets become saturated due to the flailing economy, and this can create a cycle of less investments, fewer jobs, less consumption etc. (Reich).

Governments, according to Keynes, can avoid this downward spiral of the economy from the beginning by simply intervening where private organizations do not. Keynes further commented in his work, "Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist" (Keynes, 1963).

According to the Keynesian model, changes in output and income levels can also result in equilibrium of savings and investment, which in turn cause equilibrium of total national income as well as output. Keynes stated that in such a situation a reduction in wages would certainly not eliminate unemployment. Keynes ideas were similar to those of 19th century British economist Thomas Robert Malthus.

THE KEYNESIAN REVOLUTION REVISITED

The Keynesian Revolution suggested that, "the goods market could be at an underemployment equilibrium, in that it did not ensure equilibrium in the labor market" (Keynes).

Keynes emphasis on demand as the major factor determining output was phenomenal. Economists did start looking at how consumer demand related to income levels and how interest rates might change due to resulting changes or shifts in equilibrium.

Prior to the Keynesian Revolution, the major though process related to the economy was considered "classical." It argued that the interest rate led to a balance between savings and investment, which would in turn result in a balance in the goods market. Keynes however, differed in his opinion and argued that the interest rate's primary purpose was to act as a balance between the supply and demand for money and not savings and investment. His view correlated to why savings did not always correlate with investment or the interest rate.

Keynes basically asserts in his revolutionary theory that "quantities (and not prices) that adjust to eliminate excess demands or supplies." Keynes published a book entitled "Theory of Employment, Interest and Money." On page 63, he notes the following regarding his revolutionary economic theory:

Equation 1: Income = value of output = consumption investment

Equation 2: Saving = income - consumption

Equation 3 (therefore): Saving = investment"

Keynes is referring to national income, and comparing it to the output, which he considers equal to the "price recoverable" in regards to all goods and services provided by any industry at any point in time or given period. According to this equation, Keynes defines savings as "income that is not consumed" (Cooney).

One important point to consider proposed by Keynes is the idea that the "preservation" of equilibrium, or maintenance of a system of checks and balances is dependent on a regular market for goods (Cooney). If the market or "demand" for goods, a central idea and philosophy in Keynesian economics, is not met, then obviously the equilibrium of production and sales will be disturbed, resulting in fluctuations of all economic variables. This includes inflation rates, unemployment and wage issues.

THE SIGNIFICANCE OF THE REVOLUTION

The Keynesian Revolution was very significant in that it set the stage for macroeconomic thinking in a microeconomic economy, and world of political thinkers. John Maynard Keynes attempted to develop a model of global economic theory which can be best described as "aggregate economics."

John Maynard Keynes emphatically supported the concept that full-employment was possible in a system that was in balance or equilibrium, if under-utilized resources were fully mobilized and government policy makers became involved in fiscal and monetary policy changes.

Keynes wrote the following in his Essays on Persuasion (1930): "Full employment, government expenditure for social economic stimulation, productive investments, need for low interest rates, economic policies and the general equilibrium framework based on these conditions, are essential elements of ethic-economics."

ANALYSIS AND SUMMARY OF KEYNESIAN REVOLUTION AND CRITICIMSMS OF JOHN MAYNARD KEYNES MODEL FOR ECONOMY

The Keynesian Revolution actually proposes a very simple process. It suggests that price systems do not work when evaluating wages, and basically everything economic affects everything else economic.

For example, take the following reference. If consumers are spending at a rate that is less than the income that they are receiving, then essentially income is considered above it's "equilibrium level" (Keynes). If however, consumers are actually spending more than the income they are receiving, then income is actually below its equilibrium level. What all this basically translates into is the idea that in order to maintain an adequate system of checks and balances, people should only be spending as much as their income affords, but also should be spending at minimal at that level.

When consumer habits vary from this "norm" proposed by Keynes, then this sets the stage for economic downturns such as recession and depression. It makes perfect sense that in times of low income, consumers are more likely to hold onto their cash than spend it. Individual entities and organizations in turn lower prices and offer discounted merchandise in an effort to attract buyers to their stores and gain income. If consumers don't however, decide to spend their income and settle on saving, then merchandisers lose out on income.

This in and of itself creates an imbalance in the system. Classical theorists would presume that the solution to economic downturns is lowering of wages in response to poor production and sales.

The Keynesian Revolution however, represents the complete opposite of this idea. John Maynard Keynes proposed that the actually culprit in all economic ventures was "aggregate demand." He proposed that production and income levels "wax and wane" according to the demand of consumers.

John Maynard Keynes was Revolutionary in his approach to economics. He was not necessarily looking out for the little corporation or individual entities, but rather looking out for the good of the "whole" or complex organization. He asked politicians and governments to consider the economy on a national and global level.

John Keynes was criticized for many of his ideas. In the late 19th century most people as demonstrated above believed that simply altering or lowering the wages of employees could manipulate the economy. This certainly would prove beneficial to individual entities and corporations seeking to maximize their profits.

John Keynes ideas were controversial because he asked the governing bodies of countries to step in. He suggested that they create a deficit where necessary to control the system of "checks and balances" and create a greater degree of equilibrium. He argued that by creating such a deficit, the needs of employees and organizations would balance out and create a very productive economy.

The Keynesian Revolution presented the idea that recessions and depression were wholly unnecessary. If the government of any nation were to institute policy changes and monetary and fiscal reviews, the needs of producers and purchasers could be balanced out. In theory his ideas and methods seem perfectly sound. Many people however, still oppose government intervention in the economics and policies of a market economy.

It is easy to see why many governments seeking to increase their wealth would oppose the ideas of the Keynesian Revolution. It is much easier to manipulate the wages of employees and workers than to manipulate the general monetary and fiscal policies of a nation. What is most interesting about Keynes Revolution however, is that for the first time someone challenged political theorists and economists to look at the economy from a global perspective.

Most notably, the Keynesian Revolution brought about the idea of macroeconomics, which is still a crucial factor and consideration in governmental politics and global structuring today. Keynes was very correct in assuming a circular diagram of economics. Expenditures by one party certainly can result in income for another party.