Keynesian Economic Policies and Its Effective Implementation During the Golden Age - Research Paper Example

Introduction Keynesian economic policies derive its name from the proposed ideas of the British economist John Maynard Keynes. The economic theory of Keynes was based on the circular flow of money which attained great significance during the golden age of capitalism in UK. The golden age of capitalism is the period after the Second World War during 1945 to mid-1970s. During this period, the governments increased their spending and even embraced fiscal deficits in order to boost the aggregate demand in the economy. The increase in level of liquidity in the economy resulted in increased production of goods thereby leading to higher GDP growth rates. The end of golden age prompted policy makers to resort to monetarist economic policies. Keynesian economic policies and its effective implementation during the Golden Age According to Keynes’ economic theory, the expenditure of one person leads to an income of another person. The purchase of goods and services from one person leads to an expense of another person. This expense results in the earnings of the person that has sold the goods or services. According to Keynes, this is the underlying theory for circular exchange of money in the economy which leads to its smooth functioning (Hein and Stockhammer, 2011, p.59). Keynesian economic policies state that the aggregate demand in the economy could be boosted by raising government expenditures. The increase in government spending would encourage private investment. This is supported by a rise in investment savings (IS). Thus the IS curve would shift from IS1 to IS2 as shown below. The IS-LM curve shown below is interpreted as follows. Due to shift in the IS curve, the point of general equilibrium with the LM (liquidity preference and money supply) curve also shifts upward. This gives rise to rise in interest rates from i1 to i2 as shown in the graph. Also the liquidity level of the economy enhances due to rise in money supply from Y1 to Y2. After the great depression in 1929 and during the post world war period from 1945, the economy of UK experienced unprecedented growth. The economic prosperity in UK during this period of reconstruction and industrialization led to the emergence of golden age which prevailed from 1945b to 1970s (Rollings and Middleton, 2002, p.5). This could be attributed to the Keynesian economic policies. During the golden age, the policymakers banked on the underlying theories of Keynesian economics and increased government spending. The policymakers embraced government deficits and reduced government taxes in order to boost the income level and employment rates in the economy of UK. Thus the government spending was increased in order to boost the productivity and demand of the economy in UK (Tobin, 1989, p.27). The growth rate of GDP and per- capital income level increased rapidly. This was comparatively much higher with respect to the earlier phases of the economy. The income- level per person grew at the rate of 3.4% in the 1960s as compared to 2% in 1950s. The total productivity of labour increased doubly as compared to earlier stages in the economy. As compared to the last century, the GDP growth rates were also double. The trade volumes increased eight times as compared to the period before the World War. The growth of industries, total factor productivity, growth in the volume of trade and increase in capital stock led to booming conditions in the economy of UK (King, 2003, p.60). Thus the golden age during the period of 1945 to mid-1970s showed the effectiveness of Keynesian economic policies. The end of the Golden Age The golden age which existed in the developed countries like UK in the post world war period came to an end during the later stages of 1970. The decline of the golden age highlighted the flaws of Keynesian economic policies. The developed countries like UK embraced the policy of increasing the government spending and at the same time not paying much heed to the increasing fiscal deficits and reduction of taxes (Weinblatt and Young, 2011, p.50). This policy measure was adopted by the UK government and other developed countries in order to boost the aggregate demand in the economy. However, this brought to light serious flaws of the Keynesian economic policies that led to end of the golden age. The increase in government spending encourages private investments in the economy. Hence with the passage of time, the investment savings started to grow. A point was reached when there was excessive investment in the economy. Due to excessive savings in the economy of the country, the funds allocated for investments were lowered (GLOVES OFF, 2004, p.1). This phenomenon has been described with the help of investment-saving graph shown below. An excess of savings caused the investments in the economy to decline. Thus the level of investments lowered from old “I” to new “I” which is shown by the downward shift of the investment line in the graph given below. The rise in savings and fall of investments would cause the interest rates to decline from old ‘I’ to new ‘I’. The fall in interest rate would increase the amount of short term funds in the economy. The fall of interest rate increased the money flow that triggered inflation in the economy of the country in the later stages of 1970s. On the other hand, excessive savings hampered further investments due to which the employment level and the level of income lowered. The decline of labour productivity reduced the growth rates of gross domestic product of countries like UK. Thus country headed towards a decline in gross domestic production along with the adverse effects of inflation. Due to the circular flow of money, the consumption demand of the economy also hampered due fall of production in the economy. Thus excessive government spending during the golden age in the post world war era led to higher inflation rates and eventually the production levels of the economy were hampered (Gnos and Rochon, 2006, p.56). This is how the golden age in Europe and UK came to an end. The rise of Monetarism and monetarist economic polices The decline of the golden age led to the rise of monetarism in the economy of UK and other developed nations. The monetarist economic policies adopted by the government helped to revive the growth rates of the economy. The monetarist economic policies aimed at deciding the optimum level of money supply in the economy which would play a vital role in boosting the gross domestic production. Apart from the achievement in GDP growth rates, the monetarist economic policies are also aimed at achieving price stability of goods and services in the economy. The policymakers varied the supply of money in the economy through different ways of variation of interest rates as well as reduction of taxes. The reduction of interest rates by the policymakers led to decisions being taken against parking of funds in the financial institutions that offered lower rate of interest. This increased the supply of money in the economy and increasing in purchasing power of the people. Hence due to availability of money supply in the economy, the consumption demand got the required boost. Excessive availability of money led to the rise in demand above the level of supply of goods produced. This hike in the price of goods and services resulted into inflation in the economy. The monetary policies should, therefore, be reviewed in order to boost the income level and the demand in the economy and at the same time, keep a control over inflation (Mishkin, 2007, p.37). The relation between the unemployment rate and the inflation rate could be explained from the Philip’s curve given below. The increase in money flow in the economy of the country led to the increase in demand. In order to fulfil the demand, the production of the economy increased. This created employment opportunities and the level of unemployment decreased. The rise in income level of the population caused the aggregate demand in the economy to exceed the supply of goods and services (Mankiw, 2011, p.48). This resulted in increase in the level of prices and ultimately occurrence of inflation. Thus lower the unemployment rates in the economy of the country, higher was the rate of inflation in the age of monetarism. The fall in the GDP and the rise of unemployment rates resulted into higher inflation rates in the economy. The monetary policies at the end of the golden age aimed at providing the optimum money supply in the economy in order to boost the demand of the economy and at the same time keep inflation rates under control (Marshall, 2006, p.35). The evidence of monetarism is visible from the monetary policies of the UK government. An analysis of the recent statistical figures indicates that the change in production levels of the economy affected the employment rates and the inflation rates of UK. Although the economy of UK has started to revive from the declining growth rates due to the economic recession, the economy is yet to recover fully from the economic downturn. As a result of the periodic revision of the monetary policies by the policymakers in order to achieve dual objectives of boosting economic demand as well as controlling inflation, the production output of UK fell by 0.6% in April, 2013 as compared to the last fiscal. This resulted in increase of unemployment for around 5000 people although the unemployment rates remained stable at 7.8%. As the fall in aggregate demand was less than the fall of domestic production and supply rates, it caused the inflation rates in the economy of UK to rise from 2.4% in April, 2013 to 2.7% in May, 2013 (Office for National Statistics, 2013, p.1). Conclusion Looking at the current situation of the economy, the economic growth rates have declined due to the economic crisis. The domestic production and the level of employment have decreased. The fall in the income levels have caused a reduction of demand among the consumers. The production levels lowered to a greater extent than the aggregate demand leading to high inflation rates. In such a condition, the government would need to increase the money supply in the economy with the central bank reducing interest rates. With the rise in the level of liquidity in the economy, the private investments would grow leading to an increase in the production capacities and supply as compared to the aggregate demand thereby pulling the inflation rate down. References GLOVES OFF. 2004. The Post-World War Ii Golden Age Of Capitalism And The Crisis Of The 1970s. [Online]. Available at: http://www.glovesoff.org/features/gjamerica_1.html. [Accessed on 19 June, 2013]. Gnos, C. and Rochon, L. P. 2006. Post-Keynesian Principles of Economics Policy. Edward Elgar Publishing; UK. Hein, E. and Stockhammer, E. 2011. A Modern Guide to Keynesian Macroeconomics and Economic Policies. Edward Elgar Publishing; UK. King, J. E. 2003. A History of Post Keynesian Economics Since 1936. Edward Elgar Publishing; UK. Mankiw, G. 2011. Principles of Economics. Cengage Learning; Stamford. Marshall, A. 2006. Principles of Economics. Osprey Learning; Washington. Mishkin, F. S. 2007. Monetary Policy Strategy. MIT Press; USA. Rollings, N. and Middleton, R. 2002. British Economic Policy In The 1950s And 1960S. [Pdf]. Available at: http://eis.bris.ac.uk/~hirm/Downloadpapers/Rollings%20and%20Middleton%20(2002)%20British%20economic%20policy%20in%20the%201950s%20and%201960s%20conf%20ver.pdf. [Accessed on 19 June, 2013]. Tobin, J. 1989. Policies for Prosperity: Essays in a Keynesian Model. MIT Press; USA. Weinblatt, J. and Young, W. 2011. Perspectives on Keynesian Economics. Springer; Germany. Office for National Statistics. 2013. Index of Poduction. [Online]. Available at: http://www.ons.gov.uk/ons/index.html. [Accessed on 20 June, 2013]. Read More