The Rise and the Fall of Keynesianism - Essay Example

The Rise and the fall of Keynesianism Rise and the fall of Keynesianism Keynesianism or Keynesian economics is a body of ideas, which were set forth by John Maynard Keynes (1883-1946) in his works that included the book titled ‘The General Theory of Employment, Interest, and Money’ – 1936 (Keynes and Krugman, 2007). This was meant to give a theoretical basis for policies of government with regard to full-employment. He was against the notion that full employment could be restored by allowing wages to fall to lesser levels as proposed by the classical economists. Keynesianism was for the proposal that employers would not hire workers to produce goods, which could not be sold. This stems from the belief that unemployment is a result of insufficient demand for services and goods. This view was neoclassical and is defined as a ‘demand-side’ theory whose focus is short-run, in which aggregate demand strongly influences economic output especially during economic fluctuations such as recessions. Keynesianism was so much attached to the government policies in its advocacy (Keynes and Krugman, 2007). Keynes asserted that investment is a dynamic factor that determines the height of economic activity by responding to future expectations as well as interest rate variations. In this sense, he maintained that full employment could be fostered through deliberate action by the government. Such direct government influence on goods and services demand could be in terms of changing public expenditures and tax policies. The rise of Keynesian economics took place during later periods of World War II, the Great Depression, as well as the economic expansion after the war that is from around 1945 to 1973. Keynesianism was portrayed as a rational, beneficial, scientific advance in economic management providing a basis for triumphing over the crisis of capitalism and creation of just capitalist societies (Keynes and Krugman, 2007). The theories proposed by Keynes in the course of and after World War II gained worldwide influence and their adoption was an integral part of establishing new patterns of relations between labour and capital. This forms the basis on which the term Keynesianism is used often in broad reference to patterns of economic and political relations, which are associated with those policies and theories. The broad concept of employment, curiosity, and money proved to be a unique contribution that was acceptable to economic and political establishments propagating the spread of Keynes’s policies as well as theoretical ideas. Keynes was keen to oppose his theories to and differentiate them from economic theories of classical economists like David Ricardo and some of his followers such as Arthur Cecil Pigou, Francis Ysidro Edgeworth, Alfred Marshall, and John Stuart Mill (Harcourt, 2008, p. 125). The classical view opposed by Keynes was Say’s Law, which proposes that demand is created by supply. Keynes was out to develop a theory, which would explain what determines production, investment, consumption, and saving where the level of employment and output are determined by interaction of aggregate supply and aggregate demand. Keynes neoclassical theory supported money and labour as the main costs, which shift supply and demand. Supply and demand can be adjusted through monetary policy distribution. Wide acceptance of Keynes’s ideas occurred after the Second World War until early 1970’s (Harcourt, 2008, p. 125). Keynesianism was the main source of inspiration, in the developed nations of the West, for economic policy makers. Governments continuously prepared economic statistics of high quality and adopted what had become a norm of basing their economic policies on Keynesian theories. Keynesianism enjoyed posterity in a the ‘Golden Age of Capitalism’ where social democracy and new liberalism led to modest inflation as well as low, stable unemployment in many western capitalist nations. The main tools employed by Keynesian economics after the war were monetary policy and fiscal policy. These central features of Keynesianism acknowledged the strength of the working class in organizing themselves. Fiscal policies and monetary policies were used in a counter-cyclical manner to enhance industrial development through moderating the degrees of demand by government (Harcourt, 2008, p. 125). Keynesianism shifted emphasis from study of microeconomics (economic behaviour of companies and individuals) to macroeconomic study, which entailed the whole economy. Keynesianism was regarded as a revolutionary theory by asserting an economy’s most important force of drive was aggregate demand that was created by the government, businesses, and households. The adoption of Keynesian models meant dismissal of free market theories due to lack of self-balancing mechanisms that could result in full employment. The recommendation by Keynes for government intervention through public policies aimed at achieving price stability and full employment was a warmly welcome theory by the political class. The Keynesian theory was as well propagated by the economic sense it made (Harcourt, 2008, p. 125). Keynesianism managed at its onset to change the way the world perceived economic mechanisms. Keynes started by introducing a theory, which showed that aggregate demand determined equilibrium. Aggregate demand is the amount of services and goods demanded by all buyers at different prices. Keynes proposed that an increase in demand in the economy prompted companies to provide more services or produce more goods thus heading towards full employment. Keynesianism came up with a theoretical frame in which, spending would be encouraged by both firms and consumers, in turn increasing demand. Increased aggregate demand would encourage production and help the economy out of depression/recession. The wake of Keynesianism saw the theories affect economic policies in governments such as Franklin D. Roosevelt’s in the ‘New Deal’ that led to creation of agricultural jobs for farmers who were unemployed. Another President who embraced Keynesianism was Richard Nixon the Republican who even claimed to be a ‘Keynesian in economics’. The prosperity of Keynesianism at this point seemed permanent especially in the ‘go go’ 1960’s (Keynes and Krugman, 2007). The post-war era saw Keynesian analysis put together with neoclassical economics to formulate the ‘neoclassical synthesis’ having dominance of the mainstream thought in macroeconomics. There was thought that tendency toward full employment was not automatic but many Keynesian economists believed that it was possible to use government policy to ensure it. This would lead the economy to behave as predicted by the neoclassical theory. The domination of Keynesianism in the post-war period was broken in the stagflation that occurred in the 1970’s. This was a period where inflation rate became very high and could no longer conform to the Keynesian theory in macroeconomics of mutual exclusiveness with recession as portrayed in the Phillips curve. Stagflation proves extremely difficult and costly to eradicate both in budget deficits and human terms as put across by the British politician, Ian Macleod, Chancellor of the Exchequer as from 1970. The fall of Keynesianism had begun at this point stemming from economic problems in the 1970s and oil shock of 1973 (Farrell and Quiggin, 2012). Modern liberal economies were the first to fall out of favour with the Keynesian theory. The reason for this was the rising and high inflation, coupled with rising and high unemployment all of which contradicted the prediction of the Phillips curve. Occasioned by an oil embargo proclaimed by the Organization of Arab Petroleum Exporting Countries (OAPEC), the oil crisis in 1973 caused dramatic inflation suppressing economic activity. The affected nations included developed economies such as the United States, the United Kingdom, the Netherlands, Japan, as well as Canada. Keynesianism was bound to suffer a big blow because these economies predominantly employed the Keynesian theory of macroeconomics. The economic and political effects of the ‘oil price shock’ were quite persistent leading to simultaneous application of contractionary (anti-inflation) as well as expansionary (anti-recession) policies (Farrell and Quiggin, 2012). This dilemma resulted in the downfall of Keynesianism domination of the 1960s. Throughout the 1970s, there arose ideas, which were based on increased classical analysis that included new classical economics, supply-side economics, and monetarism. This period also called for reorganization of thinking by the Keynesian economists who tolerated higher inflation in their new models for the sake of emphasizing on maximal economic growth and low unemployment. The consequences of inflation in this era had to be kept in check by methods like indexing while its rate on the overall was to be kept low and steady by potential policies like the one developed by Martin Weitzman known as share economy. The shift in representation of international money from the gold standard to the dollar meant movement of money was more volatile and much faster on the international platform (Farrell and Quiggin, 2012). The Keynesian theory seemed to be incompatible with accumulation of money globally, which brought occasion for new state policies. The old post-war patterns of economic, social, and political relations were rapidly changing with increased social unrest and decreasing profits. These factors made a mockery of claims by Keynesianism that a crisis-free, harmonious development of capitalism could be ensured through reconciliation of social conflict. One of the essential elements of Keynesian conceptualization was state intervention. Once the international monetary system broke down, the insulation of the world market in terms of harmony was removed. Tensions of this nature found expression during sharp recession experienced in 1974 – 1975. Death of Keynesianism was being proclaimed from every side because during this period, production plummeted sharply in leading developed countries (Farrell and Quiggin, 2012). This led to soaring of unemployment and inflation rates made worse by the influx of ‘petrodollars’ into markets dealing in Eurodollars. The result was increased volatility of world monetary systems. Macroeconomists could not come to consensus at this time and the major blow was on Keynesianism. Whenever economists debated, Keynesian theory lost ground quickly to newly formulated and fashionable economic theories, which were monetarist. The state was under increased and constant attack by conservative politicians in most developed nations, for example, the U.S. and Britain due to expansion, consensus politics, and position of trade unions. In a bid to justify their position, they turned to theorists like Hayek and Fredmann. The biggest blow for Keynesianism was denouncing of Keynesian solutions as unrealistic by social democratic parties (Farrell and Quiggin, 2012). These parties held their position in political systems based on recognition of labour power, a concept highly vouched for in Keynesianism. At a conference in 1976, the then British PM, James Callaghan, candidly denounced the Labour Party’s belief in the Keynesian theory of spending their way out of a recession as well as increasing employment by boosting government spending and cutting taxes. Keynesianism was described as an option that existed at some point after the war but could no longer hold in the economic and political predicament at that moment in time. In retrospect, Keynesianism had taken nearly thirty years of struggle to establish in which, capitalism had gained stability. Capitalism had finally plunged into chaos again necessitating reformulation of the Keynesian macroeconomic theory or its abandonment altogether. This gave rise to Post-Keynesian economists who rejected neoclassical economics and synthesis applied to macroeconomics. This school holds both New Keynesian and Neo-Keynesian economics as not only incorrect, but a misrepresentation of the ideas put across by John Maynard Keynes. Reference List Farrell, H. and Quiggin, J. 2012. Consensus, dissensus and economic Ideas: the rise and fall of Keynesianism during the economic crisis. Centre for the Study of Development Strategies. Harcourt, G. 2008. On Paul Krugman on Maynard Keynes General Theory: [Keynes, John Maynard. The General Theory of Employment, Interest and Money. With a New Introduction by Krugman, Paul 2007.]. History of Economics Review, (47), p. 125. Keynes, J. M. and Krugman, P. R. 2007. The general theory of employment, interest, and money. Houndmills, Basingstoke, Hamshire: Palgrave Macmillan. Read More