Economic analysis: ¿Is keynes to blame?

Alan Sánchez Martinez The name of the 1936 book wrote by John Maynard Keynes is General Theory of Work, Interest and Money. These three terms are key in the Keynesian thought; Work it’s relevant according to Keynes due to the fact that high wages weren’t the source of unemployment and cutting wages for diminishing costs and better the balance of trade was not a real solution, moreover because if you cut wages, laborers will not have money to spend as consumers, and since the Keynesian theory focuses in spending to inject money into the economic circular cycle, then depression would only get worse.

Interest comes when Keynes suggest low interest rates to stimulate investment and lower saving, he talks about consuming as the cure for UK depression during The First World War because aggregate demand had been neglected by the “classical approach”.

Keynes talks about money because it’s the main problem (commercial and financial situations were poor), but also the solution to escape from depression. Hence he explains the money circular flow and how it affects to economic situations.

He thought that the fundamental principles of the “classical economics” school only fulfill when there’s a situation of full employment in production, in that case boosting aggregate demand would only raise price levels. En the classical model markets are perfect and without trends to fail, so that prices, inflation and wages reach optimum levels automatically without any help from government intervention. And there’s no need to manage aggregate demand due to aggregate supply creates it’s own demand.

So it’s obvious that rising aggregate demand from de classical view only brings inflation problems (Reflation). Also classical thought analyzes economics from an individual perspective, maybe that’s why they assume that offer creates it’s own demand (and so employment).

However we’ve seen that markets tend to fail, and this was proven during the World War, balance of trade and general depression in UK didn’t seem to fix automatically by market forces, in other words by “clearing-market”, all the supply focused on war due to exporting industries turned into producing munitions. And so, unemployment was much higher than supply. So we can say that Keynes assuming that markets are not perfect believed that classical thought it’s hard to fulfill.

That’s why in a tough panorama like in a World War period, boosting aggregate demand can be the solution to increase growth and a way out of depression without rising dramatically price levels.

From a personal view I think that although a great wave of criticism against Keynesian policies began to gain popularity, in the worst moment these policies were a clear spring back out from the terrible situation UK was in, it was impossible to sit and wait until the market forces stabilized economic situation themselves. Even nowadays we keep using Keynesian policies like for example in 2009 when United States government had to inject money to American companies like Chrysler and General Motors to protect investment and jobs from a world crisis caused by a credit crunch. However the real dilemma comes when a governmental intervention is always in mind, so that a moral – hazard is created and companies lose discretion in their decision making, it’s relevant to remember that capital structure is important to obtain real growth. But maybe a government intervention combined with well established market rules could be the solution to recession and depression situations (2012). Reference:

Lecture layouts (2012). Development of economic analysis. Univerity of Westminister. London, United Kindom.

Annexes

AD3

AD2

AD1

AS

Y

P

P3 P2

P1

YR YFE

P = Price Y = C + I + G AS = Supply AD= Aggregate Demand FE = Full Employment