Keynesian theory of Economics

November 24, 2017
Figure 17.3 World War II Ends

Until the onset of the Great Depression (1929–1939), it was conventional wisdom in classical economics that the best way to manage the economy was to take a laissez-faire, or "hands off, " approach. Classical economists believed that, left to their own devices, economies tended toward full employment on their own, and that the best way to deal with a depression was to expand the money supply and wait for the economy to return to "equilibrium."

In his landmark 1936 book, The General Theory of Employment, Interest, and Money, the English economist John Maynard Keynes (1883–1946) argued that the classical economists had it all wrong. Some depressions were so severe that consumer demand needed to be artificially stimulated by government fiscal policies such as deficit spending, public works programs, and tax cuts. During deep depressions, Keynes believed, when the government expanded the money supply pessimistic consumers would simply hoard the money rather then spend it. As proof that Keynesian economic theory was true, economists pointed to the fact that the U.S. economy recovered from the Great Depression only through heavy deficit spending during World War II (1939–1945). Keynesianism became official government policy when the Employment Act of 1946 gave the federal government the explicit responsibility to use fiscal policy to maintain full employment as a way of keeping consumer demand and economic growth strong.

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