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Economy and Finance

What is Keynesian Economic Theory?

09 Aug 2023 Zinkpot 238
What is Keynesian Economic Theory?
  1. Keynesian economic theory is the macroeconomic concept that justifies government intervention through public policies that aim to achieve full employment and price stability.
  2. It was developed in the 1930s by a British economist named John Maynard Keynes as a response to the Great Depression and a critique of classical theory, which suggests supply-side opportunities will correct the economy without government intervention.
  3. This theory assumes that changes in demand are the prime influencers of output and employment and that stimulation of demand can pull an economy out of depression.
  4. Termed demand-side theory, Keynesian theory suggests that the primary factor that drives economic activity is the demand for goods and services. In order to spur this demand, government policies focus on direct intervention as a way to influence demand and prevent a recession.
  5. The theory suggests that during a recession when consumers stop spending, the government should step in and spend to fill the void. It is a theory that says, the government should increase demand to boost growth.
  6. The main tools of government intervention are government spending on infrastructure, unemployment benefits, and education.
  7. According to the Keynesian economic theory, there are three main metrics that government should closely monitor: interest rates, tax rates, and social programs.
  8. Interest rates or the cost of borrowing money play a crucial role in enabling economic prosperity. During times of recession, the theory prompts governments to lower interest rates to encourage borrowing. The investments in the private sector will help increase output and drive the economy out of recession.
  9. During times of a boom cycle, the theory argues that the central bank should increase interest rates in order to generate more income from borrowing. Controlling the magnitude of an economic boom is important since too much investment in the public and private sectors could lead to a reduction in the money supply and severe recession, as a result.
  10. Taxes are one of the most important sources of income for the government to finance the public sector. During a recession, the theory suggests that governments should lower income tax rates on individuals and businesses to enable the private sector to have the additional financial capital to invest in projects and drive the economy forward.
  11. Governments may also choose to introduce entirely new taxes that did not exist before in order to generate even more income. To help supplement the initiative, the government may also offer proportionally smaller tax breaks in order to spur consumer spending.
  12. During times of boom, the theory argues that government should decrease spending on social programs since they were no longer needed during boom cycles. On the other hand, during times of recession, the government should increase spending on social programs in order to stimulate the job market with an influx of skilled labour.
     

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