Economic Theory

After learning about the various approaches towards stabilization of our economy, I would have to say that I most closely agree with Keynesian’s theory behind economic policy.  Keynes stipulated that decisions by the private sector can sometimes lead to inefficient outcomes for the public sector and advocated for monetary policy actions by the Federal Reserve (which was to be created after his theory became widely accepted) and fiscal actions by government in an effort to fill in the gaps of the business cycle.  I disagree with the Classical Economic theory or Say’s Law that ruled supply will create demand.  Logically, in the short-term, if there isn’t adequate employment or a sufficient money supply, then the purchase of goods and services proves quite challenging for consumers.  The Monetarist theory, developed by Milton Freidman proved to be quite ineffective in the late 70s and early 80s as well.

When an economy is in contraction, Keynes’ recommended increased government spending and lower interest rates to help boost consumer spending.  Since this theory was adopted, after the Great Depression, it has proven to be the most reliable way to shift the economy back into expansion.  However, Keynes was not a big proponent of large expansions either because this led to an increase in money supplies that he hypothesized was the catalyst to high interest rates.  He mandated that the government’s main focus for fiscal policy should be placed on smoothing out the difference between peaks and valleys in the overall state of the economy.

Summarized to the simplest of terms, Keynes theory suggests that excessive saving causes recessions or depressions.  If consumers do not spend money, companies that hire individuals do not make money and if companies do not make money, then they do not have money to spend on labor and therein lies the center of the vicious cycle that can spiral downwards from there.  Instead he debated that governments should focus on correcting the fluctuations in the short-term, rather than thinking the economy would self-correct in the long term.  To quote Keynes, “In the long term, we are all dead.”  When applied over the long-term of the past several economic expansions and contractions, Keynesian Economics has proven to be the most effective at creating stabilization.  We still have expansions and recessions, but we have seen overall steady growth and less variance in the economy when it rises or falls.

Our current monetary and fiscal policy seems to be a blend of Keynesian Economics and Classical thinking.  I believe this is a crucial error on the public sector’s part.  Unemployment has continued to be higher than the natural rate for more than 18 months, yet the government has advocated for cutbacks in spending which is strictly against what Keynes would recommend and the current policy has failed to pull the economy out of a recession.  As the global market begins to make severe cutbacks in their public sectors, I fear that will lead to larger amounts of private sector savings, instead of investing which will only deepen the state of the recession.

It is impossible at this point for the economy to recover when there aren’t enough jobs for workers who are willing to work, and the private and public sectors are equally at fault for creating the shortage.  Keynes emphasized that government’s main focus for spending should be on basic research, public health, education, and infrastructure, yet these are the areas experiencing the largest decreases in government spending.  The proposed tax increase, from the current administration, will only exacerbate the recession, according to Keynes.  From a common person’s perspective, this seems like a shortcut by the government to stabilize the economy.  After all, without any training in economic policy, how does the government expect to get any water when the well is dry?

Works Cited

(1)   Krugman, Paul and Robin Wells. Macroeconomics. 2nd Edition. Worth Publishers. 2009

(2)   Klein, Ezra, “Larry Summers: ‘I think Keynes mistitled his book’”, The Washington Post, July, 26, 2011