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Keynesian Economics

Keynesian Economics

Introduction

Keynesian economics is a very important approach to economics. It is one of the fundamentals of the subject and in order to develop a good understanding of the study, we need to properly distinguish between macroeconomics and macroeconomics. 

But I’m getting ahead of myself, we need to answer an important question first; what exactly is economics?

What is Keynesian economics?

Ah, the million-dollar question: What is Keynesian economics? In short, Keynesian economics theorizes that aggregate demand is the main factor influencing total output in the economy.

In other words, Keynes suggested that the growth of our economy is largely dependant on how much we spend. 

You must be wondering how this single idea has developed into its own field of study. That’s a good question. To tackle that doubt, we need to know the roots of the subject.

The History of Keynesian Economics

To answer your question, we need to take a deep dive into the history of the subject. Let’s start by taking a look at the life of the eponymous economist: John Maynard Keynes.

John Maynard Keynes

John Maynard Keynes, 1st Baron Keynes CB FBA  was a legendary British economist whose contributions to the study of macroeconomics were instrumental to advance our understanding of the subject. You aren’t called “Lord Keynes” for no reason.

John Maynard Keynes
John Maynard Keynes

He is sort of a superhero for economics nerds. His theories and idea contradicted the immensely popular neoclassical economics and even disproved several “proven” theorems. He was one of the first economists to successfully influence government policies. 

But believe it or not, he didn’t start off as an economist. 

The Brilliant Mathematician

Before revolutionizing the field of macroeconomics, Keynes was a promising student of mathematics. He grew up in a loving and nurturing home where his father personally coached him in his studies. This clearly paid off as he received a scholarship to go the esteemed Eton College.

There, he showed an aptitude in multiple subjects, particularly mathematics, history and classics. His talent was such that one of the greatest economists of all time, Arthur Marshall, “begged” him to pursue a career in economics. I found this on Wikipedia so take my words with a grain of salt here.

Anyway, soon he received another scholarship to study at the King’s College in Cambridge to study mathematics. Unsurprisingly he also killed it there, becoming renowned as an excellent debater and ending up the head of the Cambridge Union Society and Cambridge University Liberal Club, both very prestigious clubs.

Eventually, Keynes graduated with a first-class BA in mathematics, which was equivalent to being one of the best students at the institution.

His Love of Philosophy

Keynes had a keen interest in the art of philosophy. It is reported that this is one of the reasons he initially rejected economics as a career option. He was an avid follower of G.E Moore’s ideology.

His attraction to philosophy was so strong, in fact, that even after graduating, he attended the college to further study the subject often attended lectures despite being a graduate.

His Trust in Governance

Keynes was infamously optimistic. His belief that government officials could be efficient and dedicated is something that spearheaded his style of economics but yet again, I’m getting ahead of myself.

As he also trusted his own problem-solving skills, Keynes got into civil service. Working as a clerk in the India Office, he soon learnt how tiresome and tedious bureaucracy truly was. He soon quit, shifting his attention to a career he rejected multiple times in the past. No prizes for guessing what.

His True Calling

Finally, Keynes started pursuing the career that he was destined to revolutionize, It all started with a study on Probability theory. His research was funded by only two people, his father and renowned economist, Arthur Pigou.

His interactions with Pigou piqued his interest in economics to a point where he published his first economic article analysing the global downturn in India. This gained plenty of traction. So much so that he earned a lectureship on economics funded by Alfred Marshall, the man who had already predicted his potential.

The hobby soon turned into a passion as he founded the Political Economy Club where weekly discussions on the world economy were held. 

World War 1

Economics turned out to be the ideal career path for him as he soon became editor of the Economic Journal and the book,  Indian Currency and Finance, that he wrote earn him a job in the royal commission on Indian currency and finance.

His wit and incisiveness proved to be an asset to his nation during World war, acting as a vital negotiator in The 1919 Versailles Treaty. This earned him acclaim as a national hero.

Now that we know a little about the creator of the subject, let’s discuss a key moment in his life and the time Keynesian economics was discovered and how it shaped modern economics as we know it today.

The Great Depression

This was perhaps the defining moment in his career. The world desperately needed his expertise as it plunged into a deep dark recession. As all hope seemed lost, Keyes founded a form of economic thought that rescued all of humanity.

Fiscal Policies

His brave criticism of the government’s measures on increasing their budget by saving up money rather than spending was the first emergence of this school of thought. This is a quote that exemplifies his strong disapproval of the British government’s actions during that time:

“For Government borrowing of one kind or another is nature’s remedy, so to speak, for preventing business losses from being, in so severe a slump as the present one, so great as to bring production altogether to a standstill.”

He always emphasized the need for the Fiscal policy, which didn’t have a name yet. This is a fundamental way to increase demand in the economy and he was a strong supporter of it for that very reason.

The General Theory of Employment, Interest and Money

In 1936, he published his book; “The General Theory of Employment, Interest and Money”, his masterpiece. This book is the origin of all Keynesian economics. This is where all the theories and ideas are derived from. 

The General Theory of Employment, Interest and Money” heavily suggested that governments focus on the aggregate demand in the economy to get out of this slump and fighting unemployment was one of the key ways to increase demand.

This book is often credited as the basis for the following boom in the world economy and gave birth to Keynesian Economics that we study today.

Now that you know why the subject is so highly regarded and why Keynes is seen as a pioneer of modern economics. Let’s analyse a few Keynesian models and concepts.

Keynesian Models

Finally, we’ll be discussing a few models that are exclusive to Keynesian economics. These concepts are the basis for most Keynesian theories and hypotheses.

Keynesian Multiplier

Let’s get a complicated concept out of the way first. The Keynesian multiplier is, in his own words;

 “the ratio … between an increment of investment and the corresponding increment of aggregate income”

Unless you are some sort of an economic expert or natural-born genius, you need me to explain that to you. In MUCH simpler words, the Keynesian multiplier is the ratio between how much people and the government are spending and the effect that has on the national income of the economy.

This ratio was vital in understanding that economic development was dependent on government spending. The multiplier mathematically proved that theory. Keynes repeatedly used it in his book to highlight the government’s poor choices during the Great Depression.

The funny thing about the “ Keynesian “ multiplier is that it was actually Richard Kahn who discovered the multiplier. He called it the “investment multiplier” while Keynes opted to call it the “employment multiplier”. Of those two, I prefer Kahn’s label as it is more accurate.

But alas, it was named the Keynesian multiplier because it was Keynes who brought it to the mainstream as Keynesian economics became an international phenomenon with this important mathematical function at its helm.

Don’t be sad, Kahn. It kind of sounds like “ Kahnisian.” Not that great of a silver lining?

The Liquidity Trap

Another important model in Keynesian economics that highlights the effects on an economy when interest rates are too low.

“Too low?! That sounds bonkers!” Really, “bonkers”? Who even says that? Anyway, poor choice of words aside, you are right. The idea seems bizarre, why would we be upset about the cost of borrowing being too low?

From our points of views, it’s great, loans are cheaper. “I’ll buy that $300,000 cat statue today!” You must be thinking. Well ignoring that financial blunder, lowering interest rates really really hurts the entire economy. “How?” you ask?

Say hello to the liquidity trap. Not everyone will splurge all their cash on cat statues when loans are cheap. A lot of us will choose to save that money. Why? Because we all know that those rates will rise again and that’s when we will loan that money. Genius, right? WRONG!

What you’re doing essentially is bleeding the economy dry. The point of the fall in interest rates was to stimulate demand in the economy. If you save that money and do not invest, you stunt the economic growth and without economic development, who even will have the financial stability to take loans from you?

 This phenomenon where the monetary policy is rendered useless by a culture to save is called the liquidity trap and one of the most compelling models in all of Keynesian economics.

Conclusion

As you can see Keynesian economics is just a branch of macroeconomics. This all may seem uninteresting and boring to you. But have you learned nothing from Keynes’ life? 

The man rejected economics at almost every stage of his life, despite all his colleagues’ persuasion. When he finally gave it a shot, it turned out to change his life and we found a generational talent who changed the world.

I’m not saying economics is a sure shot success for you but that doesn’t mean you don’t give it a try. As I said in my macroeconomics article, any career needs dedication.

What I’m adding now is that you need a passion. You may have it, you may not. You’ll never know unless you give it an honest shot.

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