How Keynesian Economics Was Engineered To Erode Your Savings
Considered a ‘demand-side’ theory, Keynesian economics was inspired by how spending in an economy affects output and inflation. This theory was created by John Maynard Keynes, an economist from Great Britain who advocated for the stimulation of demand by increasing government spending and lowering taxes. The 1930s hypothesis came about as John Keynes attempted to understand how and why the Depression happened and sought ways in which economies across the globe could be pulled out of it. Subsequently, the Keynesian Economics premise was used to front the concept that economic slumps could be prevented through the influence of aggregate demand; it stated that governments could achieve an optimal economic performance via intervention policies and activist stabilization. Click Here To Go Straight To Our Online Tutorial
Exploring Keynesian Economics
Keynesian economics brought fresh insight into inflation, output, and expenditure. Under the conventional economic way of thinking it was assumed that both economic output and employment existed in a self-regulating and modest cyclical swing. This conventional method argued that a fall in aggregate demand would trigger drawbacks in production thereby translating into weakening of prices and earnings however low-level inflation and remuneration would provide the necessary incentives for employers not just to make further capital investments but also employ extra people which would, in turn, increase the employment rate and restore economic growth. The Great Depression put this theory under severe testing.
In various works including his influential book, ‘General Theory of Employment, Interest, and Money,’ Keynes reasoned that a plunge in aggregate demand could be made worse by economic weakness brought about by structural inflexibility and other specific features of market economies.
Keynes further denotes that lower earnings do not necessarily translate to full restoration of employment simply because business owners will not onboard employees to engage in the production of goods whose demand is low. Likewise, unfavorable business conditions may restrict companies’ capital investments as they will see no benefit of investing in new plant and machinery lower prices notwithstanding. All these are factors that will adversely impact overall expenditure and investment.
Keynesian Economics And The Great Depression
Witnessing firsthand the harsh effect the Great Depression had on world economies, more so in his homeland, The United Kingdom, this British economist sought answers that conventional economic theories could not provide. His well-known 1936 book, ‘The General Theory of Employment, Interest, and Money,’ stemmed from directly observing the economic phenomena during this period.
Keynes questioned the viability of the conventional economic theory that assumed prices and output would finally return to a place of equilibrium seeing as how the Great Depression had defied this. Employment and output were at an all-time low. Low inflation and wages did not change the scenario as was advocated by conventional theories. It was his questioning that led him to establish practical applications that would have propositions for any society in an economic crisis.
Keynes economics theory became referred to as ‘Depression economics’ because the theory came about when the world was in great economic crisis, and it disputed the idea of an economy returning to its natural place of equilibrium. Instead, Keynes saw economies as existing in an ever-changing mode that was always contracting and expanding; a situation also known as boom and bust. Keynes strongly backed the idea of a countercyclical economic policy whereby the government would raise taxes or cut expenditure during boom periods and undertake deficit spending should economic woe befall it.
At the same time, Keynes disparaged the British government for cutting welfare spending and raising taxes to balance its books. According to him, the measures taken by the government would discourage people from spending thereby creating an unstimulated economy that would not be able to revive itself and go back to its days of glory. Keynes suggested and encouraged the government to expend more money to boost consumer exigency in the economy; by doing so, the economy would see an overall increase in economic activities which would then translate into increased employment and deflation.
Keynes theories sought to prevent deep economic depressions in future and as such he greatly discouraged excessive savings unless one was saving for further education or retirement. Keynes reasoned that these savings resulted in stagnation of money and reduced the total money available in the financial system for stimulating growth – a situation that is dangerous for any economy.
Naturally, conventional financial analysts and free-market activists have condemned Keynes methodologies because the market self-regulates and natural influences inescapably return it to a place of equilibrium. Keynes, however, did not have any faith in the cyclical swings of a self-regulating economy that relied on natural forces having witnessed firsthand its failure in a time of deep depression. He greatly believed that government could influence and create a robust economy.
Keynesian Economics: Multiplier Effect
A key factor in the Keynes’ fiscal stimulus theory is the Multiplier Effect. As the name suggests, an introduction of government expenditure will ultimately lead to additional business activities and more spending. The principle behind this theory is that the additional expenditure will increase aggregate output which produces more income and the ensuing increase in Gross Domestic Product (GDP) will have the potential of surpassing the original stimulus amount.
The marginal tendency to consume is directly linked to the sheer size of the Keynesian economics multiplier. For example, money spent by one consumer translates into wages for another worker. When this worker spends, it becomes income for yet another worker, and the cycle continues. According to Keynes and his supporters, full employment and economic growth can only be affected if individuals are encouraged to raise their marginal tendency to consume by saving less and spending more.
In doing so, a dollar spent on economic stimulus will, in the long run, generate more dollars in growth. This model became popular among government economists who could now justify spending on politically accepted schemes on a nationwide scale.
Keynes theory dominated educational economics for years, however over time other economists, the likes of Murray Rothbard and Milton Friedman out to dispute this model by illustrating the misrepresentation of the relationship between investments, savings, and financial growth. Although many economists agree that financial incentive is not as efficient as the Keynes multiplier model suggests it is, they still rely on and utilize its models.
One other multiplier in macroeconomics is the Money Multiplier. The money multiplier is not as controversial as its fiscal counterpart and relates to fractional reserve banking’s system of money creation.
Interest Rates And Keynesian Economics
The focal point of Keynesian economics in recessionary periods is providing demand-side solutions. Keynesian economics theory considers government intervention vital to the economic process by way of countering low fiscal demand, underemployment, and unemployment. This stress on direct intervention by government puts economists from the Keynesian economics school of thought at loggerheads with those who advocate for limited involvement by government in the marketplace. Meaningful intervention by the government can come in the way of lowering interest rates thereby producing active fiscal demand. Keynesian economics theorists make their case by stating that a lack of intervention will see economies stabilize very slowly and over a long period and a short-term demand boost will hasten this process. The argument presented is employment and wages respond slower to market needs necessitating government involvement to stay on course.
In the same way, prices do not also respond quickly and will gradually change upon monetary policy intervention. Money supply is used as a tool, during this gradual change, to alter interest rates to advance lending and borrowing. The initiation of short-term needs by government bolsters the financial system and restores both employment and exigency for services. This reenergized activity creates a recurring growth that will see sustainable growth and development. Keynesian economics theorists suppose that without government intervention this cycle becomes upset and market growth loses it stability and becomes susceptible to disproportionate fluctuation. Stimulating the economic cycle by keeping the interest rates low encourages both individuals and businesses to borrow extra money and when the uptake of loans is encouraged, and optimized individuals and businesses will increase their expenditure and the new spending, in turn, fires up the economy. It is worth noting that lower interest rates may not necessarily result in economic improvement.
Manipulation of interest rates is not always enough to generate new economic activity as has been evidenced in countries like Japan. As an answer to economic woes, the Keynesian economics theory and its followers recommend lower interest rates however they fail to address the zero-bound issue. The zero-bound issue arises when interest rates have been lowered so much that they approach zero and at this point, no amount of lowering will stimulate the economy and attempts at economic revival will yield no results. Japan’s Lost Decade in the 90s is believed to have been plagued by the zero-bound problem. Japan’s interest rates stayed close to zero but remained largely unsuccessful in stimulating the economy.
While the Keynesian economists do not aspire for interest rates to reach the lower boundary, they acknowledge that there may be times when lowering interest rates fails to bring about its intended results. It is in these situations that they advocate for implementation of other interventionist strategies. These strategies include altering tax rates to raise or reduce money distribution indirectly, direct control of the labor supply, varying pecuniary policies or presiding over the distribution of goods and services pending restoration of employment and demand. Keynesian economics theorists are occasionally required to look further than interest rates and apply other strategies when their interventionist methods fail.
Level of Demand vs. Structure of Demand
When full costs of production cannot be met recession occurs. In other words, when the production costs of goods and services cannot be recovered in the pricing of these goods and services, recession becomes imminent. Several reasons and factors can be blamed for the poor production reasons however at the end of the day; structural issues are behind the recession. The proximate cause of recession does not lie in a fall in production and market needs rather in structural imbalances brought about by errors in production decisions.
We cannot overemphasize this. Today, we have embraced the idea that macroeconomics is all about the level of demand. Before Keynes, economists looked at the structure of demand to understand recessions. For today’s policy-makers, aggregate demand is the central issue when analyzing the cause of a recession which contradicts the thought patterns of economists who lived before Keynes since the latter believed that the only way to explain the cause of a recession was to look at the reason behind markets becoming unbalanced
In the modern economic theory, the focus is placed on the fluctuating levels of spending. For this reason, additional spending is not considered part of the problem, and ways are devised to foster public expenditure and to add to shortfalls because we believe that the two are viable and intrinsic parts of the solution.
Modern-day economic debates are ignorant of the fact that structure is crucial. They fail to see that the economy is made up of several pieces which must fit together. They fail to understand that economics works like an apparatus whose parts function in symmetrical balance and if a part or several parts of this apparatus go awry, then the recession will follow and persist until these parts are once again realigned.
When we critically analyze the cause of the downturn, we will realize that none of is related to a lack of demand. Decisions to engage in the unsustainable production of goods and services, often backed by a misrepresentation of facts are the causes of the downturn.
Let us review a couple of examples to explain the point further:
- Foreclosure of homes in the United States was the result of financial institutions lending funds to borrowers without taking into consideration their financial soundness. These financial institutions that had once been persuaded to lend to all and sundry were now foreclosing homes and displacing millions of people.
- The banking institution had bundled mortgages into attractive financial products and suffered massive losses when values of housing took a tumble.
- In the American money market, the Chinese cunningly recycled the dollars received thereby dealing massive and long-term budget deficits for the Americans people. They achieved this by either intentionally disallowing rise the value of the Yuan or purchasing American goods or services using the funds received.
- The unusual fluctuations in oil prices which drastically affected production costs across the board.
- Disjointed opinions from economies worldwide over greenhouse gases and carbon emissions leading to disagreements as to actions to be taken to limit these dangerous gases
- The more often than not biased assessments carried out by central banks who use money policies in illogical and unpredictable ways to influence inflation.
- Loss of personal savings following worldwide plummeting of share prices in the stock markets.
The average business has at one time or another been faced with all sorts of uncertainty especially financial and economical, but these pale in comparison to the momentum that the economic downturn has acquired over time; presenting a bleak future for businesses.
Keynesian economics theories of demand-deficiency offer no credible explanations for our economic downturn and neither can we garner solutions from them. It is not a lack of demand that is strangulating world economies today and as far as coming up with remedial policies is concerned; demand stimulus is not the right response. Spending our way into recovery is a potential catastrophe that will plunge us deeper into the recession; a recession whose depth is anyone’s imagination but one that we are assured will be deep and require heart-wrenching sacrifices to overcome.