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March 16, 2009
Don’t Fall for Pundits’ Prattle that We’re All Keynesian Economists Now
By Wade Rousse
Before they learned the lessons of the Great Depression, Classical economists thought wages and interest rates would adjust on their own during economic downturns and guide the economy back to full employment in a relatively short amount of time. However, the 1930s undermined this line of thought, as the decade was characterized by very high unemployment rates.
Therefore, in an effort to explain the prolonged length of the Depression, English economist John Maynard Keynes developed a new theory. His key point was that businesses would produce the amount of goods and services they believed consumers, investors, governments, and foreigners would buy. But if this productivity level were below the economy’s capacity, a prolonged recession could follow. No natural economic forces would automatically guide the economy back to full employment. Hence, the theory goes, it’s the responsibility of the government to increase spending and return the economy to its potential growth rate.
But the popularity of this theory has diminished over time. First, it doesn’t explain the stagflation era of the 70s. Second, economies around the globe have been relatively stable in recent decades. In addition, many economists now believe that bad monetary policy contributed to the depth and duration of the Great Depression, when the money supply was allowed to shrink substantially. This is not the case in the current recession.
So it’s important to realize that modern macroeconomics continues to evolve. It is a combination of Keynesian views in the short run and Classical ones in the long run. Let’s not get carried away with the pundits who declare, “We are all Keynesians now.” Macroeconomics has moved beyond that.
Posted by Wade at March 16, 2009 10:16 PM
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