Learn something new every day More Info... by email
Keynesian economics is an economic policy popular in many countries since World War II, with economists who practice this theory making a distinct difference between private and public-sector macroeconomics. The biggest push behind Keynesian theory is the ability for the public sector — namely, the federal government — to jump-start an economy. In theory, monetary and fiscal policy in Keynesian macroeconomics stabilize the business cycle and prevent economic downturns or troughs. Through increased government spending, the theory states that any inefficiency in standard economic theory will go away as government picks up the slack. In short, Keynesian economists believe in a more mixed economy than a completely free market enterprise.
Wages and spending are two of the most important concepts in Keynesian macroeconomics. Keynes believed in nominal wages being set between an employer and an employee, such as a barter relationship. This relationship would be difficult to break as there would be no government intervention in the economy for wages, save minimum wage laws. To boost employment, real wages — nominal wages adjusted for price changes over a time period — would need to go down. As a result, sales revenue would go down as consumer demand fell, creating equilibrium in the supply and demand curves.
Spending — or, rather, the lack of it — could be another problem in the market. When individuals would not spend all their income, they may place it in a bank account as savings. Investment in long-term projects would fall due to this money not being in the general use of the overall market. Therefore, Keynesian macroeconomics desired changes to employee wages as described above, where the money received from employment would meet with a consumer's need for spending. The argument for excessive saving, as Keynes called it, would affect interest rates in the business environment; he therefore described complex models to outline policies for these effects.
From these two previous theories sprang the belief in government intervention into a market. When consumer spending or wages fell too low, a lack of buying power would cause ill effects in an economy, such as the Great Depression. Keynesian macroeconomics then placed the ability to rectify this problem on the government. A government could increase spending and soak up the entire excess product in a market. This covers the inefficiency of oversupplied markets and lack of consumer demand.
A problem with Keynesian macroeconomics is that prices and wages do not flex as much as first thought. Government intervention — through monetary or fiscal policy — may not help immediately. Therefore, the prolonged effects of these policy changes may make things worse or not help at all, depending on current economic conditions.