Why do Keynesian economists believe market forces do not automatically adjust for unemployment and inflation? What is their solution for stabilizing economic fluctuations? Why do they believe changes in government spending affect the economy differently than changes in income taxes?
Keynesian economics, also called Keynesianism, is an economic theory based on the ideas of an English economist, John Maynard Keynes, as put forward in his book The General Theory of Employment, Interest and Money, [ published in 1936 in response to the Great Depression of the 1930s. Keynesian economics promotes a mixed economy, where both the state and the private sector play an important role.
The rise of Keynesianism marked the end of laissez-faire economics (economic theory based on the belief that markets and the private sector could operate well on their own, without state intervention).
In Keynes's theory, general (macro-level) trends can overwhelm the micro-level behavior of individuals. Instead of the economic process being based on continuous improvements in potential output, as most classical economists had believed from the late 1700s on, Keynes asserted the importance of aggregate demand for goods as the driving factor of the economy, especially in periods of downturn. From this he argued that government policies could be used to promote demand at a macro level, to fight high unemployment and deflation of the sort seen during the 1930s.
A central conclusion of Keynesian economics is that there is no strong automatic tendency for output and employment to move toward full employment levels. This, Keynes thought, conflicts with the tenets of classical economics, and those schools, such as supply-side economics or the Austrian School, which assume a general tendency towards equilibrium in a restrained money creation economy. In neoclassical economics, which combines Keynesian macro concepts with a micro foundation, the conditions of General equilibrium allow for price adjustment to achieve this goal. More broadly, Keynes saw this as a general theory, in which resource utilization could be high or low, whereas previous economics focused on the particular case of full utilization.
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