KEYNESIAN

ECONOMICS
THEORY
HOW IT WORKS WITH
EXAMPLES
 INTRODUC
TION

KEYNESIAN ECONOMICS is a theory that says the

government should increase demand to boost growth.
Keynesians believe consumer demand is the primary
driving force in an economy. As a result, the theory
supports expansionary fiscal policy. Its main tools
are government spending on infrastructure,
unemployment benefits, and education. A drawback is
that overdoing Keynesian policies increases inflation.
The British economist John Maynard
Keynes developed this theory in the 1930s.
The Great Depression had defied all prior
attempts to end it. President Franklin D.
Roosevelt used Keynesian economics to build
his famous New Deal program. In his first 100
days in office, FDR increased the debt by $3
billion to create 15 new agencies and laws.
For example, the Works Progress
Administration put 8.5 million people to work. Keynes described his premise
The Civil Works Administration created 4 in “The General Theory of
million new construction jobs. Employment, Interest, and
Money.” Published in February 1936,
it was revolutionary. First, it argued that
government spending was a critical
factor driving aggregate demand. That
meant an increase in spending would
increase demand. 
Second, Keynes argued that government spending
was necessary to maintain full employment.

Keynes advocated deficit spending during
the contractionary phase of the business cycle. But
in recent years, politicians have used it even during
the expansionary phase. President Bush's deficit
spending in 2006 and 2007 increased the debt. It
also helped create a boom that led to the 2007
financial crisis. President Trump is increasing the
debt during stable economic growth. That will also
lead to a boom-and-bust cycle.
 KEYNESIAN VERSUS CLASSICAL ECONOMIC THEORIES

Classical economic theory promotes laissez-faire

policy. It says the free market allows the laws
of supply and demand to self-regulate the business
cycle. It argues that unfettered capitalism will create a
productive market on its own.

It will enable private entities to own the factors of

production. These four factors
are entrepreneurship, capital goods, natural
resources, and labor. In this theory, business owners
use the most efficient practices to maximize profit.

Classical economic theory advocates for a limited

government.
Keynesian Economics
•Government spending on infrastructure, unemployment benefits, and education will
increase consumer demand.
•Government spending is necessary to maintain full employment.

Classical Economics
•Increasing business growth will boost the economy.
•Government should play a limited role and target companies, not consumers.
It should have a balanced budget and incur little
debt. Government spending is dangerous because
it crowds out private investment. But that only
happens when the economy is not in a recession.
In that case, government borrowing will compete
with corporate bonds. The result is higher interest
rates, which make borrowing more expensive. If
deficit spending only occurs during a recession, it
will not raise interest rates. For that reason, it also
won't crowd out private investment.
 CRITICISM

Supply-side economists say that increasing

business growth, not consumer demand, will
boost the economy. They agree the
government has a role to play, but fiscal policy
should target companies. They rely on tax cuts
and deregulation.

Proponents of trickle-down economics say

that all fiscal policy should benefit the wealthy.
Since the wealthy are business owners,
benefits to them will trickle down to everyone. 

Monetarists claim that monetary policy is the

real driver of the business cycle.
Monetarists like Milton Friedman blame the
Depression on high-interest rates. They believe
expansion of the money supply will end recessions
and boost growth.

Socialists criticize Keynesianism because it

doesn't go far enough. They believe the
government should take a more active role to
protect the common welfare. This means owning
some factors of production. Most socialist
governments own the nation's energy, health care,
and education services. 

Even more critical are communists. They believe

the people, as represented by the government,
should own everything. The government
completely controls the economy.
 KEYNESIAN MULTIPLIER

The Keynesian multiplier represents how much

demand each dollar of government spending
generates. For example, a multiplier of two creates
$2 of gross domestic product for every $1 of
spending. Most economists agree that the
Keynesian multiplier is one. Every $1 the
government spends adds $1 to economic growth.
Since government spending is a component of
GDP, it has to have at least this much impact.

Important:
The Keynesian multiplier also applies to
decreases in spending.
The International Monetary Fund estimated that
a cut in government spending during a
contraction has a multiplier of 1.5 or more.
Governments who insist on austerity measures
 NEW KEYNESIAN THEORY

In the 1970s, rational expectations theorists

argued against the Keynesian theory. They said
that taxpayers would anticipate the debt caused
by deficit spending. Consumers would save today
to pay off the future debt. Deficit spending would
spur savings, not increase demand or economic
growth. 

The rational expectations theory inspired the New

Keynesians. They said that monetary policy is
more potent than fiscal policy. If done right,
expansionary monetary policy would negate the
need for deficit spending. Central banks don't need
politicians’ help to manage the economy. They
would merely adjust the money supply.
 EXAMPLES

1 President Ronald Reagan promised to reduce government

spending and taxes. He called these
traditional Republican policies, Reaganomics. But instead of
cutting spending, Reagan increased the budget 2.5 percent each
year. He increased defense spending from $444 billion to $580
billion by the end of his first term. He also cut income taxes and
the corporate tax rate. Instead of reducing the debt, Reagan
more than doubled it. But that helped end the 1981 recession.

2 President Roosevelt ended the Great

Depression by spending on job creation
programs. He created Social Security,
the U.S. minimum wage, and child labor
laws. The Federal Deposit Insurance
Corporation prevents bank runs by insuring
deposits. 
3 Bill Clinton's expansionary economic policies
fostered a decade of prosperity. He created more
jobs than any other president. Home ownership
was 67.7 percent, the highest rate ever recorded.
The poverty rate dropped to 11.8 percent.

4 Barack Obama's policies ended the Great

Recession with the Economic Stimulus Act. This act
spent $224 billion in extended unemployment
benefits, education, and health care. It created
jobs by allocating $275 billion in federal contracts,
grants, and loans. It cut taxes by $288
billion. Obamacare slowed the growth of health
care costs. 
THANK
YOU!