British economist John Maynard Keynes (1883 to 1946) gave his name to his theory of the need for government intervention in a mixed economy, which was influential in the United States in the 1930s when President Franklin D. Roosevelt applied his New Deal policy as a response to the financial collapse of the Great Depression. Keynesian theory became reconsidered and re-examined by politicians in many nations following the 2007 economic meltdown.
Keynesian economics sees national governments as having a stabilizing role in the economy, complementing the private sector’s freedom to conduct business. According to Keynesian economics, a government needs to intervene to boost overall economic growth, especially at a time of downturn, using government spending on capital projects and by offering tax breaks. The prevailing economic theory and practice before Keynes was “laissez-faire,” where the state had little or no role in matters of the economy beyond the raising of taxes for the defense of the nation, in the belief that an economy will operate most effectively if the government does not intervene.
In his work The General Theory of Employment, Interest, and Money, published in 1936, Keynes said government intervention in the economy was important especially in case of chronic unemployment. According to him, an increase in spending on public works by the government could help prevent or alleviate economic depression. He stated that such projects would create more jobs and as a result, national purchasing power would rise. In turn, consumer spending and investment in business would also rise and there will be more jobs beyond the public-work projects.
Keynes was a Cambridge University mathematics graduate who was drawn in to economics work with the British government just before the beginning of World War I in 1914. In 1919, Keynes attended the Versailles peace conference outside Paris as a member of the British delegation, and warned strongly against the imposition of heavy, punitive reparations on the defeated nations, in particular Germany. In later years, historians and economists would look to the burden of reparations on Germany as influential in the collapse of that country’s economy in the 1920s and the subsequent rise of Nazism.
Keynesian economics emphasizes the role of demand in an economy. According to Keynes, the main cause of unemployment is low consumer demand for goods and services. Excessive consumer demand for products and services creates inflation. Therefore, the government is responsible for managing the total demand for goods and services, known as aggregate demand, by adjusting its spending and taxes.
Keynes was largely responsible for the development of macroeconomics, which examines large-scale economies from the top down. In Keynesian theory, the micro-level decisions and the behaviors of individuals can be outweighed by macro-level trends and for this reason the government should intervene to affect these large-scale factors. The other main branch of economics, the bottom-up approach called microeconomics, studies how individual decisions affect the overall supply and demand for goods and services, which determine prices.
Alternative approaches to macroeconomics started emerging as inflationary pressures, such as the global oil crisis of the early 1970s, were on the rise after a sustained post-war reconstruction period of steady growth and low unemployment in most western economies. One of the alternative theories to Keynes was developed by in the late 1960s by Milton Friedman (1912 to 2006) and others was called monetarism. The monetarists believed that inflation can be controlled by reducing and restricting the amount of money in circulation in the economy.
Through the 1980s and 1990s, Keynesian economics lost some popularity among government finance departments, because it was seen as a short-term fix to economic problems, but not as a long-term solution. Keynes acknowledged that his work owed much to several predecessors and there have been suggestions that major elements of his theory were anticipated by others, most notably by the Polish-born economist Michael Kalecki (1899 to 1970).