Keynesian Economics

What Is Keynesian Economics?

Keynesian economics is the tradition founded by John Maynard Keynes, especially in The General Theory of Employment, Interest and Money (1936). Keynes argued that total spending in an economy can fall short of what is needed for full employment, and that such slumps need not correct themselves quickly. Investment depends partly on animal spirits, the spontaneous optimism that drives business beyond cold calculation, and in a deep downturn cutting interest rates can fail as people hoard cash, a liquidity trap. The paradox of thrift shows how everyone trying to save at once can shrink total income. Keynes concluded that governments should support demand through fiscal and monetary policy rather than wait, remarking that in the long run we are all dead.

Why It Matters

Keynesian economics reshaped how governments respond to recessions. In AP Macroeconomics its signature is an aggregate supply curve that is flat or upward-sloping below full employment, so that demand-side policy can raise real output rather than only prices. That logic underlies stimulus packages and countercyclical budgets used around the world. Critics point to the crowding-out effect, in which government borrowing raises interest rates and reduces private investment, offsetting part of the stimulus. Later economists refined the tradition into New Keynesian economics, which supplies microfoundations for sticky prices and wages while incorporating rational expectations. Keynes also led the British delegation at the 1944 Bretton Woods Conference, shaping the postwar monetary order.

Test Your Knowledge

Questions on this topic from the EconRecall fact bank:

• In AP Macroeconomics, how do the classical and Keynesian views of aggregate supply differ?
  Classical theory treats long-run aggregate supply as vertical at full employment, so demand-side policy moves only the price level; Keynesian analysis allows a flat or upward-sloping range below full employment, where demand-side policy raises real output
• In AP Macroeconomics, what is the "crowding-out effect" that critics raise against Keynesian deficit spending?
  Government borrowing raises interest rates, which reduces private investment and offsets part of the fiscal stimulus
• What chiefly distinguishes New Keynesian economics from the original Keynesian tradition?
  It supplies explicit microfoundations for sticky prices and wages, combining broadly Keynesian conclusions with rational expectations and optimizing agents