Evolution of Keynesian Theory in the US Economy
For the purpose of understanding the evolution of Keynesian Theory in the US economy, it is eminent to understand Keynesian economics. Keynesian economics is based on the ideas the English economist John Maynard Keynes.
According to Keynesian economics, private sector decision leads to inefficient macroeconomics and thus argues actively in favor of policy made by the government, specially the actions by the central banks and the fiscal policy measures by the central government.
Keynesian theory was more of a socialist one and fanatically defending the free markets as the same time. Keynesian economics warns against the practice of too much saving, or under-consumption, and not enough consumption or spending. Besides it supports redistribution of wealth, when required. He was of the view that if the poor are given wealth, they are most likely to spend it, rather than save it, which would support economic growth considerably.
Keynesian economics advocates a mixed type of economy, predominantly a private sector economy with significant role of the government and the public sector, which served as an economic model during the later part of Great Depression, World War II and the post-war economic expansion through the 60s and the 70s. Though it lost its significance during stagflation of 1970s, the global economic crisis of 2007 caused revived interest in Keynesian thought.
The New Deal
The New Deal, a program including economic changes in the US in the period 1933 to 1936, were passed by the US Congress and were an answer to Great Depression which had hit the world in 1929. The New Deal was focused on ‘3 Rs’.
Relief meant for unemployed and the poor
Recovery for the economy from disastrous to normal level and,
Reform of financial system to prevent Depression from repeating itself.
The New Deal is historically divided into two parts-the First New Deal, (1933) which dealt with diverse groups, from banking and railroads to industry and farming, and the Second New Deal, (1934-36) which included the Wagner Act to promote labor unions, the Works Progress Administration Act relief program, and Social Security Act and the other acts and reforms to aid tenant farmers and workers. Later major inclusion of the New Deal legislations included creating the US Housing Authority and the Farm Security Administration, both of which were implemented in 1937, the Fair Labor standards Act in 1938 and the Agricultural Adjustment Act of 1938.
Its Political Implications
The New Deal made the Democratic Party, the majority party in the US, which was based on ideas of liberal thinking and had its base with newly empowered people like workers. The republicans got divided over this, some completely opposing the deal as against business growth, and others accepting a part of it while striving to make it better. This realignment came up as the ‘New Deal Coalition which dominated American politics till the 60s.
Keynes however opposed some aspects New Deal, which he considered to be more affected by psychological process, which is difficult to rely upon.
After Great Depression
Towards the ‘Great Society’- 1960s
Great Society was a set of domestic programs in the US promoted by President Johnson and fellow democrats in the 1960s, under which the two main goals were the elimination of poverty and racial justice. The major spending programs were undertaken for education, medical care, urban problems, and transportation sector. Although the ‘Great Society’ resembled the ‘New Deal’, it was different in terms of the programs enacted.
Political Scenario and ‘Great Society’
The landslide victory of the Democrats in 1964 elections brought many new liberals to congress, making the House of Representatives the most liberal house since 1938. Anti-war members complained that spending much on the Vietnam War choked the Great Society, due to which some programs were eliminated while many of them continue to the present. Great Society’s programs expanded under the administration of Nixon and Ford.
Stagflation, 1970s and Nixon imposing the wages and price restrictions in 1971 and 1972, cancelling Bretton Woods, barring of US dollar into gold directly, and also the oil crisis of 1973,due to which recession came-up, began a criticism of the Keynesian economic theory and thought government intervention not effective enough. The Federal Reserve of US, under the guidance of Volcker adopted stringent money supply policies an effort to bring inflation under control.
In the early 1980s the monetary experiments in the US were taken at peak of non-Keynesian thought. The test of monetarism helped formulate the opinion of fiscal policy being in-effective and that the monetary policy is supposed to be looking at only the supply of money and not the real interest rates.
Across 1999 to 2007
The bush administration brought back Keynesian economics, although in a moderate sense, by taking the following measures:
Lowering interest rates artificially to reduce unemployment and decrease the effect of inflation
Tax reductions that were imposed to increase consumer spending
Fiscal intervention and stimulus injections including bail-out reforms
US administration continued ignoring Keynesian thought of avoiding huge imbalances of trade. Till 2000s, influence of the free markets continued in institutions like World Bank, IMF, and also in the opinion-forming circles. They were of the view that imbalance in current account does not matter when situation of increasing US deficit exists. Another important anti Keynesian thought that sustainably dominated the US action was that the markets would work best when not regulated.
The revival of Keynesian economics-2008-09
During 2007, up to 2010, the ‘free market’ thought began to taken negatively even by leading opinion-makers, who were opposed to revision and reassessment of the normative opinion being taken, the fiscal stimulus being the most attention gaining part. As against the economic orthodox scenario, the IMF had found effectiveness and supported a thought for a fiscal stimulus required by the entire world in January 2008.
Keynesian perspective grew in areas including:
Imbalances in world trade, which Keynes opposed to. US discussed, in 2010, a possibility of limiting current account imbalances to the ones which Keynes proposed.
Keynes also favored capital controls-restriction of short-term capital movement which, once again became to be an accepted as government macroeconomic policy in 2010.
Keynes was also opposed to over-use of statistical theories and models to deal with economic processes and difficulties. In practicality, it was actually the complexity of products and processes that lead to contributing to the 2008-09 crises.
Obama towards Keynesian economics:
In 2009, Obama introduced a plan to undertake domestic consumption to combat recession, further reflecting Keynesian thought. Questions were asked and an extensive debate took place concerning the necessity, adequacy, and the likely effects of the package. Thus by the time was passed by the Senate, the amount had reduced to $787 billion from $819 billion.
Also in 2010, the Volcker rule, endorsed by Obama looks at restricting banks from making speculative investments that do not benefit customers, since it was speculation which played a critical role in the financial crisis of 2007-10. Plans for further stimulus were announced by President Obama in September 2010.
Although Keynesian theory was supposed to be flawed, economists and politicians all over the world used tools therein during economic downturns. ‘Deficit spending’ is considered as the cornerstone of economics as far as theory of recovery is concerned, which has been utilized time and again to pull out economies from recession and depression in the US.
Multiplier Effect is another central thought of Keynesian economics, and implies that the spending which the government undertakes creates positive effect on the economy and consumer spending, which in-turn increases employment. For example, by paying for the fiber-optic installation, a large number of tech jobs can be created to bring full value of broadband to America, its business and residential areas.
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Reddy S. “The New Old Big Thing in Economics: J.M. Keynes”. 8 Jan 2009, Web. http://online.wsj.com/article/SB123137373330762769.html
Obama signs $787bn stimulus plan, 17 Feb 2009, Web. http://news.bbc.co.uk/1/hi/business/7895078.stm
Obama seeks GOP help for recovery bill, 29 Feb 2009, Web. http://www.msnbc.msn.com/id/28891939
Recession Loosens Grip But Weak Recovery Ahead, 28 July 2009, Web. http://www.imf.org/external/pubs/ft/survey/so/2009/RES070809A.htm