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Course: Macroeconomics > Unit 7
Lesson 4: Keynesian economics and its critiques- Keynesian economics
- Risks of Keynesian thinking
- Macroeconomic perspectives on demand and supply
- Keynes’ Law and Say’s Law in the AD/AS model
- Aggregate demand in Keynesian analysis
- The building blocks of Keynesian analysis
- The Phillips curve in the Keynesian perspective
- The Keynesian perspective on market forces
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Risks of Keynesian thinking
Why Keynesian thinking might not be ideal sometimes. Created by Sal Khan.
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- Could Keynesian economics be used in any situation other than a time where the economy was not functioning at a full level?(12 votes)
- Sure. We do it all the time -- especially on defense, right now. The problem is that a lot of constituents rely on defense spending. Munitions plants employ people. And the CEO's, boards and shareholders of military contractors love the money. So the government blindly transfers money to the "next big thing." Which keeps prices artificially high. Wins them donations from the military contractors. And support from the communities.
The net effect though has driven us into an economy where we spend an insane amount (considering that we have had no credible military threat since the USSR collapsed) amount on defense. To put this in perspective, the US spends about half of the entire world's purchases of military goods.
Another place we do this is food subsidies. Which transfers perks to our agribusiness & food processors. Who create unhealthy food that is devoid of nutrients, but is tasty as all get out (you should see me with a bag of chips -- they don;t stand a chance).(28 votes)
- You never explain where the government gets the money to do the "stimulus", it either have to:
1: tax the money, depriving the population of the money, thus no net increased spending.
2: borrow the money, depriving firms of valuable capital aswell as driving up the rate of interest ifn't 3: is done.
3: print the money, buy up gov debt to lower interest rates, this causes inflation.(10 votes)- The government may either extra funding from other states, For example for developing countries this could be in the form of international development aid or very low interest rates loans from other countries or from the international financial institutions such as the World Bank or the IMF.
For developed countries, they can do it buy selling more government bonds which are popular for international investor (China has a lot of these of the US)
I hope this helps.(6 votes)
- This is my first foray into the world of economics so this may be an oversimplification. What is the main philosophy in opposition of Keynesian thinking? Would it be Laissez-Faire?(5 votes)
- It's more formally called "classical economic theory", but essentially you're correct. Laissez-faire philosophy (literally translated from the French as "all of you, leave it [alone] to produce") believes that the economy is naturally self-correcting and operates most efficiently when there are no (or very few) external regulations or restrictions upon it. This line of thinking dominated U.S. economic philosophy through the 1920s, although in truth the federal and state governments always played a significant role in the performance of the economy through things like protective tariffs, subsidies for railroad construction, and manipulation of the money supply.
The Great Depression of the 1930s, however, exhibited such a breakdown of the national economy that it appeared its self-correcting mechanisms would not kick in. Hence, FDR, Congress, and state governments alike adopted (though not necessarily consciously so) the essential aspect of John Maynard Keynes' expansionary fiscal policy: stimulate the economy back to full employment through government spending and tax policies to increase aggregate demand, accepting higher inflation as a necessary side-effect. (Since prices were so low at the time, this was not necessarily seen as a problem.) Most other Western governments did the same thing at the time, and thus Keynesianism became the dominant economic theory among the political class down to the present day. Classical economic theory has tended to make something of a comeback in recent years, however, owing to dissatisfaction over what is perceived to be an excessive degree of governmental interference in the economy that inhibits economic growth and efficiency.(12 votes)
- Regarding the circle idea you brought up in the first three minutes, why wouldn't producers, when faced with a reduction in demand for their product, lower prices in the marketplace to stimulate demand back to previous levels?(4 votes)
- The people selling at a 50% discount are now bringing in 50% as much revenue, and can only spend 50% as much. So if everyone lowers their prices it would increase demand, but that revenue is someone's wage as well. Bringing in 50% of the revenue means that wages are going to have to fall. People are highly adverse to having their wage lowered, plus prices tend to be sticky in the short run, plus deflation increases the real amount of debt - all of which make models of returning to potential GDP via deflation rather unreasonable imo.(5 votes)
- Why does the US get a "free pass?"(4 votes)
- They are the reserve currency of the world. It basically means the USD is the default currency, therefore, a lot of people (and governments) have US currency. If many people (and governments) have American currency, this will allow them to more easily buy American goods and invest in American business.(6 votes)
- Were Eisenhower policies responsible for the "golden age" of the American economy or was it the fact that we had a monopoly on manufacturing because the rest of the world was devastated by WWII? What does the domestic consumption and export data show?(4 votes)
- At5:30, Sal explains that sometimes taxes decrease and government spending increases. Is this what is referred to when people discuss 'Bush's tax cuts', in unison with the increased wartime spending? Did GWB's actions cause an increase in price?
Just trying to apply this to reality, thanks in advance!(4 votes)- War spending is a bit unusual, because you're literally paying to buy things and then soon after blowing them up. You're destroying wealth on a vast scale with each explosion of a bomb. As such, war spending is particularly destructive to the economy. In that sense, war spending is the epitome of a Keynesian stimulus - it boosts aggregate demand, while benefiting no one's standard of living.
You would expect, however, an increase in the price of commodities/labor directly related to the production of those military purchases.(1 vote)
- If the gov't can influence consumer spending or saving by changing rates, why can't that be utilized to try to avoid the consumption/investment (rabbit/trap-inventing) issue mentioned at the end? Consumption gets too high from Keynesian policies? Up the rates so people save and invest more. No good?(4 votes)
- They can influence consumer spending and saving, but they do not actually control it. If I save money from taxes or receive a bonus at work, I still choose what to do with the money I made or saved. I choose whether to spend or save it.(2 votes)
- 'Stuart' in one of the answers to 'mullachv' said that 'by creating an institution like the Fed, fiscal policy would be dictated by non-elected officials who are not accountable to the people'. but today, it seems that one of the problems of the government is that they are too restricted by politics to make changes that are really needed. for instance, in promising not to raise taxes (to garner more votes) the government has restricted itself to very few solutions to the economic problem today, resorting to increasing its debt to keep spending up. isn't this rather detrimental to the economy?(3 votes)
- Wouldn't the fact that the governments step in to attempt to fix the problems make the economy dependent on that kind of save? Is that why we have the "Too big to fail" issues with companies now? The economy is quite complex, and I'm trying to get a better understanding of it.(1 vote)
- Yes, and yes. If we need the government's help to keep the economy running, we have an economy dependent on the government. Whether we do or not is a question that's open for debate, but people will come to expect (and depend on) government intervention when the government consistently intervenes.(2 votes)
Video transcript
Voiceover: In the last video
we had a little bit of review of classical economics
and then we talked about how Keynesian thinking was a departure, especially, and why it
might have made sense in the context of the Great Depression, where the economy was operating well below its potential. What I want to do - It may be true anytime that
the economy is operating well below its potential. What I want to talk about in this video is how Keynesian thinking
can sometimes be dangerous. One thing I do want to
emphasize over the course of this video is Keynesian
policies are often associated with people on the left,
with policies on the left, democrats in the United States. The republicans also, for the most part, especially mainstream republicans, especially the last
several administrations, they have practiced what
can only be described as Keynesian policies. When the economy started
to recede, they tried to stimulate it by shifting
aggregate demand to the right somehow and we'll talk about
that they tried to do it in a slightly different
way, through tax cuts, instead of government spending increases, but it was Keynesian in
its underlying thinking. Now just as a bit of a
backup, I'm going to talk a little bit more about that
cycle that we talked about in the last video. If you have person A, person
B, person C, and person D or maybe their firms. B supplies A, A supplies D, D supplies C, and C supplies B, and for
the sake of simplicity, we said that they're all
supplying 2 units of their good and service to each other. Let's just say that C has a
bad dream, feels pessimistic, ate something bad and all of
a sudden isn't feeling good about the future and wants to buy less, just out of caution. Maybe he wants to hoard a bit of cash, just in case C needs it. He buys a little bit
less from D, but D says, "Gee, my business is
bad, now I can't afford "as many goods and
services," buys less from A, A does the same thing from
B, and then B's business is bad, so buys less stuff
from C, goods and services from C, and now C feels
like they're psychic, even though we see that it was actually a self-fulfilling prophecy,
that C's pessimism actually led to that reality actually occurring. In a worst case, it actually
could get worse and worse. C could say, "Wow, I was
pessimistic and I was right. "My business actually did get bad." Maybe it even got worse
than C had expected and then C could then say,
"I'm going to buy even less. "Maybe I'm only going to
buy a half from D now," and then D says, "Maybe I'm
only going to buy a half "from A," and that cycle
could go down and down and down until each of them
are just buying exactly just what they need to get
by, even though they all could be producing more,
the economy could be producing more and could
be wealthier and they all could be way better off. This is, at least in my mind,
a pretty good description of what happens in a depression, especially the Great Depression. So there might be a
rationale to say, "Hey, look, "why doesn't the government
come here at some point "in this economy and stimulate demand?" Why doesn't the government come here? Let's say B is already buying 1 from C, the government comes and
says, "Hey, I'll buy another 1 "from C," and then C says,
"Hey, things are good again. I can buy 2 from D," D can buy 2 from A, and then A can buy 2 from
B and then B can buy 2 from C and so things have gotten back to their potential state. The economy is revving. In an ideal state, the
government would say, "Hey, my work is done now. "I can now take a step
back and I don't want "to overheat the economy. "I don't want to push
aggregate demand too far "to the right and cause
inflation," so they will take a step back. The danger here is that
this is not so easy for governments to do. This was some type of stimulus, some type of government spending. Although maybe it was a tax decrease, so maybe B could've
increased their demand, but either way, once you
do a policy like this, and let's say it was government spending, it's very hard to unwind. This government spending might have been for a project that some people like, it might have employed many, many people. Those people are voters. They're not just going to
sit there while you cancel this government project. There's a risk that maybe
there is a justification for a Keynesian policy,
but when it's time to undo that Keynesian policy,
to undo that stimulus, it's very hard to do it. It's kind of a sticky policy. What you might have is when times are bad, you do Keynesian stimuli,
but when times are good, you're not willing to undo it
and if that Keynsian stimuli involves more and more deficit spending or more and more government spending, then the government size
is just going to grow relative to the economy, or
the deficit is just going to grow relative to the
economy and you're never going to unwind it, because
unwinding is unpopular. I want to be clear that this
is true of both the left and the right. In the stereotypical
sense, the left might say, "Hey, let's do a Keynesian
stimulus by spending more," so the government spends
more and let's hold our revenue constant, our tax revenue, let's hold it constant. Obviously, the government
would have to borrow more money to fund this, or
sometimes they might even increase taxes if they actually
wanted to be more purist about it, but this is
the variety that you see and this would be a true stimulus. This is using the fiscal
lever to put more demand in the economy, but in
the right you often see the other side. You see taxes being
lowered, essentially saying instead of the government spending it, why don't we let people
decide where to spend it and they might spend it
in a more efficient way, but it's going to be a
stimulus, because spending is held constant. Then you have the double
where you do both sides of it, where you lower the taxes, you lower the inbound revenue, and you increase spending. This is true, this has been
done by both republican and democratic administrations. Lowering taxes, but
then going and starting a hugely expensive war and obviously this would increase deficits. There might even be a
justification for doing any of these, a Keynesian
justification if the economy truly is operating well below its potential. The tough thing is it might be justified, you actually don't know
exactly where that potential is and you might not be able
to unwind this once you get to your potential and
then you might overheat the economy, might lead to inflation, and that actually might
undermine the productivity of the actual economy. The other negative of a Keynesian mindset is what happens over the long run. In the short run this
might make a lot of sense. Let's prime the pump, let's
get the cycle to happen in the right away again,
but in the long run, it's essentially just trying
to get people to consume and consume more. You'll often hear, when
the economy slows down a little bit, you'll hear the president, you'll hear politicians
say, "Hey, we're just trying "to get people to spend more "through some combination
of these Keynesian policies. "We're going to lower taxes,
we're going to increase "spending,"but you'll never hear them say, "Hey, we want people to save more, "so that we can invest more, "so that in the classical
sense we can increase "our total productive capacity." The US has gotten a free pass on this, because the US has been
doing, essentially, the deficit spending has been able to do the Keynesian stimuli and
that's why the US consumer keeps spending more and
more, saving less and less. The government is doing the same thing, but the US has also
been getting investment because it's the foreigners
who've been saving and then plowing that
money and they've been, essentially, investing
in the US, so that the US could increase its productive
capacity, but that is a risk for a country if it's not
blessed with that free pass that the US has gotten for
the last several decades is that when you have some resources, so in a given year, you
have some resources. Let's say it's your time. You could either hunt and eat rabbits or you could spend your time to invent new rabbit trapping devices. This is the hunting and eating the rabbits and this is spending some time to go and figure out ways to be more productive at hunting rabbits,
building some bow and arrows or something like this. You always have a tradeoff
between consumption and investment. Keynesian policies,
they're all about, hey, let's get consumption as high as possible and that might be a good
idea in the short run, especially if we are operating
well below our potential, well below our full capacity utilization, but it could be a risk in the
long run, if you don't get the free pass, because you
might have underinvestment and in the classical sense,
you're never able to move your potential to the right.