Contents

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• 1Historical context

• 2Theory

  • 2.1Concept

    • 2.1.1Wages and spending

    • 2.1.2Excessive saving

    • 2.1.3Active fiscal policy

    • 2.1.4"Multiplier effect" and interest rates

    • 2.1.5IS–LM model

• 3History

  • 3.1Precursors

    • 3.1.1Schools

    • 3.1.2Concepts

  • 3.2Keynes and the classics

  • 3.3Postwar Keynesianism

• 4Other schools of economics

  • 4.1Stockholm School

  • 4.2Monetarism

  • 4.3Public choice theory

  • 4.4New Classical

• 5See also

• 6References

• 7Further reading

• 8External links

Historical context[edit]

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Prior to the publication of Keynes's General Theory, mainstream economic thought held that a state of general equilibrium existed in the economy: because the needs of consumers are always greater than the capacity of the producers to satisfy those needs, everything that is produced will eventually be consumed once the appropriate price is found for it. This perception is reflected in Say's law^[6] and in the writing of David Ricardo,^[7] which state that individuals produce so that they can either consume what they have manufactured or sell their output so that they can buy someone else's output. This argument rests upon the assumption that if a surplus of goods or services exists, they would naturally drop in price to the point where they would be consumed.

Keynes's theory overturned the mainstream thought of the time and brought about a greater awareness of structural inadequacies: problems such as unemployment, for example, are not viewed as a result of moral deficiencies like laziness, but rather result from imbalances in demand and whether the economy was expanding or contracting. Keynes argued that because there was no guarantee that the goods that individuals produce would be met with demand, unemployment was a natural consequence especially in the instance of an economy undergoing contraction.

He saw the economy as unable to maintain itself at full employment and believed that it was necessary for the government to step in and put under-utilized savings to work through government spending. Thus, according to Keynesian theory, some individually rational microeconomic-level actions such as not investing savings in the goods and services produced by the economy, if taken collectively by a large proportion of individuals and firms, can lead to outcomes wherein the economy operates below its potential output and growth rate.

Prior to Keynes, a situation in which aggregate demand for goods and services did not meet supply was referred to by classical economists as a general glut, although there was disagreement among them as to whether a general glut was possible. Keynes argued that when a glut occurred, it was the over-reaction of producers and the laying off of workers that led to a fall in demand and perpetuated the problem. Keynesians therefore advocate an active stabilization policy to reduce the amplitude of the business cycle, which they rank among the most serious of economic problems. According to the theory, government spending can be used to increase aggregate demand, thus increasing economic activity, reducing unemployment and deflation.