When Does Keynesian Economics Work?

Readers Question: I have a hunch that Keynesian responses to recession work best in industrial countries such as China and 1930’s USA as opposed to post industrial societies such as the US and UK. In the great depression consumption and production were, generally, in the same countries, e.g. cars produced in America would be consumed (bought) in America. Would it then follow that the positive multiplier effect caused by stimuli money would be greater in an industrial nation than a post industrial country?

No, I don’t think it makes much difference. Keynes was concerned with boosting aggregate demand (AD) during a period of falling private sector spending / investment.

Even in a ‘post-industrial’ country like UK, there can be slumps in AD. In this case, AD could be increased through spending on a variety of projects from building new hospitals to improving roads and rail links. There is no reason why the basics of Keynesian economics can’t work in an economy which is dominated by the service sector.

When Keynes was trying to make his point, he suggested the government pay workers to dig a hole in the ground and then fill it in again; the point he was trying to make is that it doesn’t really matter what you spent the money as long as you spent it.

Another tale is that Keynes deliberately knocked his napkin on the floor in a restaurant. His reason was that he wanted to make sure the waiter was ‘fully employed’

One possible feature of the 1930s, is that some regions were heavily specialised in certain industries. When these industries closed down, there was a very strong negative regional multiplier effect (e.g. depression worse in South Wales and North East England)

But, the basic principles of Keynesian economics apply in post-industrial nations like the US and UK. (BTW, the UK may be classed as a ‘post-industrial’ nation, but it still has some industry and manufacturing.

Liquidity Trap

Keynesian intervention works best in a liquidity trap. A period where there is a rise in private sector saving. This paradox of thrift leads to a rise in private sector saving and fall in private sector spending. Without government intervention, this fall in AD leads to negative growth and high unemployment.

Because there are spare resources in the economy, Keynes said the government could effectively borrow from the private sector and inject this money into the economy.

 

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