Keynesian Economics ~ Capitalism is Crisis-Prone

Ø      Classical Economics: Up to 1930s, the market system was thought to be self-equilibrating. No long-term gluts. All unemployment was voluntary caused by workers resisting wage cuts. Business cycles not studied ~ didn’t have to if system righted itself.

Ø     J.M. Keynes wanted to save capitalism while K. Marx wanted to bury it.

Ø     Keynes rejects Say’s Law that supply creates its own demand ~ a classical economics assumption. All goods produced must find a buyer but Keynes argued that periodically with some regularity they would not; and the system wasn’t self-regulating after some point in a prolonged crisis of under-consumption.

·        Circular flow of goods and money

·        Leakages of savings, taxes, imports

·        Leakages = Injections if system is to equilibrate.

Ø     Classical School believed workers were essentially inert, prodded out of lethargy by being paid to work. Believed aggregate demand always tended toward equality with aggregate supply (workers fighting wage cuts caused recessions and depressions, i.e., blamed workers).

Ø     The Multiplier and liquidity Trap: Keynes argued that any circulation of an extra $1 of new spending would cause multiple increases in spending as it was passed from person to person through further transactions (multiplier). Moreover, it would spiral downward (multiple decreases in spending & income) if spending initially fell by $1. As an economy reached some low level of activity, interest rates would fall so low that everyone would want to hold assets in cash (liquidity trap) and no one would be enticed to borrow and increase spending.

Ø     Identity between total income and total value of goods creates potential for crisis through capitalist pessimism or loss of “animal spirits” and leakages won’t be offset by injections.

Ø     Keynes Solution: Government injection of new spending to offset inadequate spending in private sector and reduction of interest rates to spur borrowing and investing (if not in liquidity trap), -- Laissez-

     Faire was dead from 1940s through to 1980s during the period of  the   

     greatest sustained growth in U.S. economic history.

Ø     Laissez-Faire Backlash: The high rates of inflation and unemployment of 1970s couldn’t be relieved by Keynesian policies. Classical School was back in the saddle.

Ø     Bretton Woods System (1945): Helped underwrite international finance and the reconstruction of economies after WWII began to be used to break down barriers to American Capital interests during the 1970s. Free trade reigns supreme as philosophy of the moment – hence battles over policies of World Bank, IMF and WTO.