Question

1) What is the Keynesian school of thought relating to business cycles?

2) What are the strengths of the Keynesian school of thought?

3) What are the weaknesses of the Keynesian school of thought?

4) How has the Keynesian school of thought impacted economics/public policy over the last 80+ years?

Answer 1

1)

Keynes relate to the business cycles through the change in the investment rate. The investment rate in turn changes due to the variations in the Margninal Efficiency of Capital (known as expected profit from the investment).

An expansionary phase in the business cycle is caused by the positive expectations of the entrepreneurs toward investment return. In such expectations, investors invest huge amount of money. The increase in the income due to this is much higher than the original increase in the investment money due to multiplier effect. So, due to these fluctuations or business cycles, keynes school of thought believed that economy can reach to a short run equilibrium which is left to the full employment output.

2)

Strenghts of Keynesian School of Thought:

- High Income and Employment: Keynes believed that the only way to fight recession is to increase government spending. Higher government spending raises the aggregate demand and improves the income and employment status of the general public,

- Control on the spending made by the Government

- Provides mechanistic approach to economic crisis such as recessionary period

3)

Weaknesses of Keynesian Schoold of Thought:

- Crowding Out: An increased government spending crowds out some part of the investment from the market which was essential for the business to grow.

- Government borrowings to increase the spending and pay its debt will put an upward pressure on the interest rates. This will make the borrowing by the general public more expensive. Also higher interest rates will discourage the investment

- Keynesian Net Fiscal Policy effect might be smaller than what was intended initially.

- Keynesianism ignores the monetary and financial sector from its mechanistic approach

4)

Over the last 80+ years, the Keynesian ideas help the governments to rescue from the recesssionary periods. The theory tells the government that the economy will be in an underemployment equilibrium if it spends more and put money in the pockets of public. Keynes theory helped the nations in 1930 depression and 2008 financial crisis. The ideas of Paradox of Thrift and Liquidity Trap indeed help the governments to understand their economy better