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Chp 21 & 22 : The Keynesian School-Development Since Keynes (Keynesian…
Chp 21 & 22 : The Keynesian School-Development Since Keynes
Keynesian School
The school began with the publication of
Keynes's The General Theory of Employment, Interest and Money 193
6
Although Keynes criticized certain aspect of neoclassical economies which he lumped with
Ricardian doctrines
, under headings of 'classical economics'. he used many of its method
It arose out of the neoclassical school and most significant school of economic thought
This approach became increasingly necessary as the public became more eager for the government to deal actively with unemployment
After the world war 1,
rate of population was declining,
most of the world had already been
colonized,
no
room for further geographic expansion
, production outrun consumption as
incomes and savings rose
These policies were presented before the publication of Keynes's The General Theory.
But it was Keynes who provided the
analytical framework that integrated these ideas and touched off the "Keynesian revolution' in economics
Major Tenets of Keynesian Schoo
l
Macroeconomics emphasis
Concerned with the determinants of total or aggregate amount of
consumption,saving, income, output and employment.
Not interested in individual firm decision.
Demand orientation
stressed the importance of
effective demand
as the immediate determinant of
national income, output and employment.
AE = C + I + G + NX
The effective demand establishes the
economy's actual output
, which is less than the
full employment level of output
Instability in the economy
Changes in investment plans cause
national income and output
to change by amounts
greater than the initial changes in investment
Equilibrium level of I and S change due to
changes in national income
Wage and price rigidity
Wages tend to be inflexible bcs of institutional factors such as
union contracts, minimum wage laws and implicit contracts
Active fiscal and monetary policies
To fight recession or depression government should
increase spending or reduce taxes
It should also increase the money supply to
drive down interest rates in the hope that it will increase investment
Government should intervene through appropriate
monetary policy and fiscal policy
Keynesian
John Maynard Keynes
student of marshall and Pigou
at 28, he became editor of
Economic Journal
In 1926, he published a brief book entitled the
End of Laissez-Faire.
He stated that the
evils of the day were the fruits of risk, uncertainty and ignorance
Keynesian system
In The General Theory, he developed the idea of
interrelated elements of the economy ad first is consumption function
Consumption Function
He pointed out the
"fundamental phychosology law"
concerning the relationship between
consumption (C) and income (Y)
People will
increase their consumption as income increase
but not as much as the increase in income
This implies that
savings (S) also rises with income
, and is a
positive function of income
Investment
Keynes defined investment as the
purchase of capital goods
He distinguished the difference between
economic investment and financial investment
Financial investment is not investment in Keynesian sense bcs
it does not directly represent purchases of capital goods
For Keynes, financial instrument simply are
alternative of people savings.
Liquidity Preferences
Transaction motives
- Need for cash to pay for current purchases for consumption and business needs
Precationary motives
- the desire to keep some cash on hand for unforeseen emergencies
Speculative Motives
- desire to hold cash while waiting for interest rates to rise or bond price to fall or price level fall
Policies to promote Full-Employment & Stability
Keynes proposed a
large government role
to stabilized the economy at a full employment level of national income
To increase AE : stimulate private investment during a depression by
forcing down interest rate
through Central Bank policy
When r is low,
people will increase their money holding
cause people to hold idle balance rather than buy bonds. Subsequently r will not fall
Bcs of
liquidity trap
, MP will not be effective as a way to
reduce r and increase I
during severe depression
Paul Anthony Samuelson
The Multiplier- Accelerator Interaction
He published 2 papers where explored the
interaction between the principles of multiplier and accelerator
This interaction become one of the foundations of
modern business cycle theory
He used
difference equation
, demonstrated that
change in consumption will depend on size of marginal propensity
to consume and size of accelerator coefficient.
The Phillips Curve
Samuelson and Robert Solow
,plotted a Phillip scatter diagram for USA,which they mad a rough estimate of US Phillips Curve in 1960
These questions became the focal point of macroeconomic analysis in 1960 and 1970
Other Contributions
Revealed preference theory
Efficient markets theor
y
Comparartive static
Factor price equalization theory
Public expenditure theory
Alvin H. Hansen
He published
Business Cycle Theory
, which gave him the r
eputation as the nation's leading macroeconomic scholar
He pointed out a
mathematical error
in Keynes Treatise on Money. In 1941, he published
Fiscal policy and Business Cycle,
which supported Keynes analysis of macroeconomic problems and
endorsed active government policies to stabilize the economy.
Hick-Hansen synthesis
Hicks pointed out that Keynes's Theory of Interest and theory of equlibrium income was
inconclusive
In trying to solve the problem, he developed a
unified economic model that synthesized a Keynesian and neoclassical perspectives
Hansen elaborated on Hick's article in his Monetary Theory and Fiscal Policy, refer Hick-Hansen synthesis as
IS-LM model
The IS curve
the curve represents
equilibrium point in the goods market
represents all the
combination of interest rates
and
levels of income
at which planned investment equals planned saving
The IS curve is
negatively sloped
The LM curve
shows
potential points of equlibrium in
the money market
It indicates all combination of
interest rates and levels of income
at which
money supplied and demanded are equal
It is trade of between
interest rate and the amount of money
people desire to hold for speculative purposes
The demands for money will depend on
price of bonds
(high interest rate will cause the price of bonds to fall)
The LM curve is thus
positively
The IS- LM Equlibrium
The goods and market and money market are simultaneously in
equlibrium when S=I and L=M
Hansen added goverment spending and taxation to the IS-LM model and use it to
analyze the income effects of FP and MP
Fiscal policy shifts the
IS curve
. Monetary policy shifts the
LM curve.
Stagnation Thesis
Hansen shared Keynes's idea that
investment would be increasingly
inadequate for the economy to reach its full potential
In order for national income and output rise,
new investment spending must grow
. But bcs the
population isn't growing,investment growth was almost not possible at that time
.
But Hansen recognized that government could overcome the problem through
compensatory finance-increasing governement expenditures
could fill the gap between
private sector demand and potential output