So we talked about Classical Economics, which was all well and good until The Great Depression came along and as it turns out, people really weren’t keen on the idea of sucking it up, waiting it out and working for a penny in the mean time.
In response to this JMK (that would be John Maynard Keynes) reasoned that:
- Prices were not perfectly flexible – especially on the down side of things.
Based on this, he decided that Government should intervene by either spending more money or cutting taxes so that consumers could spend more money and it would speed up the process of arriving back at full employment GDP and cut out a lot of the pain in the middle.
It’s not an entirely bad plan, because the original idea for increased government spending was to do it through acceleration of projects that would eventually need to be completed and by providing a bit of a safety net to people that really needed it.
Insert tangent here: The down side of that is that all good things end up getting abused and acceleration of necessary projects has a tendency to become pork barrel spending and a minimalist safety net is easily abused if it does not leave proper inspiration for people to actually return to work instead of just living off of said safety net.
Keynes believed that once this new money was injected into the system it would effectively be recycled being spent over and over based on the consumer’s marginal propensity to consume (the amount of each dollar earned that is actually re-spent). This would create a multiplier effect that could close a relatively large gap between the amount of unemployment and output in a recession and where it should be in the long run.