Editing Keynesian economics (section)

== Keynesian economic policies ==
=== Active fiscal policy ===
{{Multiple issues|section=yes|
{{More footnotes needed|section|date=October 2015}}
{{Essay-like|section|date=October 2015}}
}}
[[File:Economic Policy - Intervention Strategy Matrix.png|class=skin-invert-image|thumb|350px|right|Typical intervention strategies under different conditions]]
Keynes argued that the solution to the [[Great Depression]] was to stimulate the country ("incentive to invest") through some combination of two approaches:

# A reduction in interest rates (monetary policy), and
# Government investment in infrastructure (fiscal policy).

If the interest rate at which businesses and consumers can borrow decreases, investments that were previously uneconomic become profitable, and large consumer sales normally financed through debt (such as houses, automobiles, and, historically, even appliances like refrigerators) become more affordable. A principal function of [[central bank]]s in countries that have them is to influence this interest rate through a variety of mechanisms collectively called ''monetary policy''. This is how monetary policy that reduces interest rates is thought to stimulate economic activity, i.e., "grow the economy"—and why it is called ''expansionary'' monetary policy.

Expansionary fiscal policy consists of increasing net public spending, which the government can effect by a) taxing less, b) spending more, or c) both. Investment and consumption by government raises demand for businesses' products and for employment, reversing the effects of the aforementioned imbalance. If desired spending exceeds revenue, the government finances the difference by borrowing from [[capital market]]s by issuing government bonds. This is called deficit spending. Two points are important to note at this point. First, deficits are not required for expansionary fiscal policy, and second, it is only ''change'' in net spending that can stimulate or depress the economy. For example, if a government ran a deficit of 10% both last year and this year, this would represent neutral fiscal policy. In fact, if it ran a deficit of 10% last year and 5% this year, this would actually be contractionary. On the other hand, if the government ran a surplus of 10% of GDP last year and 5% this year, that would be expansionary fiscal policy, despite never running a deficit at all.

Contrary to some critical characterizations of it, Keynesianism does not consist solely of [[deficit spending]], since it recommends adjusting fiscal policies according to cyclical circumstances.<ref>{{cite news| title = I Think Keynes Mistitled His Book| newspaper = The Washington Post| date = 26 July 2011| url = https://www.washingtonpost.com/blogs/ezra-klein/post/larry-summers-i-think-keynes-mistitled-his-book/2011/07/11/gIQAzZd4aI_blog.html| access-date = 13 August 2011| archive-date = 8 October 2018| archive-url = https://web.archive.org/web/20181008133419/https://www.washingtonpost.com/blogs/ezra-klein/post/larry-summers-i-think-keynes-mistitled-his-book/2011/07/11/gIQAzZd4aI_blog.html| url-status = live}}</ref> An example of a counter-cyclical policy is raising taxes to cool the economy and to prevent inflation when there is abundant demand-side growth, and engaging in deficit spending on labour-intensive infrastructure projects to stimulate employment and stabilize wages during economic downturns.

Keynes's ideas influenced US President [[Franklin D. Roosevelt]]'s view that insufficient buying-power caused the Depression. During his presidency, Roosevelt adopted some aspects of Keynesian economics, especially after 1937, when, in the depths of the Depression, the United States suffered from recession yet again following fiscal contraction. But to many the true success of Keynesian policy can be seen at the onset of [[World War II]], which provided a kick to the world economy, removed uncertainty, and forced the rebuilding of destroyed capital. Keynesian ideas became almost official in [[social democracy|social-democratic]] Europe after the war and in the U.S. in the 1960s.

The Keynesian advocacy of deficit spending contrasted with the [[classical economics|classical]] and [[neoclassical economics|neoclassical]] economic analysis of fiscal policy. They admitted that fiscal stimulus could actuate production. But, to these schools, there was no reason to believe that this stimulation would outrun the side-effects that "[[Crowding out (economics)|crowd out]]" private investment: first, it would increase the demand for labour and raise wages, hurting [[rate of profit|profitability]]; Second, a government deficit increases the stock of government bonds, reducing their market price and encouraging high [[interest rate]]s, making it more expensive for business to finance [[fixed investment]]. Thus, efforts to stimulate the economy would be self-defeating.

The Keynesian response is that such fiscal policy is appropriate only when unemployment is persistently high, above the [[NAIRU|non-accelerating inflation rate of unemployment]] (NAIRU). In that case, crowding out is minimal. Further, private investment can be "crowded in": Fiscal stimulus raises the market for business output, raising cash flow and profitability, spurring business optimism. To Keynes, this [[accelerator effect]] meant that government and business could be ''[[complement good|complements]]'' rather than [[substitute good|substitutes]] in this situation.

Second, as the stimulus occurs, gross domestic product rises—raising the amount of [[saving]], helping to finance the increase in fixed investment. Finally, government outlays need not always be wasteful: government investment in [[Public good (economics)|public good]]s that is not provided by profit-seekers encourages the private sector's growth. That is, government spending on such things as basic research, public health, education, and infrastructure could help the long-term growth of ''[[potential output]]''.

In Keynes's theory, there must be significant [[unemployment#Cyclical unemployment|slack in the labour market]] before [[deficit spending|fiscal expansion]] is justified.

Keynesian economists believe that adding to profits and incomes during boom cycles through tax cuts, and removing income and profits from the economy through cuts in spending during downturns, tends to exacerbate the negative effects of the business cycle. This effect is especially pronounced when the government controls a large fraction of the economy, as increased tax revenue may aid investment in state enterprises in downturns, and decreased state revenue and investment harm those enterprises.

===Views on trade imbalance===

In the last few years of his life, [[John Maynard Keynes|Keynes]] was much preoccupied with the question of balance in international trade. He was the leader of the British delegation to the [[United Nations Monetary and Financial Conference]] in 1944 that established the [[Bretton Woods system]] of international currency management.
He was the principal author of a proposal – the so-called Keynes Plan – for an [[International Clearing Union]]. The two governing principles of the plan were that the problem of settling outstanding balances should be solved by 'creating' additional 'international money', and that debtor and creditor should be treated almost alike as disturbers of equilibrium. In the event, though, the plans were rejected, in part because "American opinion was naturally reluctant to accept the principle of equality of treatment so novel in debtor-creditor relationships".<ref>
{{cite book|author=Crowther, Geoffrey|title=An Outline of Money|version=Second Edition|publisher= Thomas Nelson and Sons|year=1948|pages=326–29}}</ref>

The new system is not founded on free trade (liberalization<ref>{{cite web|url=http://www.investopedia.com/terms/d/deregulate.asp|title=Deregulation|author=Investopedia Staff|date=25 November 2003|access-date=30 June 2017|archive-date=2 July 2017|archive-url=https://web.archive.org/web/20170702012600/http://www.investopedia.com/terms/d/deregulate.asp|url-status=live}}</ref> of foreign trade<ref>{{cite web|url=http://www.investopedia.com/terms/t/trade-liberalization.asp|title=Trade Liberalization|author=Investopedia Staff|date=3 April 2010|access-date=30 June 2017|archive-date=23 June 2017|archive-url=https://web.archive.org/web/20170623034035/http://www.investopedia.com/terms/t/trade-liberalization.asp|url-status=live}}</ref>) but rather on regulating international trade to eliminate trade imbalances. Nations with a surplus would have a powerful incentive to get rid of it, which would automatically clear other nations' deficits.<ref>{{cite web | url=https://scholarworks.umass.edu/cgi/viewcontent.cgi?referer=https://en.wikipedia.org/&httpsredir=1&article=1127&context=peri_workingpapers | title=Current Global Imbalances and the Keynes Plan | first=Lilia | last=Costabile | date=December 2007 | publisher=Political Economy Research Institute | access-date=8 November 2020 | archive-date=20 January 2021 | archive-url=https://web.archive.org/web/20210120101918/https://scholarworks.umass.edu/cgi/viewcontent.cgi?referer=https%3A%2F%2Fen.wikipedia.org%2F&httpsredir=1&article=1127&context=peri_workingpapers | url-status=live }}</ref> Keynes proposed a global bank that would issue its own currency—the ''bancor''—which was exchangeable with national currencies at fixed rates of exchange and would become the unit of account between nations, which means it would be used to measure a country's trade deficit or trade surplus. Every country would have an overdraft facility in its bancor account at the International Clearing Union. He pointed out that surpluses lead to weak global aggregate demand – countries running surpluses exert a "negative externality" on trading partners, and posed far more than those in deficit, a threat to global prosperity. Keynes thought that surplus countries should be taxed to avoid trade imbalances.<ref>{{cite web |url=https://www.theguardian.com/commentisfree/2010/may/05/reform-euro-or-bin-it-greece-germany |title=Reform the euro or bin it |author=Joseph Stiglitz |date=5 May 2010 |website=www.theguardian.com |access-date=30 June 2017 |archive-date=30 August 2017 |archive-url=https://web.archive.org/web/20170830234718/https://www.theguardian.com/commentisfree/2010/may/05/reform-euro-or-bin-it-greece-germany |url-status=live }}</ref>
In ''"National Self-Sufficiency" The Yale Review, Vol. 22, no. 4 (June 1933)'',<ref>{{Cite web | url=http://www.uam.es/personal_pdi/economicas/jsanchez/documentos/1601%20KEYNES%20National%20Self-sufficiency%201933.pdf | title=Inicio | access-date=30 June 2017 | archive-date=9 December 2017 | archive-url=https://web.archive.org/web/20171209065022/http://www.uam.es/personal_pdi/economicas/jsanchez/documentos/1601%20KEYNES%20National%20Self-sufficiency%201933.pdf | url-status=live }}</ref><ref>{{cite web|url=http://www.india-seminar.com/2009/601/601_david_singh_grewali.htm|title=601 David Singh Grewal, What Keynes warned about globalization|website=www.india-seminar.com|access-date=30 June 2017|archive-date=1 May 2017|archive-url=https://web.archive.org/web/20170501115139/http://www.india-seminar.com/2009/601/601_david_singh_grewali.htm|url-status=live}}</ref> he already highlighted the problems created by free trade.

His view, supported by many economists and commentators at the time, was that creditor nations may be just as responsible as debtor nations for disequilibrium in exchanges and that both should be under an obligation to bring trade back into a state of balance. Failure for them to do so could have serious consequences. In the words of [[Geoffrey Crowther, Baron Crowther|Geoffrey Crowther]], then editor of [[The Economist|''The Economist'']], "If the economic relationships between nations are not, by one means or another, brought fairly close to balance, then there is no set of financial arrangements that can rescue the world from the impoverishing results of chaos."<ref>{{cite book|author= Crowther, Geoffrey|title=An Outline of Money|version=Second Edition|publisher=Thomas Nelson and Sons
|year=1948|page=336}}</ref>

These ideas were informed by events prior to the [[Great Depression]] when – in the opinion of Keynes and others – international lending, primarily by the U.S., exceeded the capacity of sound investment and so got diverted into non-productive and speculative uses, which in turn invited default and a sudden stop to the process of lending.<ref>{{cite book|author=Crowther, Geoffrey| title=An Outline of Money|version=Second Edition|publisher=Thomas Nelson and Sons|year=1948|pages= 368–72}}</ref>

Influenced by Keynes, economic texts in the immediate post-war period put a significant emphasis on balance in trade. For example, the second edition of the popular introductory textbook, ''An Outline of Money'',<ref>{{cite book|author=Crowther, Geoffrey|title=An Outline of Money|version= Second Edition|publisher=Thomas Nelson and Sons|year=1948}}</ref> devoted the last three of its ten chapters to questions of foreign exchange management and in particular the 'problem of balance'. However, in more recent years, since the end of the [[Bretton Woods system]] in 1971, with the increasing influence of [[Monetarist]] schools of thought in the 1980s, and particularly in the face of large sustained trade imbalances, these concerns – and particularly concerns about the destabilizing effects of large trade surpluses – have largely disappeared from [[mainstream economics]] discourse<ref>See for example, Krugman, P and Wells, R (2006). "Economics", Worth Publishers</ref> and Keynes' insights have slipped from view.<ref>although see Duncan, R (2005). "The Dollar Crisis: Causes, Consequences, Cures", Wiley</ref> They received attention again during the [[2008 financial crisis]].<ref>See for example,{{cite web|url= http://www.monbiot.com/archives/2008/11/18/clearing-up-this-mess/|title=Clearing Up This Mess| date=18 November 2008| archive-url= https://web.archive.org/web/20090123161345/http://www.monbiot.com/archives/2008/11/18/clearing-up-this-mess/| archive-date= 23 January 2009 | url-status= live}}</ref>

===Views on free trade and protectionism===
====The turning point of the Great Depression====
At the beginning of his career, Keynes was an economist close to [[Alfred Marshall]], deeply convinced of the benefits of free trade. From the crisis of 1929 onwards, noting the commitment of the British authorities to defend the gold parity of the pound sterling and the rigidity of nominal wages, he gradually adhered to protectionist measures.<ref name="J.M. Keynes, free trade and protectionism">{{Cite journal|doi = 10.7202/045556ar|title = J.M. Keynes, le libre-échange et le protectionnisme|year = 2011|last1 = Maurin|first1 = Max|journal = L'Actualité Économique|volume = 86|pages = 109–129|doi-access = free}}</ref>

On 5 November 1929, when heard by the [[Macmillan Committee]] to bring the British economy out of the crisis, Keynes indicated that the introduction of tariffs on imports would help to rebalance the trade balance. The committee's report states in a section entitled "import control and export aid", that in an economy where there is not full employment, the introduction of tariffs can improve production and employment. Thus the reduction of the trade deficit favours the country's growth.<ref name="J.M. Keynes, free trade and protectionism" />

In January 1930, in the Economic Advisory Council, Keynes proposed the introduction of a system of protection to reduce imports. In the autumn of 1930, he proposed a uniform tariff of 10% on all imports and subsidies of the same rate for all exports.<ref name="J.M. Keynes, free trade and protectionism" /> In the ''Treatise on Money'', published in the autumn of 1930, he took up the idea of tariffs or other trade restrictions with the aim of reducing the volume of imports and rebalancing the balance of trade.<ref name="J.M. Keynes, free trade and protectionism" />

On 7 March 1931, in the ''[[New Statesman and Nation]]'', he wrote an article entitled ''Proposal for a Tariff Revenue''. He pointed out that the reduction of wages led to a reduction in national demand which constrained markets. Instead, he proposes the idea of an expansionary policy combined with a tariff system to neutralize the effects on the balance of trade. The application of customs tariffs seemed to him "unavoidable, whoever the Chancellor of the Exchequer might be". Thus, for Keynes, an economic recovery policy is only fully effective if the trade deficit is eliminated. He proposed a 15% tax on manufactured and semi-manufactured goods and 5% on certain foodstuffs and raw materials, with others needed for exports exempted (wool, cotton).<ref name="J.M. Keynes, free trade and protectionism" />

In 1932, in an article entitled ''The Pro- and Anti-Tariffs'', published in ''[[The Listener (magazine)|The Listener]]'', he envisaged the protection of farmers and certain sectors such as the automobile and iron and steel industries, considering them indispensable to Britain.<ref name="J.M. Keynes, free trade and protectionism" />

====The critique of the theory of comparative advantage====
In the post-crisis situation of 1929, Keynes judged the assumptions of the free trade model unrealistic. He criticized, for example, the neoclassical assumption of wage adjustment.<ref name="J.M. Keynes, free trade and protectionism"/><ref name="The non-neoclassical foundations of protectionism">{{Cite thesis|url=http://www.sudoc.abes.fr/cbs/xslt/DB=2.1//SRCH?IKT=12&TRM=170778401|title = Les fondements non neoclassiques du protectionnisme|year = 2013|publisher = Université Bordeaux-IV|last1 = Maurin|first1 = Max}}</ref>

As early as 1930, in a note to the Economic Advisory Council, he doubted the intensity of the gain from specialization in the case of manufactured goods. While participating in the MacMillan Committee, he admitted that he no longer "believed in a very high degree of national specialisation" and refused to "abandon any industry which is unable, for the moment, to survive". He also criticized the static dimension of the theory of comparative advantage, which, in his view, by fixing comparative advantages definitively, led in practice to a waste of national resources.<ref name="J.M. Keynes, free trade and protectionism" /><ref name="The non-neoclassical foundations of protectionism" />

In the Daily Mail of 13 March 1931, he called the assumption of perfect sectoral labour mobility "nonsense" since it states that a person made unemployed contributes to a reduction in the wage rate until he finds a job. But for Keynes, this change of job may involve costs (job search, training) and is not always possible. Generally speaking, for Keynes, the assumptions of full employment and automatic return to equilibrium discredit the theory of comparative advantage.<ref name="J.M. Keynes, free trade and protectionism" /><ref name="The non-neoclassical foundations of protectionism" />

In July 1933, he published an article in the ''New Statesman and Nation'' entitled ''National Self-Sufficiency'', in which he criticized the argument of the specialization of economies, which is the basis of free trade. He thus proposed the search for a certain degree of self-sufficiency. Instead of the specialization of economies advocated by the Ricardian theory of comparative advantage, he prefers the maintenance of a diversity of activities for nations.<ref name="The non-neoclassical foundations of protectionism" /> In it he refutes the principle of peacemaking trade. His vision of trade became that of a system where foreign capitalists compete for new markets. He defends the idea of producing on national soil when possible and reasonable and expresses sympathy for the advocates of [[protectionism]].<ref name="National Self-Sufficiency">{{Cite web|url=http://www.mtholyoke.edu/acad/intrel/interwar/keynes.htm|title=John Maynard Keynes, "National Self-Sufficiency," the Yale Review, Vol. 22, no. 4 (June 1933), pp. 755–769.|access-date=20 November 2021|archive-date=15 May 2011|archive-url=https://web.archive.org/web/20110515044928/http://www.mtholyoke.edu/acad/intrel/interwar/keynes.htm|url-status=live}}</ref> 
He notes in ''National Self-Sufficiency'':<ref name="National Self-Sufficiency" /><ref name="J.M. Keynes, free trade and protectionism" />
{{cquote|A considerable degree of international specialization is necessary in a rational world in all cases where it is dictated by wide differences of climate, natural resources, native aptitudes, level of culture and density of population. But over an increasingly wide range of industrial products, and perhaps of agricultural products also, I have become doubtful whether the economic loss of national self-sufficiency is great enough to outweigh the other advantages of gradually bringing the product and the consumer within the ambit of the same national, economic, and financial organization. Experience accumulates to prove that most modern processes of mass production can be performed in most countries and climates with almost equal efficiency.}}

He also writes in ''National Self-Sufficiency'':<ref name="J.M. Keynes, free trade and protectionism" />{{cquote|I sympathize, therefore, with those who would minimize, rather than with those who would maximize, economic entanglement among nations. Ideas, knowledge, science, hospitality, travel—these are the things which should of their nature be international. But let goods be homespun whenever it is reasonably and conveniently possible, and, above all, let finance be primarily national.}}

Later, Keynes had a written correspondence with [[James Meade]] centred on the issue of import restrictions. Keynes and Meade discussed the best choice between quota and tariff. In March 1944 Keynes began a discussion with [[Marcus Fleming]] after the latter had written an article entitled ''Quotas versus depreciation''. On this occasion, we see that he has definitely taken a protectionist stance after the [[Great Depression]]. He considered that quotas could be more effective than currency depreciation in dealing with external imbalances. Thus, for Keynes, currency depreciation was no longer sufficient, and protectionist measures became necessary to avoid trade deficits. To avoid the return of crises due to a self-regulating economic system, it seemed essential to him to regulate trade and stop free trade (deregulation of foreign trade).<ref name="J.M. Keynes, free trade and protectionism" />

He points out that countries that import more than they export weaken their economies. When the trade deficit increases, unemployment rises and GDP slows down. And surplus countries exert a "negative externality" on their trading partners. They get richer at the expense of others and destroy the output of their trading partners. John Maynard Keynes believed that the products of surplus countries should be taxed to avoid trade imbalances.<ref>{{Cite web|title=Reform the euro or bin it|date=5 May 2010|author=Joseph Stiglitz|website=[[TheGuardian.com]]|url=https://www.theguardian.com/commentisfree/2010/may/05/reform-euro-or-bin-it-greece-germany|access-date=30 June 2017|archive-date=30 August 2017|archive-url=https://web.archive.org/web/20170830234718/https://www.theguardian.com/commentisfree/2010/may/05/reform-euro-or-bin-it-greece-germany|url-status=live}}</ref> Thus he no longer believes in the theory of [[comparative advantage]] (on which free trade is based) which states that the trade deficit does not matter, since trade is mutually beneficial.
This also explains his desire to replace the liberalization of international trade ([[Free Trade]]) with a regulatory system aimed at eliminating trade imbalances in his proposals for the [[Bretton Woods Agreement]].{{citation needed|date=December 2021}}