Editing Keynesian economics (section)

=== 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.