By: Rodney Hunter
Keynesian economics is a theory of total spending in the economy (called aggregate demand)and its effects on output and inflation. A Keynesian believes that aggregate demand is influenced by a host of economic decisions both public and private. The public decisions include, most prominently, those on monetary and fiscal policies. According to Keynesian theory, changes in aggregate demand, whether anticipated or unanticipated, have their greatest short-run effect on real output and employment, not on prices. This idea is portrayed, for example, in Phillips curves that show inflation rising only slowly when unemployment falls. Keynesian's believe that what is true about the short run cannot necessarily be inferred from what must happen in the long run, and we live in the short run. They often quote Keynes’s famous statement, “In the long run, we are all dead,”. But Keynesian's believe that, because the prices are somewhat rigid, fluctuations in any component of spending consumption, investment, or government expenditures, caused output to fluctuate. If government spending increases, for example, and all other components of spending remain constant, then output will increase. Keynesian models of economic activity also include a so-called multiplier effect; that is, output increases by a multiple of the original change in spending that cause. For Keynesian economics to work, however, the multiplier must be greater than zero. Keynesian's believe that prices, and especially wages, respond slowly to changes in supply and demand, resulting in periodic shortages and surpluses, especially of labor. Even Milton Friedman acknowledged that “under any conceivable institutional arrangements, and certainly under those that now prevail in the United States, there is only a limited amount of flexibility in prices and wages.’’ In current parlance, that would certainly be called a Keynesian position. Keynesian's do not think that the typical level of unemployment is ideal—partly because unemployment is subject to the caprice of aggregate demand, and partly because they believe that prices adjust only gradually. In fact, Keynesian's typically see unemployment as both too high on average and too variable, although they know that rigorous theoretical justification for these positions is hard to come by. Keynesian's also feel certain that periods of recession or depression are economic maladies, not, as in real business cycle theory, efficient market responses to unattractive opportunities.
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