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According to Keynesianism, decisions made by the private sector sometimes have unproductive macroeconomic effects. As a result, this school of macroeconomic thought supports the use of active policy and fiscal response measures using the public sector, monetary policy actions undertaken by the central bank and fiscal policies adopted by the government with the prime objective of stabilizing business cycle output (Baumol & Alan 2006, 102). Keynesianism advocates for the use of a mixed economy, which comprises mainly the private sector and the government with the public sector playing a considerable role. This was the economic model deployed during the last phase of the Great Depression, the Second World War, and the post-war economic expansion witnessed during 1945-1973 (Blanchard 2000, 36). Keynesianism lost its influence during the 1970s stagflation and counter-revolution. The recent global financial crisis has resulted in the resurgence of Keynesian thought in economic models. This paper attempts to explain the rise and fall of Keynesianism.
The significant influence of Keynesianism during the World War II is extensively attributed to the eradication of mass employment, which resulted in an intense influence and spread of Keynesianism relating to the government’s responsibility of maintaining full employment (Snowdon & Vane 2005, 102). For instance, in 1944, the United Kingdom government adopted a strategy towards ensuring a “high and stable level of employment” as a part of its employment policy (Snowdon & Vane 2005, 103). In the United States, the Employment Act of 1946 reflected the commitment of the Federal Government in adopting measures to achieve “maximum employment, production and purchasing power”. The commitments by both the United Kingdom and the United States were of ultimate significance regarding the spread and influence of Keynesianism, although they were devoid of the ways of achieving the stated objectives of maximum employment (Snowdon & Vane 2005, 105). In the case of the United Kingdom, Keynes held a view that the target 3% of average employment was extremely optimistic and said that there was no potential harm in putting it into practice. It is apparent that the post-war prosperity enjoyed by the UK and the US can be attributed to the stabilization policy of Keynesianism. Tobin, the most prominent US Keynesian economist, once argued that a strong case had been established for the success of Keynesianism (Snowdon & Vane 2005, 125).
Blanchard (2000) argued that almost all advanced democratic and capitalist nations embraced Keynesian demand policies managed after the Second World War (152). 1950-1975 reflected unmatched prosperity evidenced by an increase in the global trade and stability. It is during this period that most economies witnessed low inflation and unemployment rates. It is apparent that Britain and western economies enjoyed maximum employment in the post-war period, because the government maintained their commitments towards full employment, basing on Keynesian policy responses (Pugel 2007, 145). Before the 1980s, there was conventional wisdom suggesting stabilization of the real output in the United States economy because of the built-in and discretionary stabilization policies implemented after 1946, and especially after 1961, the period before the World War II. This is an instance of the most broadly held empirical generalization regarding the United States economy (Guillermo & Rodrigo 2008, 147). On the other hand, this generalization that the period after 1945 was more stable that the period before the Great Depression was challenged by Romer (1999, 140). According to Romer, the business cycle during the pre-Great Depression was somewhat more severe than economic instability observed after 1945. By Romer (1999), a close evaluation of unemployment, industrial production and Gross National Product data points out that methodologies used in formulating these data depicted systematic biases in findings (142). Romer (1999) used consistent post-1945 and pre-1945 data to point out that both booms and recessions were extremely severe during the period after 1945 (143). The conclusion held by Romer was that there was little evidence to conclude that the US economy before 1929 was more volatile than after 1945. Despite a slight decline and volatility of real macroeconomic indicators, and the severity of recessions between the pre-1916 and post 1945 periods, there is sufficient evidence to conclude that recessions reduced and became uniform. The effect of the Keynesian stabilization policies included prolonging the post-1945 expansions and preventing extreme economic downturns (Romer 1999, 145). It is apparent that the increased influence and spread of Keynesianism can be attributed to a conventional view that economic stability during the post-war period was relatively higher than in the pre-1914 period, which was characterized by the Keynesian revolution in economic policies. The fact is that the rise of Keynesianism is attributed to unmatched economic prosperity during the period between the end of the World War II and 1973 industrial market economies. This was because Keynesianism stressed the importance of fiscal policy, which resulted in the improved economic performance during the “Golden Age” period (Pearson 2009, 189). Outstanding performance can be attributed to an increase in the liberalization of the global trade and transactions, encouraging economic policies that led to low inflation rates in terms of buoyant aggregate demand, the increased governmental support of buoyant domestic demand, and the accumulation of growth potentialities after the end of World War II (Snowdon & Vane 2005, 147). For instance, GDP per capita in Western Europe increased by 4.08 % during 1950-1973, the growth and expansion were observed in centrally planned economies, such as Asia, Africa and Latin America.
The “Golden Age” of unmatched economic prosperity ended after 1973, with the economic stagnation of the 1970s leading to the fall of Keynesianism. The 1970s stagnation was characterized by the increasing rates of inflation and unemployment, and the reduced rates of economic growth. According to Keynesian critics, the economic stagnation attributed to the misguided expansionary policies adopted under the disguise of Keynesianism. For instance, during 1960-2002, average unemployment and inflation rates were low. During 1983-1993, inflation reduced, but unemployment rates were high in most countries, particularly in Western Europe, which attributed to hysteresis effects and rigidities in the labor market (Guillermo & Rodrigo 2008, 147). In the recent period of 1994-2002, it is apparent that inflation rates were low, but unemployment rates were high in Western Europe and reduced in the US. It is only during the period of 1973-1983 that high inflation and high unemployment rates were recorded simultaneously. This is referred to as stagflation. According to Keynesianism critics, stagflation was an unavoidable legacy of demand management policies associated with Keynesianism (Baumol & Alan 2006).
Economists assert that there are two primary causes of stagflation. First, an unfavorable supply shock can lessen the productive capacity of an economy. Examples of unfavorable shocks include an increase in oil prices for an importing state. Such shocks have a tendency of simultaneously increasing prices and slowing the economy by the increasing costs of production and reducing profitability (Guillermo & Rodrigo 2008, 149). The second probable cause of stagnation is inappropriate macroeconomic policies. For instance, allowing an excessive growth in the supply of currency can increase inflation, and the government can create stagnation using intense regulation of goods and the labor market. These two factors played an important role in causing the 1970s global stagflation that led to the fall of Keynesianism. The stagflation commenced with massive increases in oil prices and continued, because central banks deployed the intense simulative monetary policy to resolve the recession. The fall of Keynesianism also attributed to the fact that many economists did not take into account the possibility of stagflation. Historical evidence pointed out that high unemployment rates were linked with low inflation rates and vice versa, as indicated in the Phillips curve (Pugel 2007). The assumption was that a high demand for goods increased prices, which in turn encouraged production companies to hire more people. Similarly, high employment rates increased demand. During the 1970s stagflation, it became apparent that the association between inflation rates and employment levels was not always stable. As a result, macroeconomists were doubtful about Keynesianism, ultimately leading to the end of the significance of Keynesian theories in economic policies. Monetarist economists, such as Milton Friedman and Edmund Phelps, explained a shift in the Phillips curve: they argued that when firms and workers anticipated high inflation, there was a shifting up of the Phillips curve, implying that high inflation can take place at any rate of unemployment. Specifically, they claimed that if inflation stayed high for many years, workers and firms would begin emphasizing its effects during wage negotiations, resulting in a quick increase of wages and firms’ costs, which further accelerated inflation. This explanation was an extreme case of criticism of Keynesianism, and Keynesians gradually accepted the explanation. This reduced its spread and influence on economic policies.
In conclusion, it is apparent that the spread and influence of Keynesianism was mainly accelerated by the unmatched economic prosperity and stability in the post-war period between 1945 and 1973. The basis of Keynesianism was government intervention using active monetary and fiscal actions to regulate aggregate instability in market economies. Its downfall could have attributed to the 1970s stagflation characterized by a simultaneous increase in both unemployment and inflation rates. Critics claim that stagflation was an unavoidable legacy of demand management policies associated with Keynesianism. The ultimate fall of Keynesianism was noted by the end of the neoclassical synthesis mainstream position because of empirical and theoretical flaws. The fall of Keynesianism was also caused by the fact that many economists of that time did not take into account the possibility of stagflation.
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