John Maynard Keynes: The Man Who Transformed the Economic World

By Brad Briggs
January 21, 2010

British economist John Maynard Keynes is one of the fathers of modern macroeconomic theory and widely considered to be one of the three most important economists of all time, along with Adam Smith and Karl Marx. His ideas shook up the dominant framework of classical economics and continue to influence both economic and fiscal policy for Western governments many decades later.

The crux of Keynes' views was that government interventionist policy was necessary in order to combat excessive boom and bust cycles in a nation's economy. This marked a significant paradigm shift among economists at the time, many of whom argued for minimal governmental interference. Keynesian ideas began to gain favor during the Great Depression when many of his proposals influenced the American and British governments, particularly Roosevelt's New Deal policies. And while it took some time for Keynes' ideas to take hold, they eventually gained ground and became a dominant school of economic thought for the next 40-plus years.

Key Theories and Principles
Keynes' seminal work, General Theory of Employment, Interest, and Money, published in 1936, articulated what would later become known as the foundation for modern macroeconomics. It challenged the established consensus of the time, which was that an economy will naturally restore itself to full employment after a period of downturn.

One of the key principles Keynes theorized was that savings and investment are determined independently of each other -- savings rates being determined by a society's propensity to consume and investment by an expected rate of return relative to interest rates. He also believed that a nation's income is the aggregate of its consumption and investment. During a downturn, this could potentially create a never-ending spiral as businesses invest less, jobs are lost, consumers spend less, businesses have even less reason to invest, and so on. Therefore, in a period of unemployment and decreased production, these two problems are best resolved by increasing the amount spent on investment and consumption.

According to Keynes, that's where the government comes in. He argued it was the government's responsibility to step in and use the many tools at its disposal to stimulate investment and consumption. This meant that during hard times, governments must engage in deficit spending in order to stimulate activity. This would consequently lead to policies such as the reduction of long-term interest rates, public works projects, infrastructure spending, and the like. The implication that deficits could be a good thing for the economy was quite revolutionary at the time.

Many people note Keynes’ influence on Roosevelt's New Deal policies but this is somewhat disputed as to the degree of his actual influence on policies of that time. What is more widely acknowledged as significant is the acceptance of his theories near the end of the Depression and the adoption of Keynesian economics as de facto American policy going forward.

Bretton Woods, World Bank, and IMF
The contributions of John Maynard Keynes did not end there. As World War II began to wind down, he played a significant role in the Bretton Woods negotiations in 1944. Along with others, Keynes advocated for the establishment of a world central bank and an international currency regulation body. Keynes was instrumental in the formation process of the bodies, which would later take form as the World Bank and the International Monetary Fund.

He is also noted for what was considered a more sweeping proposal of a world reserve currency. In his proposal, Keynes suggested using what he named the "Bancor" as a world reserve currency. The Bancor would be fixed to 30 commodities and would encourage the stabilization of commodity prices and achieve trade balance through taxation of current accounts. Although not adopted, the idea has periodically seen renewed discussions up to the present day.

Resurgence
Keynesian economics began to fall out of favor during the 1970s when recession, the oil crisis, and rapid inflation hit the U.S. Prominent economists such as Milton Friedman criticized tenets of Keynesian thought and advocated a move toward Monetarist principles, which were adopted in-kind.

While Keynesian economics never truly fell out of perception among policy makers, it would experience a renaissance of sorts near the onset of the financial crisis in 2008. The passage of stimulus packages and heavy government spending in the U.S., Europe, and China to combat the crisis marked its return to prominence.