Keynesians have the same answer whenever there’s a recession: spend, spend, spend. Then, uh...spend some more.
Who? Everyone. You, your mom, your BFF, and the government, too. The theory: spending is what makes the cogs of the economy turn. Saving slows them down. Therefore, we must spend. To get more people to spend, sometimes a government will spend money via debt. Maybe on public works, maybe as a stimulus package, maybe giving more liquidity for banks to lend out. That should get people spending, right?
Economist David Ricardo said, "I don’t think so."
The Ricardian equivalence theorem is the theory that debt-financed government spending doesn’t get people to spend more. During economically down times, people will save money. If they get more money than they anticipated, they’ll save that too. Why? Because it’s still gloomy outside, and because people expect tax increases in the future to pay off that debt the government accumulated. Ricardo (perhaps foolishly) believed people are no fools—if they see government debt rising, they know they’ll have to pay for it one day.
The bottom line? Ricardo thinks that, whether the government tries to stimulate spending by using debt or taxes, it doesn’t matter—people will behave the same. And that, therefore, a government can’t really get people to spend by spending itself.
That’s a big assertion, since most modern governments attempt to affect their economies via their central banks, doing monetary policy things. So...be mindful of whom you’re talking to on this one.
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Finance: Who is Keynes?9 Views
Finance a la shmoop. Who is Keynes? That's John Maynard and Keynes rhymes with
vaccines all right well he was a British economist and founder of modern-day [Someone getting vaccinated]
macroeconomics yeah popular in the 1960s his big book yep everybody poops well [Book titled 'Everybody Poops']
yes that one but his big economics book well it was called the general theory of
employment interest and money and that was actually the original title of [Woman running from a dinosaur]
Jurassic Park but a lot of people don't know that so you get that information
for free at Shmoop. All right well the book was published in 1936 written in
the middle of the Depression when spending was hugely well declining and [Pictures of people during the depression]
the notion of putting all your cash in your mattress was actually not such a [Hand sliding cash under a bed]
bad idea at least it didn't appear that way at the time. Keynes also wrote that [Keynes writing at a desk]
once employment dropped a new balance with low employment was created and the
depression might continue on and on and on unless the government started
spending to you know kind of stimulate the economy and fix things and get [Chargers being attached to the economy]
things going again well according to Keynes the big
solution aside from lowering taxes so that the wealthy would spend more in
hire bartenders for their wild and crazy parties was to have the government spend [Someone spraying champagne and the bartender is drinking it]
and spend and spend to get things moving economically even if it meant that the [People passing a dollar along]
government had to go into debt to do so well the big goal here was to stimulate
demand and this went against the ideas that economists had before i.e. that
the economy would eventually correct itself no interference needed well not
everyone likes Keynes ideas but President Roosevelt and the rest of the [People chucking tomatoes and Keynes presentation]
administration eventually did create what was called the New Deal which took
on a broadly Keynesian quality of bigmama government taking care of us it [American Economy as a baby]
was characterized by major and unprecedented government interventions
in the economy tons of spending and that's where that whole thing about [Someone giving out 100 dollar bills]
paying people to dig a hole and then fill it back up it all came from people [Someone digs a hole and then puts the dirt back in]
kind of did that... Well Keynes also believed that the
economy could not function on its own it needed parental help to correct it [Parents pushing a kid along on his bike]
kind of always that is in times of depression [They let go and he speeds up and starts screaming]
the government needed to lower taxes and increase spending or the economy would
stay in a funk like a generally unfed cranky child and at the other end of the [Kid sat on a toy bike crying]
stick to control inflation like when times were good and everyone was
employed and people were spending and spending and spending well then the
government needed to raise taxes and decrease spending and little things
matter a lot in Keynesian economics. Witness the multiplier effect and no [Blackboard full of complicated equations]
this has nothing to do with rabbits it's kind of like that TV commercial you know [Rabbit in snow]
or the woman with the awesome hair well she tells two friends about her
conditioner and they tell two friends who tell two friends who tell two
friends who then tell these guys it's a multiplier. [People on the phone to each other]
It grows fast that is a government tax cut puts an extra 5 grand in the
hands of a lawyer who spends most of that five grand on well yes parties [Confetti falling]
because that's what they do you got to to offset being a lawyer employing caterers
and deploying his friend Mr. Walker black who then deploys money on wheat
and rye distilleries such that while the tax cut of five grand ends up being an [Money cascading down through all the people]
economic stimulus of some ten to twenty times that number like 5 grand becomes a [Small pile labelled tax cut next to big pile of cash labelled economic stimulus]
hundred grand or something like that in GDP.
Well Keynesian demand focused ideas went on to dominate academic and government
thinking about political economy through the 1960s right about the time the first
edition of everybody poops hit the shelves... [Someone taking 'everybody poops' off a library shelf]
okay so Keynes didn't write that one but you know still stimulating the economy
stimulating your bowels yeah six and one half a dozen on the other and it's all [Someone sat in a toilet cubicle]
about your !$%*
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