What Is Keynesian Economics?
Keynesian economics (Keynesian economics) refers to the thought originating from the British economist John Maynard Keynes. He is known as the first person to be able to explain simply the causes of the Great Depression.
The Great Depression that occurred in the 1930s was an economic event that is considered the most traumatic in the history of the 20th century. As a result of the economic depression, the United States experienced a decline of up to 30% of its industrial output. Nearly 50% of commercial banks collapsed, and the unemployment rate rose by more than 25%. The stock price lost 88% of its value, and the whole world, especially European countries, was threatened with disaster.
With this incident, the free market world developed feelings of anxiety about job loss, hunger and war. This caused many economists at that time to question the economics of capitalism which was developed by the classics (Ubaid AlFaruq, 2017).
Keynesian economics represents a new way of looking at spending, output and inflation. Previously, classical economic thought held that cyclical changes in employment and economic output would adjust accordingly. On the other hand, Keynesian thought argues that the government needs to intervene to restore economic equilibrium.
Keynesians argue that the role of government is needed in regulating the economy through fiscal and monetary policy instruments. Based on his understanding, the easiest way to see whether an economic model is a Classical model or a Keynesian model can be seen from the assumptions used by the model for markets and money. If the market is assumed to have a perfectly competitive structure so that government intervention is hardly needed, and money is neutral, it can be concluded that the model is a classic model. On the other hand, if the market structure is assumed to be non-perfect competition, money is not neutral and government intervention is needed in the economy, then the model is the Keynesian model.
Hayek states that the role of government in the economy must be minimized, so that it leads to laissez-faire condition. The role of the government or it can be said that government intervention in the economy makes the economy ineffective. Unemployment is caused by government intervention in the economy which causes the market mechanism to not work properly where the equilibrium point of wages for workers and producers is not reached. The minimum wage set by the state is an intervention that results in the failure of the market mechanism. The existence of the government also causes miscoordination in economic activity, so that monetary stability is affected by disturbances. According to Hayek, market independence must be maintained so that government intervention is not allowed, meaning that government regulations on market restrictions must be abolished. With the abolition of regulations on market restrictions, the market will have a large gap to regulate the existing economy.
The Debate on Keynes versus Hayek
During the early 1930s, Hayek was, in the words of John Hicks, “the principal rival to the new theories of Keynes” (Hicks 1967: 203). Keynes’s most famous work was not published until 1936, but his antithrift views and his deficit spending recommendations were already being propagated. In Prices and Production,
Hayek demonstrated that the government’s inflationary policies, not the free market, were responsible for both the economic boom and the subsequent depression. Furthermore, he argued that renewed inflation during a depression simply makes matters worse. According to Hayek, a noninterventionist policy is the fastest way to reverse an economic downturn.
Hayek had previously criticized Keynes directly in a 1931-32 series of articles reviewing his Treatise on Money in Economica. According to Hayek, Keynes’s approach to macroeconomics was too aggregative, emphasizing absolute price levels rather than relative prices, and lacked a basic understanding of the vital role of capital and interest in the economy
Both Hayek and Keynes are notable economists that have contributed in numerous thought in the field of economics, especially in macroeconomics. Their contradiction is merely proof that some economic problems could be solved with different approaches. This also implies that as an economist we must always be critical and be open to other possibilities that could also occur.