Keynes versus Orthodoxy/Classical Economics

Keynes versus Orthodoxy/Classical Economics

Two major economic theories come in the form of Classical and Keynesian economies. Classical economics was imagined by several economists but presented by Adam Smith's The Wealth of Nations around the 18th century. Keynesian economics was proposed by John Maynard Keynes around the 20th century. One of the big differences between these two theories is their outlook of the market. Classical economics view it as self-perpetuating and perfect, while Keynesian economics proposes that the market is not self-sustaining and imperfect.

Another majoring conflict is the fact that Keynesians recognizes consumer income is a stimulant to the demand of the market. Whereas classical economists say that supply equals the demand in market economy. Classical economists discourage government intervention in the market stating that it would be useless or harmful. But Keynesian economists suggest that government intervention through fiscal and monetary policy could aid in economic growth by stimulating demand or it can help rebound from boom and bust periods. Meanwhile classical economists allow boom and bust periods to automatically readjust. They believe in an invisible hand that will eventually adjust everything back to equilibrium. From these we realize that classical economists rely on the long run outcomes by sacrificing short run deficiencies with the Keynesian economists on the other hand encouraging short run alterations in the form of government intervention. (Collins, 2012).

Most Keynesian economists argue that the United States was able to come out the Great Depression because Hoover and Roosevelt followed the policies advocated by Keynes and the Second World War expanded the public sector to the greatest extent, thereby, restoring the economy back on track. Since then, there has been a never ending debate between the orthodox and Keynesian economists regarding the best policy approach for dealing with the recession. The recession of late 2000s reignited the debate where the Keynesian economists are arguing that the government should increase its spending and take an active role to bring the economy out of the recession and classical economists are arguing that the only sustainable solution to this problem is allowing the markets to operate.

The fundamental principle of the classical theory is that the economy is self-regulating. Classical economists maintain that the economy is always capable of achieving the natural level of real GDP or output, which is the level of real GDP that is obtained when the economy's resources are fully employed. While circumstances arise from time to time that cause the economy to fall below or to exceed the natural level of real GDP, self-adjustment mechanisms exist within the market system that work to bring the economy back to the natural level of real GDP. The classical doctrine—that the economy is always at or near the natural level of real GDP—is based on two firmly held beliefs: Say's Law and the belief that prices, wages, and interest rates are flexible.

Multiplier Effect

The above-mentioned arguments of Keynes became more appealing and fascinating due to the concept of “multiplier effect”. The central idea of the multiplier effect is that even a modest increase ...