Keynesian Economic Theory as Public policy Guide.

 

Meaning of public policy

 

The word public policy is widely used. It indicates to the policies taken by the government into different sectors like health, education, agriculture, industry, commerce etc. In the beginning, the public policy was used as political science and public administration. Public policy was one of the branches of the disciplines. Traditional studies described the institution in which public policy was formulated. Policy could be viewed as a set of guidelines for action aimed at achieving goals and objectives considered to be desirable or aimed at satisfying the needs of society in general or of  groups in particular.

 

Policy refers to the policies taken by the government into different economic and non economic sectors. The main objective of the public policy is to serve and develop the people by providing conducive environment, which maintains the norms and values of the society for quality of life and better human behavior.

 According to Thomas Dye: Public policy is “Whatever governments choose to do or not do”. 

Charles L. Cochran and Eloise F. Malone: "Public policy consists of political decisions for implementing programs to achieve societal goals".

 

Emergence of Keynesian economics

 

J.M Keynes (1883-1946) a famous economist; born in Cambridge, England, was a civil servant in the India office (1906-08), lecturer of Cambridge (1908-20), fellow of king (1909-46) member of the Royal commission on India finance and currency (1913-14), Treasury official (1915-19), member of the Macmillan committee on Economic Advisory council (1940-46) and a director of the Bank of England from 1941 until his death in 1946 ( Daris, Mahdjoubi. 2002)

 

Keynesian economics is developed against the background of the World depression of the 1930s. In 1920s things were really rocking in the U.S. and around the world. The rapid increase in industrialization was fueling growth in the economy, and technology improvements had the leading economist believing that the up rise would continue. During this boom period, wages increased along with the consumer spending and stock prices began to rise as well. Billions of dollars were invested in the stock market as people began speculating on the rising stock prices and buying on margin.

 

The enormous amount of unsecured consumer debt created by this speculation left the stock market essentially irregular. Many investors caught up in the race to make a killing invested their life savings, mortgaged their homes, and cashed in safer investments such as treasure bonds and bank accounts. As the prices continued to rise, some economic analyst began to warn of forthcoming correction, but they were largely ignored by the leading exports. Many banks eager to increase their profits, began to decrease, and was followed by an even selling trend. Due to this in the end of 1929, prices dropped sharply as more and more investors tried to sell their holdings. The New York stock exchange had lost four billion dollars in a single day. Many of the banks which had speculated heavily with their deposits were wiped out by the falling prices, and these banks sparked a “run” on the banking system. Each failed bank, factory business and investors contributed in the downward spiral that would into the Great Depression. The worldwide crisis of the 1930s, which followed the bottom of the “Roaring Twenties”, strengthened the belief in endogenous causes of trade cycles and the search for a way to counteract their harmful effects. It was upon this background that the British economist J.M. Keynes whose book “General Theory of Employment, Interest and Money” published in 1936 is the foundation of Keynesian school. (Dunn, W.D. 2004).

 

  J. M. Keynes shaded light on his famous book in own words, “I have called this book the General Theory of Employment, Interest and Money, placing the emphasis on the prefix general. The object of such a title is to contrast the character of my arguments and conclusions with those of the classical theory of the subject, upon which I was brought up and which dominates the economic thought, both practical and theoretical, of the governing and academic classes of this generation, as it has for a hundred years past. I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover , the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.” (Keynes, 1936).

 

 During the Great Depression of the 1930s, it was found that the market, by itself, could not manage the economic chaos. Keynes was one of the firsts to advocate government spending as a means of stimulating the economy and creating employment opportunities. To maintain the closest possible approach to full employment, Keynesian economic policy requires a steady flow of purchasing power - in economic terms, aggregate demand, which sets the limits on what the economy could produce.

 

 Keynes main ideas on policy Guide.

 Keynes, opposing a larger role of government, classical economist generally view a market economy as a self- mechanism that will achieve an equilibrium of full employment, maximum productivity, and stable prices if left alone by the government. The price mechanism will adjust the balance between demand and supply of goods and labor. But the Great Depression of the 1930s shattered popular confidence in classical economics. During the decade, the unemployment rate was 18 percent, rising to 25 percent in the worst year, 1933. (Dye, Thomas R. 2002).

 

According to J.M. Keynes, economic instability was a product of fluctuations in   demand. Both unemployment and lower wages reduced the demand for goods; businesses cut production and laid off more workers to adjust for lower demand for their goods; but cuts and layoff further reduced demand and accelerated the downward spiral.Keynes rejected communism and agreed with Adam Smith’s preference for laissez faire economy. He mainly focused on government would engage in public policies that would create a sufficient demand to maintain full employment, and profit would go to business as they had in the past. Keynes’s thinking was almost the opposite of Adam  smith’s invisible hand of the marketplace  which  works automatically  when the economy stumbles but Keynes argued that we cannot wait for an invisible hand to provide the needed adjustments  The government must intervene to safeguard jobs and income            ( Cochran, Charles L. 2007).

 

 Keynes stressed the importance of aggregate demand as the immediate determinant of national income, output, and employment, which is the sum of consumption, investment, government expenditures, and net exports.

Effective demand establishes the economy’s equilibrium level of actual output.  A recession occurs when the equilibrium level of actual output is less than the level necessary to maintain full employment. The basic characteristic of a recession or depression is a decline in aggregate demand or purchasing power by consumers, business and government. According to Keynes, if the economy could fall into a recession, in sufficient demand and massive unemployment then government could take the necessary countercyclical steps to expand demand by spending more money itself and lowering taxes.

 

To maintain the closet possible approach to full employment, Keynesian economic policy requires a steady follow of purchasing power. In economic term, aggregate demand, which sets the limits on what the economy, could produce. There are three substantive lines of corrective action that will increase the follow of aggregate demand as required. First, taxes can be lowered, thus, realizing to the consuming public more revenue to be expanded on private consumption. Second, interest rates can be reduced by central bank action, thus encouraging business and consumer borrowing and investment or expenditure which adds to the flow of aggregate demand. Third, the government can contribute directly to the follow of demand by new expenditure in a excess of taxes receipts by a deliberately accepted deficit. (Dye, Thomas R. 2002).

According to Keynes government spending might well be a necessary public policy to help a depressed market economy regain its vigor. Keynes is of the opinion that government should intervene through fiscal and monetary policies to promote full employment, stable prices, and economic growth if there were market failures leading to sufficient demand. (Cochran, Charles L. 2007).

 

Especially in crisis situations such as depressions or wars, it is not realistic option for governments to do nothing. The questions of economic stability, employment, growth, and inflation require government leadership and cannot be left to laissez-faire inaction and faith that the system will resolve all economic problems in its own time. Keynes theory was a clear advancement in our understanding of market capitalism.

 

Frictional unemployment refers to the temporary unemployment of new entrants to the labor force or those better one. Structural unemployment refers to unemployment due to a mismatch between the skills of the labor force and the jobs available. Frictional and structural unemployment are not considered major problems. Cyclical unemployment, which refers to unemployment caused by a lack of jobs in the economy due to a general economic downturn, is of serious concern. (Cochran, Charles L. 2007).

 

Inflation occurs when there is an increase in the average level of prices for goods and services. Inflation hurts all particularly poor people suffered a lot. It makes some worse off; it must make others better off. Inflation acts like a tax in which money is redistributed from one group to another. To curb inflation government intervene through monetary and fiscal policy and restore the price stability in the economy. Government has major macroeconomic role with their state, through public policies it encourages economic growth by stabilizing inflation and unemployment. Fiscal policy involves the use of government taxing and spending to stimulate or slow the economy, and the budget is the means by which fiscal policy is implemented. The government can increase and decrease aggregate demand by increasing or   decreasing its share of taxing and spending. (Cochran, Charles L. 2007).

Conclusion

Keynesian doctrine suggests that the government should, in the time of serious unemployment, run deficits to support the flow of aggregate demand and a wise government could stabilize the economy close to full employment and avoid fluctuations and inflation. Government should not left the economy in the invisible hands for self correcting and the faith that the system will resolve all economic problems in its own time. If necessary government should coordinate the fiscal and monetary policy either reduce unemployment or reduce inflation. Business sector and government sector would act as partners in running the economy by mobilizing public policy.

 

 

References

Cochran, Charles L. (2007). “Public Policy – Perspectives and Choices”. New Delhi: Viva Books Pvt. Ltd.

Dye, Thomas R. (2002). “Understanding Public Policy”. Pearson education, Inc.

Daris, Mahdjoubi. (2002). “Keynesian Economics and the linear model of innovation”.

Dunn, W.D. (2004).  “Public Policy Analysis: An Introduction”, New Jercy: printice hall.

Keynes, J. M. (1936). “General Theory of Employment, Interest and Money”.