KEYNESIAN ECONOMICS AND STIMULUS Keynesian economics is…

““KEYNESIAN ECONOMICS AND STIMULUS Keynesian economics is based on the notion that unemployment arises when total or aggregate demand in an economy falls short of the economy’s ability to supply goods and services. When products go unsold, jobs are lost. Aggregate demand, in turn, comes from two sources: the private sector (which is the majority) and the government. At times, aggregate demand is too buoyant—goods fly off the shelves and labor is in great demand—and we get rising inflation. At other times, aggregate demand is inadequate—goods are hard to sell and jobs are hard to find. In those cases, Keynes argued in the 1930s, governments can boost employment by cutting interest rates (what we now call looser monetary policy), raising their own spending, or cutting people’s taxes (what we now call looser fiscal policy). By the same logic, when there is too much demand, governments can fight actual or incipient inflation by raising interest rates (tightening monetary policy), increasing taxes, or reducing its own spending (thus tightening fiscal policy). That’s part of standard Keynesian economics, too, although Keynes, writing during the Great Depression, did not emphasize it. Setting aside the underlying theory, the central Keynesian policy idea is that the government can—and, Keynes argued, should—act as a kind of balance wheel, stimulating aggregate demand when it’s too weak and restraining aggregate demand when it’s too strong. For decades, American economists took for granted that most of that job should and would be done by monetary policy. Fiscal policy, they thought, was too slow, too cumbersome, and too political. And in the months after the Lehman Brothers failure, the Federal Reserve did, indeed, pull out all the stops—while fiscal policy did nothing. But what happens when, as was more or less the case by December 2008, the central bank has done almost everything it can, and yet the economy is still sinking? That’s why eyes started turning toward Congress and the president—that is, toward fiscal stimulus—after the 2008 election.””

— Alan S. Blinder