Keynesianism

Classical economics before Keynes relied on Say's law, that supply creates its own demand, and held that if wages and prices fell far enough the market would return to full employment. The mass unemployment of the Depression shook that belief. In chapter 3 of the General Theory Keynes called the point where the aggregate demand and aggregate supply functions intersect the "effective demand" and made it the determinant of employment. Because people do not spend all of a rise in income and investment rests on unstable expectations of future profit, the economy can settle into an equilibrium with mass unemployment.

The core of the remedy is government spending. In 1931 Richard Kahn calculated as a "ratio" the chain by which money spent hiring the unemployed becomes others' income and is spent again, and at Keynes's suggestion it was renamed the "multiplier": in a slump, spending even at a deficit generates several times as much demand and employment. In chapter 24 of the General Theory Keynes wrote that banking policy alone was unlikely to secure the right rate of investment, so that "a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment", and spoke of the "euthanasia of the rentier", while adding that it was not the ownership of the instruments of production that the state needed to assume.

The same ideas arose elsewhere. The Polish Marxist economist Michał Kalecki laid the foundations of a theory of effective demand in 1933, and the Stockholm school in Sweden developed similar concepts independently in the 1930s. In Japan Takahashi Korekiyo carried out deficit spending and devaluation before the General Theory appeared.

As part of the neoclassical synthesis, Keynesian economics was the standard macroeconomic model of the developed countries in the later Depression, the Second World War and the post-war expansion of 1945–73. It lost much of its influence after the oil shock and stagflation of the 1970s, and from the late 1970s neoliberalism replaced it as the dominant paradigm. New Keynesian economics later became part of mainstream macroeconomics, and in the 2008 financial crisis governments turned again to Keynesian remedies.

Criticism came from several directions. Austrian economists such as Hayek and Mises and monetarists such as Friedman argued that Keynesian policies distort price signals through credit expansion and deficit spending, causing malinvestment, inflation and unsustainable public debt. On the Marxist side, Paul Sweezy in 1946 granted that much in the General Theory's analysis of effective demand was useful but held that Keynes never saw capitalism as a totality, treated the class struggle carelessly and overlooked the class role of the capitalist state. Kalecki predicted in "Political Aspects of Full Employment" (1943) that because full employment would make the working class more assertive and weaken the social position of business leaders, capitalists would use their political power to undo Keynesian policy.