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Keynesian Ideas Can Only Make Things Worse

In the New York Times on September 8, 2020, Paul Krugman suggested that

“The CARES Act, enacted in March, gave the unemployed an extra $600 a week in benefits. This supplement played a crucial role in limiting extreme hardship; poverty may even have gone down”.

For Krugman and many economic commentators, it is the duty of the government to support the economy whenever it falls into an economic slump. Following in the footsteps of John Maynard Keynes, most economists hold that one cannot have complete trust in a market economy, which is seen as inherently unstable.  If left free the market economy could lead to self-destruction. Hence, there is the need for governments and central banks to manage the economy. Successful management in the Keynesian framework is done by influencing overall spending.

It is spending that generates income. Spending by one individual becomes income for another individual according to the Keynesian framework of thinking. Hence the more that is spent the better it is going to be. What drives the economy then is spending. If during a recession, consumers fail to spend then it is the role of the government to step in and boost overall spending in order to grow the economy.

In the Keynesian framework of thinking the output that an economy can generate with a given pool of resources (i.e. labour, tools and machinery, and technology) without causing inflation, is labelled as potential output. Hence the greater the pool of resources, all other things being equal, the more output can be generated.

If for whatever reasons the demand for the produced goods is not strong enough this leads to an economic slump. (Inadequate demand for goods leads to only a partial use of existent labour and capital goods).  In this framework then, it makes a lot of sense to boost government spending in order to strengthen demand and eliminate the economic slump.

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