Keynesian economics is the economic theory of John Maynard Keynes associated with a stress on the necessity of active government intervention in the direction and control of the economy. The central idea in Keynesian economics is that the business cycle of capitalist economies, irregular alternations of boom and bust, can be smoothed out by government creation of credit, investment activity and income transfers during economic contraction and the raising of revenue surplus during periods of expansion.
Keynesian economists believe in consumption, government expenditures and net exports to change the state of the economy. The New Keynesian theory arrived in the 1980s and focuses on government intervention and the behavior of prices. Both theories are a reaction to depression economics.
Since the mid 1970's, monetarism has challenged and, to some extent, displaced Keynesian economics as the framework for public policy and academic work. Keynesian economics offered insurance against the human cost of mass unemployment and the wastage of productive capacity by economic instability.
The terminology of demand-side economics is synonymous to Keynesian economics. Keynesian economists believe the economy is best controlled by manipulating the demand for goods and services. Keynesian economists do not completely disregard the role the money supply has in the economy and on affecting gross domestic product, or Gross Domestic Product. Yet, they do believe it takes a great amount of time for the economic market to adjust to any monetary influence. For several decades, beginning in the 1930's, Keynesian economics was the dominant model for the economic policies of western governments.
Keynesian economics is linked to a strong public policy, the welfare state and active state involvement in the economy, while monetarism supports a non-interventionist state, privatization and reliance on the self-regulating forces of the market. Monetarism is the doctrine or theory that economic stabilization is achieved by tight control of the money supply; control of the money supply according to this doctrine. Monetarist economics is Milton Friedman's criticism of Keynesian economics theory.
President Herbert Hoover failed in his approach to balance the budget, which entailed increasing taxes and spending cuts. President Roosevelt followed next and focused his administration's efforts on increasing demand and lowering unemployment. It is worth noting that Roosevelt's New Deal and other policies increased the supply of money in the economy.
The difference between monetarist economics and Keynesian economics is that monetarist economics involves the control of money in the economy, while Keynesian economics involves government expenditures. Monetarists believe in controlling the supply of money that flows into the economy. In contrast, Keynesian economists believe that a troubled economy continues in a downward spiral unless an intervention drives consumers to buy more goods and services. Monetarist economics and Keynesian economics directly impact the way lawmakers create fiscal and monetary policies.