I'm debating someone on inflation and deflation, and we moved onto the topic of the stagflation which plagued the economy a few decades back. He says stagflation was ended by "causing a massive demand reducing recession that raised unemployment by a hell of a lot, forcing people to spend less and ask for lower wages. Demand side economics, or in a word, Keynesianism." He is identifying Keynesianism as the saviour of the economy. Since I'm a newbie to economics (especially this area) does anyone have any criticisms of this explanation or an alternate view? There's something not quite right about saying Keynesianism saved us!
LOL. The central tenet of 1970's Keynesianism was the Philips curve. Look it up. Basically, the Philips curve shows that there's a trade-off between unemployment and inflation. Either you can have high unemployment, high inflation, or both. Well, following their own policy prescriptions, the Keynesians inflated every time unemployment rose. Of course, inflation expectations rose and misallocated resources were being discovered, pushing unemployment to new highs, which in turn forced the Keynesians to further inflate in order to push unemployment down. The end result was stagflation, a great failure of Keynesianism. Stagflation is what caused economists to seek other answers in monetarism, new classical economics, and Austrian economics. The other schools of thought saw it necessary to put the economy through a corrective recession, in order to end the stagflation brought on by the Keynesians. It was this corrective disinflationary recession under Carter/Reagan which finally ended stagflation and brought about more sustainable growth. This was thanks to non-Keynesian economists, like Paul Volcker (head of the Fed under Carter and Reagan). Keynesians at the time were blaming the stagflation on monopolies, oligopolies, cartels, speculators, and everyone under the sun EXCEPT the Fed. Restricting the money supply finally ended the cycle of higher inflation and higher unemployment, and returned the economy to low-inflation, normal growth, and normal unemployment.
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While Krazy Kaju has an excellent reply of his own, I'd like to point out that Keynesianism isn't simply "demand-side economics". The whole point of Keynesianism is to keep prices from falling in the wake of financial crises. When a financial crisis happens, some (if not many) kinds of assets are revealed to have been overvalued, so their prices understandably go down. Keynesianism calls this "decline in aggregate demand", which is technically one way of putting it. The answer to this, according to Keynes and his intellectual ilk, is for the government to step in and "stimulate aggregate demand" -- that is, somehow cajole or coerce people into revaluing the assets at their former levels. Of course, the whole point of this is to preserve the status quo. Anyways, I think your friend is simply mistaken about that Keynesianism really is.
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