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The history and use of keynesian theory

Keynesian theory is central to understanding the Great Depressive disorder. Well review just the idea here, and reserve for other sections the possibility to decide if the incidents of the 1930s endure out the theory.

Keynesianism is known as after John Maynard Keynes, a English economist who resided from 1883 to 1946. He was a guy of several contradictions: an elitist whose financial ideas would be embraced by liberals the world over; a bisexual who loved a happy and lifelong relationship to a Russian ballerina; a genius with an uncanny capacity to predict the future, but whose works were often badly organized and sometimes very wrong. I mention this only because many of Keynes' critics make an effort to refute his ideas by directing to the person himself. This is worse than unimportant, of course; such criticisms tend to be prejudiced.

What is not in contention is that even Keynes' critics call him the best and most important economist of the 20th century. For this reason, he's known as "the father of modern economics. "

When the Great Depression struck worldwide, it fell on economists to explain it and devise a remedy. Most economists were persuaded that something as large and intractable as the Great Depression must have complicated causes. Keynes, however, developed a conclusion of economical slumps that was amazingly simple. Actually, when he shared his theory and proposed solution with Franklin Roosevelt, the President is thought to have dismissed them with what: "Too easy. "

Keynes explanations of slumps ran something similar to this: in a normal economy, there is a advanced of occupation, and everyone is spending their income as usual. This implies there is a circular stream of profit the current economic climate, as my spending becomes part of your profits, and your spending becomes part of my income. But suppose something happens to tremble consumer confidence in the economy. (There are numerous possible known reasons for this, which we'll cover in a moment. ) Anxious consumers may then try to weather the coming economic hardship by keeping their money. But because my spending is part of your wages, my decision to hoard money makes things worse for you. And also you, giving an answer to your own difficult times, will start hoarding money too, making things a whole lot worse for me. So there's a vicious circle at the job here: people hoard profit difficult times, but times are more difficult when people hoard money.

The cure because of this, Keynes said, was for the central standard bank to expand the money supply. By adding more charges in people's hands, consumer self-assurance would returning, people would spend, and the circular circulation of money would be reestablished. Just that simple! Too simple, in truth, for the policy-makers of this time.

If this is actually the proposed description and treatment for recessions, then how about depressions? Keynes believed that depressions were recessions that had dropped into a "liquidity trap. " A liquidity snare is when people hoard money and refuse to spend no matter how much the federal government tries to expand the money suply. In these dire circumstances, Keynes thought that the federal government should do what individuals weren't, specifically, spend. In his memorable word, Keynes called this "priming the pump" of the market, a final federal government work to reestablish the round movement of money.

Let's go back now to the reasons why people start hoarding profit the first place. There are many possible explanations, all of which are open to argument. It might be a consumer lack of confidence in the economy, perhaps triggered by a visible event just like a currency markets crash. It may be a natural devastation, such as a drought, earthquake or hurricane. It may be a sudden loss of jobs, or a weakened sector of the economy. It might be inequality of prosperity, which results in the abundant producing a surplus of goods, but leaving the poor too poor to get them. It might be something intrinsic within the market which in turn causes it to go through a natural circuit of recessions and recoveries. Or the Federal Reserve may tighten up the money supply too much, compelling people to hang on with their disappearing us dollars. This previous point is especially important, since many critics of activist administration believe is how the Great Depression began.

As mentioned above, Keynes' advice on stopping the Great Unhappiness was rejected. President Roosevelt tried countless other approaches, which failed. Virtually all economists concur that World Battle II cured the Great Depression; Keynesians believe that this is so because the U. S. finally commenced massive public spending on defense. This is a large part of the reason why "wars are best for the current economic climate. " Although nobody knows the entire secret to monetary development (the world's top economists remain focusing on this secret), wars are an financial boon in part because government authorities always vacation resort to Keynesian spending during them. Naturally, such spending do not need to be directed only towards war -- communal programs are much more preferable.

In seven short years, under considerable Keynesian spending, the U. S. gone from the best depression it has ever recognized to the greatest economic boom they have ever known. The success of Keynesian economics was so resounding that almost all capitalist governments about the world used its procedures. And the effect appears to be nothing less than the extinction of the monetary depression! Before World Conflict II, eight U. S. recessions worsened into depressions (as took place in 1807, 1837, 1873, 1882, 1893, 1920, 1933, and 1937). Since World Battle II, under Keynesian plans, there have been nine recessions (1945-46, 1949, 1954, 1956, 1960-61, 1970, 1973-75, 1980-83, 1990-92 ), and not one has turned into a depressive disorder. The success of Keynesian economics was in a way that even Richard Nixon once announced, "We are all Keynesians now. "

After the battle, economists found Keynesianism a good tool in controlling unemployment and inflation. And this setup a theoretical war between liberals and conservatives that persists to this day, although it appears that Keynesianism has survived the conservatives' disorders and has emerged the predominant theory among economists. Before explaining this battle, however, we have to take a look at the way the money source is widened or contracted.

In the U. S. , there are several ways to grow the money resource. The most frequent is for National Reserve bankers to buy U. S. debt from commercial banking institutions. The amount of money that commercial banks accumulate from the sale of these administration securities escalates the amount they can provide. A second way is to loosen credit requirements, in that way increasing the amount of money generated by the bank operating system. A 3rd way is to slice the prime financing rate, which is the rate the Government Reserve lending options to commercial bankers. To reduce profit the current economic climate, the Given commits all the opposite actions.

To battle unemployment, the Given traditionally expands the money supply. This creates more spending in the economy, which creates more careers.

But what would happen if the Given expanded the amount of money resource too much? For example, let's imagine the Treasury published a whole lot money which it made every American a millionaire. After everyone retired, they might notice there would be no more workers or servants left to do their bidding so they might attract them by elevating their salary, sky-high if necessary. This, of course, is the substance of inflation. Eventually, prices would go up a great deal that it could no longer signify anything to be always a millionaire. Soon, everyone would be again working at their same exact jobs.

To combat inflation, then, the Fed contracts the money supply.

The Federal government Reserve thus comes with an important role in controlling the economy. Inadequate money in the current economic climate means crushing unemployment; excess amount means runaway inflation. Finding the right balance is the work of the Federal Reserve Board, a job which demands significant discretion hence the word discretionary monetary insurance plan. Making the correct decisions is determined by reading the market correctly, and some Boards have been better at it than others. In the first times especially, the Given had a inclination to overreact to innovations, sometimes triggering more damage than good. However the art work of discretionary insurance policy has improved over time. And the consequences of monetary coverage, even when handled terribly, are immediate, deep and easily measurable. No serious economist boasts otherwise source siders apart.

Milton Friedman's episode on Keynesianism

Of course, Keynesianism has its critics, the majority of them conservatives who loathe the theory that administration could ever play a beneficial role in the economy. Among the first major critics was Milton Friedman. Although he accepted Keynes' explanation of recessions, he turned down the cure. Administration should butt out of the business of increasing or contracting the amount of money source, he argued. It will keep the money supply constant, expanding it just a little each year simply to enable the progress of the market and some other basic factors. Inflation, unemployment and end result would adapt themselves according to market demands. This plan he known as monetarism.

During the 70s, monetarism reached the optimum of its attractiveness among traditional economists. Today, however, Friedman stands almost together among top economists in his opinion that it contains any merit. Monetarism was attempted in the uk through the 80s and it proved to be a disaster. For nearly seven years, the Bank of England attempted its best to make it work. Relating to monetarist theory, the British economy should have loved low inflation and high stability. But in fact, it went berserk. The market sank into a profound recession, as the lead economic indications zigged and zagged. Although inflation came down, this is at the price tag on growing unemployment, which soared from 5. 4 to 11. 8 percent. Between 1979 and 1984, developing output fell ten percent, and developing investment fell 30 percent. Eventually, the lender of England came up under overwhelming pressure to forego monetarism, which it have in 1986. The test was such failing that not even conservatives abroad desire to repeat it.

Along with THE UK, President Reagan released that the U. S. would also follow a monetarist policy. However, this was simply a cover story, designed for public use only. The truth is, the government's guidelines were carefully Keynesian. Authorities borrowing and spending exploded under Reagan, with the nationwide arrears climbing to $3 trillion by the time he kept office. Paul Volcker, Chairman of the Government Reserve Table, battled inflation through the severe tough economy of 1980-82 through the Keynesian approach to raising interest levels and tightening the amount of money supply. When inflation seemed defeated in 1982, he abruptly slashed the perfect rate and flooded the overall economy with money. A few months later, the current economic climate roared to life, in a restoration that would last over seven years. The American experience was in direct contrast to Great Britain's. As a result, most economists forgotten monetarist theory.

Friedman is also famous for a second theory, that one containing much more merit. It's called the natural rate of unemployment, and it will go something similar to this:

Imagine an economy where the price tag on everything doubles. You have to pay doubly much for your groceries, but you don't brain, because your salary is also doubly large. Economists call this the neutrality of money. If inflation proved helpful this way, then it might be safe. Indeed, most presidents after World Conflict II decided to recognize high inflation if it meant low unemployment, and for that reason urged the Government Reserve to execute an expansionary economic policy. But why is it that when the Given expands money by, say, 5 percent, that prices and salary almost everywhere do not rise by 5 percent as well? Exactly why is it that the neutrality of money will not make this extension meaningless? Friedman argued that it was because the general public was unaware of the enlargement, or what it supposed, or by how much if it have. In other words, they didn't know that they ought to raise their prices by 5 percent. When the extra money was pumped in to the current economic climate, therefore, it was unwittingly translated into more economical activity, not higher prices.

Of course, if entrepreneurs knew a 5 percent increase was arriving, it might be in their finest interest to just raise their prices 5 percent. Doing this, they might make the same increased earnings without having to be employed by them. If everyone does this, then your Fed's monetary increases would become meaningless -- instead of leading to more jobs, it would just create higher inflation. Friedman while others argued that as entrepreneurs became savvier and learned to check out the Fed's actions, they would build their inflationary objectives to their prices. Not only would this make inflation worse, but the land would be still left with no tool to fight unemployment, which would eventually go up as well. The twin dragons of inflation and unemployment would therefore develop together, developing "stagflation. "

Friedman revealed that monetary insurance policy could not be utilized to get rid of unemployment, one of the positive goals of the Keynesians shortly after World Battle II. Instead, the most financial insurance plan could do was keep unemployment at about 6 percent, which is the rate normally achieved when the inflation rate is what the market expects it to be. Friedman called this the "natural rate of unemployment, " and it guaranteed his popularity. But Keynesian plans remain useful in keeping the unemployment rate as near to 6 percent as you can.

Robert Lucas' attack on Keynesianism

an a great deal larger strike on Keynesianism originated from Robert Lucas, the creator of the theory called rational expectations. Although taking care of of the theory won Lucas the Nobel Prize in 1995, record has not been kind to the rest than it. Lucas himself has forgotten work on logical targets, devoting himself nowadays to other financial problems, and his once wide-ranging following has almost completely dissipated.

There are two main parts to logical anticipations. First, Lucas assumed that recessions are self-correcting. Once people start hoarding money, it may take several quarters before everyone notices a recession is happening. That's because individual businessmen may know they are making less overall, but it may take awhile to understand that the same thing is happening to everybody else. Once they do identify the downturn, however, the marketplace quickly can take steps to recuperate. Producers will lower their prices to entice business, and staff will cut their wage requirements to attract work. As prices fall season, the purchasing electricity of the dollars is strengthened, which has the same result as increasing the amount of money supply. Therefore, government should do nothing but wait the correction out.

Second, government treatment runs from ineffectualness to damage. Suppose the Fed, looking at the primary economic indicators, learns that a downturn has struck. But this information is also available to any businessman in virtually any good paper. Therefore, any administration attempt to broaden the money source cannot happen before a businessman's decision to trim prices anyway. Keynesians are therefore robbed of the debate that possibly the Fed might be useful in hastening a recovery, since Lucas confirmed that the Fed is very little faster than other people in discovering the situation.

Lucas then provided a marginally fuller version of the Milton Friedman argument outlined above. Suppose the Fed established a predictable anti-recession insurance plan: for each point the unemployment rate climbs, it does increase the money resource by the certain percent. Businesses would come to anticipate these rises -- hence the word, rational targets -- and would simply raise their prices by the expected amount. To become effective, monetary insurance policy would have to shock businesses with arbitrary raises. But true randomness would make the current economic climate less stable, not more so. The sole logical conclusion is that the government's efforts to control the economy can in fact be harmful.

Lucas' work appreciated outstanding prestige in the 70s. But today we know there are at least two major flaws in the idea.

First, it is not reasonable to assume that business owners determine their prices by following macroeconomic trends. Is it possible to cite the Government Reserve's rates and regulations at the moment? The inflation and unemployment rates? Development in the GDP? Even more improbably, would you establish your prices and income demands by these signals? Only an economist (who recognizes all these information anyhow) would think this is natural habit.

Second, recessions previous for years, which is much much longer than people's ignorance with their onset. Lucas and his supporters searched for each and every model imaginable that would keep businessmen aware of the leading monetary indicators yet ignorant of the fact that they were in a downturn. Obviously, they failed.

The recessions of 80-82 and 90-92 were clear refutations of Lucas' theory. Jimmy Carter was explicitly voted out of office for a misery index (unemployment plus inflation) that crested 20 percent. Yet it had not been until 1987 that the unemployment rate fell back to 1979 levels. It is ludicrous to assume that it took the general public eight years to figure out that they were in a tough economy and they needed to minimize prices back to the required level. And voters were highly aware that these were in a slump for almost all of the 90-92 tough economy; James Carville found a resonating campaign slogan for an entire election season with "It is the economy, ridiculous. " The economy didn't even learn to recover until the summertime of 92, with job taking even longer to rebound.

By the mid-80s, it was already clear that neither monetarism nor logical expectations were adequate ideas, and neo-Keynesianism started making a comeback. (Lucas acquired the Nobel Prize for your part of his theory which suggests that businessmen can compensate for expected monetary increases by nurturing their prices appropriately. Which is true in principle, but not often in practice. ) Among the basic problems of traditional theories is that they place an almost religious faith in the belief that leaving markets alone always ends up in the best. How, in that case, does one describe recessions and depressions? Or the fact that depressions have vanished since government started taking a dynamic role? Besides, the fact that we ought to let national disasters like the Great Unhappiness run unchecked for a long time while looking forward to the economy to improve itself borders on the immoral.

Today, neo-Keynesianism has went back to prominence. At the heart of this up to date version is the theory that people aren't perfectly logical, but nearly logical. That is, they don't carefully think about the unemployment rate, inflation rate and monetary policy before making a decision to slice their monthly prices by, say, $24. 13. Instead, people have only a fuzzy idea of where their prices should be, and make their best guesses. But because people are self-interested pets, they tend to err in their own favor, underestimating how much they really need to cut. This ends in a long lag between your recognition of a recession and your choice to lower prices in earnest. Actually, the lag is so long that discretionary economic insurance plan is warranted in cutting the recession brief.

But won't a businessman's rational goals negate the Fed's activities? The answer, it turns out, is not completely. The Fed's decision to develop the money resource in 1982 was broadly debated and highly publicized. Yet businessmen generally did not make up for the Fed's announced moves by raising their prices. You can find multiple reasons: a sizable percentage of businessmen could be expected to continue to be unaware of the Fed's actions, or what they indicate. For many, raising prices incurs certain costs (reprinting, recalculating, reprogramming, etc. , not forgetting a dip running a business) that eat in to the increases and might not make them worth it. And even if they do deem the purchase price hikes worthwhile, it requires many companies quite some time to place them into effect. (Sears, for example, must reprint and remail all its catalogues. ) Also, remember that the impulse to raise prices cancels out the impulse to lessen them, which is also how Lucas believed markets cured recessions. Others may be involved in price wars using their competition. So, for these and other reasons, extending the money source still results in job-creation, regardless of the counter-effect of logical expectations.

The re-emergence of Keynesianism is testimony of its staying power. Almost certainly, future economic theories will integrate its conclusions.

The heart and soul of the 'new Keynesian' view rests on microeconomic models that signify that nominal salary and prices are "sticky, " i. e. , do not change easily or quickly with changes in resource and demand, so that quantity adjustment prevails. According to economist Paul Krugman, "while I respect the data for such stickiness as overwhelming, the assumption of at least briefly rigid nominal prices is one particular things that works wonderfully used but very terribly theoretically. " This integration is further spurred by the work of other economists which questions logical decision-making in a perfect information environment as essential for micro-economic theory. Imperfect decision making such as that looked into by Joseph Stiglitz underlines the value of management of risk in the economy.

Over time, many macroeconomists have delivered to the IS-LM model and the Phillips curve as an initial approximation of how an market works. New variations of the Phillips curve, like the "Triangle Model", allow for stagflation, since the curve can change due to provide shocks or changes in built-in inflation. Within the 1990s, the initial ideas of "full employment" had been modified by the NAIRU doctrine, sometimes called the "natural rate of unemployment. " NAIRU advocates suggest restraint in combating unemployment, in case accelerating inflation should direct result. However, it is unclear exactly what the value of the NAIRU should be or whether it even is present.

Keynes sought to build up a theory that could clarify determinants of saving, intake, investment and creation. For the reason that theory, the relationship of aggregate demand and aggregate resource determines the level of output and employment in the economy.

Because of what he considered the inability of the "Classical Theory" in the 1930s, Keynes strongly objects to its main theory adjustments in prices would automatically make demand have a tendency to the full work level.

Neo-classical theory supports that both main costs that move demand and supply are labor and money. Throughout the circulation of the financial policy, demand and offer can be altered. If there have been more labor than demand for it, wages would show up until hiring started out again. If there was too much saving, and not enough utilization, then interest rates would show up until people either minimize their savings rate or started borrowing.

During the fantastic Depression, the traditional theory defined economic collapse as just a lost incentive to produce, and the mass unemployment as a result of high and rigid real salary.

To Keynes, the willpower of salary is more difficult. First, he argued that it is not real but nominal wages that are set in discussions between employers and personnel, as opposed to a barter romantic relationship. Second, nominal income slashes would be difficult to put into result because of laws and regulations and wage agreements. Even classical economists admitted that these exist; unlike Keynes, they advocated abolishing lowest income, unions, and long-term contracts, increasing labor-market overall flexibility. However, to Keynes, people will withstand nominal income reductions, even without unions, until they see other salary falling and a general fall of prices.

He also argued that to improve employment, real income had to decrease: nominal wages would have to show up more than prices. However, doing so would reduce consumer demand, so the aggregate demand for goods would drop. This would in turn reduce business sales revenues and expected gains. Investment in new vegetation and equipment perhaps already discouraged by past excesses-would then become more risky, less likely. Instead of increasing business expectations, income cuts will make issues much worse.

Further, if pay and prices were falling, people would commence to expect them to fall. This could make the market spiral downward as those who acquired money would simply wait as falling prices managed to get more valuable somewhat than spending. As Irving Fisher argued in 1933, in his Debt-Deflation Theory of Great Depressions, deflation (falling prices) can make a depressive disorder deeper as dropping prices and income made pre-existing nominal debts more valuable in real terms.

To Keynes, unnecessary cutting down, i. e. saving beyond planned investment, was a serious problem, encouraging recession or even major depression. Excessive saving results if investment falls, perhaps credited to falling consumer demand, over-investment in prior years, or pessimistic business expectations, and if cutting down will not immediately show up in step, the economy would decline.

The traditional economists argued that interest rates would fall because of the excess supply of "loanable funds". The first diagram, modified from the only real graph in THE OVERALL Theory, shows this technique. (For ease, other sources of the demand for or way to obtain funds are disregarded here. ) Believe that predetermined investment in capital goods comes from "old I" to "new I" (step a). Second (step b), the resulting excess of conserving causes interest-rate slices, abolishing the surplus source: so again we've saving (S) add up to investment. The interest-rate (i) fall inhibits that of development and work.

Keynes experienced a complex discussion from this laissez-faire response. The graph below summarizes his debate, assuming again that set investment falls (step A). First, saving does not fall much as rates of interest fall, since the income and substitution ramifications of falling rates use conflicting directions. Second, since organized set investment in herb and equipment is mainly based on long-term anticipations of future success, that spending will not climb much as rates of interest fall. So S and I are drawn as steep (inelastic) in the graph. Given the inelasticity of both demand and offer, a huge interest-rate fall is required to close the conserving/investment difference. As drawn, this requires a negative interest rate at equilibrium (where the new I range would intersect the old S series). However, this negative interest rate is not essential to Keynes's discussion.

Third, Keynes argued that saving and investment aren't the key determinants of interest levels, especially in the brief run. Instead, the supply of and the demand for the stock of money determine interest rates in the short run. (This isn't used the graph. ) Neither changes quickly in response to abnormal saving to permit fast interest-rate modification.

Finally, because of fear of capital losses on belongings besides money, Keynes advised that there may be a "liquidity capture" establishing a floor under which rates of interest cannot land. While in this capture, rates of interest are so low that any upsurge in money supply may cause bond-holders (fearing rises in interest rates and hence capital losses on their bonds) to sell their bonds to realize money (liquidity). Inside the diagram, the equilibrium recommended by the new I brand and the old S series cannot be reached, so that unwanted protecting persists. Some (such as Paul Krugman) see this latter kind of liquidity capture as prevailing in Japan in the 1990s. Most economists concur that nominal interest levels cannot show up below zero. However, some economists (particularly those from the Chicago university) reject the life of a liquidity snare.

Even if the liquidity snare does not can be found, there is a fourth (perhaps most important) component to Keynes's critique. Cutting down includes not spending all of one's income. It thus means inadequate demand for business end result, unless it is well balanced by other sources of demand, such as resolved investment. Thus, extreme keeping corresponds to an unwanted accumulation of inventories, or what traditional economists called a general glut. This pile-up of unsold goods and materials encourages businesses to diminish both production and employment. Therefore lowers people's incomes-and keeping, triggering a leftward transfer in the S brand in the diagram (step B). For Keynes, the land in income does most of the work by ending unnecessary cutting down and allowing the loanable money market to attain equilibrium. Rather than interest-rate adjustment dealing with the challenge, a recession does so. Thus in the diagram, the interest-rate change is small.

Whereas the traditional economists assumed that the level of outcome and income was constant and given at anybody time (aside from short-lived deviations), Keynes found this as the key variable that changed to equate cutting down and investment.

Finally, a tough economy undermines the business incentive to activate in set investment. With falling incomes and demand for products, the required demand for factories and equipment (not forgetting housing) will fall. This accelerator effect would move the line left again, a change not shown in the diagram above. This recreates the problem of excessive saving and induces the recession to keep.

In sum, to Keynes there is interaction between surplus supplies in different marketplaces, as unemployment in labor market segments encourages excessive saving and vice-versa. Instead of prices adjusting to realize equilibrium, the main storyline is one of quantity adjustment allowing recessions and possible attainment of underemployment equilibrium.

The two key theories of mainstream Keynesian economics are the IS-LM style of John Hicks, and the Phillips curve; both these are declined by Post-Keynesians.

It was with John Hicks that Keynesian economics produced an obvious model which policy-makers could use to attempt to understand and control economic activity. This model, the IS-LM model is practically as influential as Keynes' original examination in determining actual policy and economics education. It relates aggregate demand and job to three exogenous amounts, i. e. , the money in circulation, the government budget, and the express of business expectations. This model was very popular with economists after World Warfare II since it could be known in terms of standard equilibrium theory. This inspired a much more static vision of macroeconomics than that detailed above.

The second main part of an Keynesian policy-maker's theoretical equipment was the Phillips curve. This curve, which was more of an empirical observation than a theory, mentioned that increased employment, and decreased unemployment, implied increased inflation. Keynes experienced only forecasted that slipping unemployment would result in a higher price, not really a higher inflation rate. Thus, the economist could use the IS-LM model to anticipate, for example, an increase in the amount of money supply would increase output and employment and then use the Phillips curve to predict a rise in inflation

Criticism

This article's Criticism or Controversy section(s) may signify the article does not present a natural viewpoint of the subject. It may be better to incorporate the materials in those parts in to the article as a whole.

Monetarist criticism

One school began in the past due 1940s with Milton Friedman. Rather than rejecting macro-measurements and macro-models of the overall economy, the monetarist university embraced the techniques of dealing with the entire overall economy as possessing a supply and demand equilibrium. However, because of Irving Fisher's equation of exchange, they regarded as inflation as only being because of the variations in the amount of money supply, somewhat than as being a consequence of aggregate demand. They argued that the "crowding out" results talked about above would hobble or deprive fiscal insurance policy of its positive impact. Instead, the concentration should be on financial policy, which was considered inadequate by early on Keynesians.

Monetarism experienced an ideological and a practical appeal: monetary insurance plan will not, at least on the top, imply all the government intervention throughout the market as other steps. The monetarist critique pressed Keynesians toward a far more healthy view of financial policy, and motivated a influx of revisions to Keynesian theory.

New traditional macroeconomics criticism

Another influential school of thought was based on the Lucas critique of Keynesian economics. This needed greater steadiness with microeconomic theory and rationality, and especially emphasized the idea of rational anticipations. Lucas and more argued that Keynesian economics required incredibly foolish and short-sighted habit from people, which totally contradicted the financial understanding of their habit at a micro level. New classical economics introduced a set of macroeconomic theories which were based on optimizing microeconomic action. These models have been developed into the Real Business Cycle Theory, which argues that business cycle fluctuations can to a big level be accounted for by real (in contrast to nominal) shocks.

Austrian economist Friedrich Hayek criticized Keynesian economical regulations for what he called their fundamentally collectivist approach, arguing that such theories encourage centralized planning, which brings about incorrect investment of capital, which is the cause of business cycles. Hayek also argued that Keynes' study of the aggregate relationships in an current economic climate is fallacious, as recessions are induced by micro-economic factors. Hayek claimed that what starts as temporary governmental fixes usually become everlasting and expanding government programs, which stifle the private sector and civil population.

Other Austrian college economists also have attacked Keynesian economics. Henry Hazlitt criticized, paragraph by paragraph, Keynes' Standard Theory. Murray Rothbard accuses Keynesianism of experiencing "its origins deep in middle ages and mercantilist thought. "

Methodological disagreement and various results that emerge

Beginning in the late 1950s neoclassical macroeconomists began to disagree with the strategy utilized by Keynes and his successors. Keynesians emphasized the dependence of usage on disposable income and, also, of investment on current earnings and current cash flow. Furthermore Keynesians posited a Phillips curve that linked nominal wage inflation to unemployment rate. To buttress these ideas Keynesians typically tracked the rational foundations of their model (using introspection) and buttressed their assumptions with statistical facts. Neoclassical theorists demanded that macroeconomics be grounded on the same foundations as microeconomic theory, profit-maximizing companies and utility making the most of consumers.

The consequence of this change in methodology produced several important divergences from Keynesian Macroeconomics

Independence of Use and current Income (life-cycle long lasting income hypothesis)

Irrelevance of Current Income to Investment (Modigliani-Miller theorem)

Long run independence of inflation and unemployment (natural rate of unemployment)

The failure of monetary policy to stabilize outcome (rational anticipations)

Irrelevance of Fees and Budget Deficits to Ingestion (Ricardian Equivalence)

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