Keynesian Economics

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Depression

During the 1930s, the global economy collapsed. While no one is certain just what caused it, there were a number of people and events in the U.S. that certainly did not help the situation.

The Stock Market Crash of 1929 is often considered the beginning of the Great Depression, but it did not have to be.

President Herbert Hoover initially treated the crash as simply a matter of public relations. He thought that as long as he projected a positive attitude about the crash, the economic repercussion would simply disappear.

• How could he believe this?

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Hoover was one of three Republicans elected during the 1920s who all had a very similar view of the economy. They thought the economy would function properly if the budget was balanced and government kept itself out of business. They believed governmental intervention would only prolong the Great Depression.

Even though Hoover invested marginally in the economy, unemployment continued to rise at a dramatic rate.

• What were they going to do?

John Maynard Keynes

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The U.S. economy was in shambles by the 1930s when British economist John Maynard Keynes revealed his brand-new solution to traditional economic theory in his book The General Theory of Employment, Interest, and Money.

His beliefs diverged from Hoover. Instead of balancing the budget, Keynes thought the only way out of a depression like this was for government to spend far more than it made.

• How could this be good during economic ruin?

To see how Keynes justified this idea, watch a portion of John Maynard Keynes, Influencing the Economy from NBC News Learn:

Keynes thought that, by increasing spending and decreasing taxes, more money could be put into the hands of Americans and this would be the fastest way to jump-start the economy.

• But at what cost?

Instead of balancing the budget, his theory advocated for the exact opposite. It also assumed, however, that the government would pay off this increased debt as soon as economic prosperity was restored.

It is important to realize that no economic theory is perfect, but Keynes' theory recognized that the economy was not always going to behave as expected.

• Was it really possible, however, to fix an economy just by spending a lot of money?
• Or did something else happen to make the investment worth it?

Franklin D. Roosevelt

In the final months of Hoover's administration, he tried out some of Keynes' economic theories. It was far too late by that time, however, and he did not spend very much. There was no way he was going to be re-elected.

Instead, Franklin Roosevelt was elected, and he immediately embraced the tenants found in The General Theory of Employment, Interest, and Money.

Roosevelt passed 76 laws within his first 100 days in office, most aimed at the economy. He subsidized American farmers so they could have a stable income, and he established public projects that would go on to hire millions of people.

Later, he founded the Social Security program, which gave people too old to work financial independence.

• What effect did FDR's policies have on the American people and public morale?

See how the mood turned to one of hope as you watch America the Story of Us: FDR | History:

Inspired by Keynesian theory, Roosevelt focused on establishing public works projects where people were hired to build roads, trails, bridges, and hydroelectric dams.

While the nation may not have needed all this infrastructure at the time, it was a way to massively lower the unemployment rate and get the economy moving.

Look at this graph showing the U.S. unemployment rate from 1910-1960, and note how it changed in 1933, when FDR became president:

^{Image by Pharexia, via Wikimedia Commons, is licensed under the CC BY-SA 4.0 license.}

FDR's policies had a very real effect on the unemployment rate and the lives of the American people. However, by 1940, 15% of Americans were still out of work.

• What brought it all the way down to ~2% just a few years later?

World War II took the idea of Keynesian economics and magnified it 10 times. While public works projects were slowly bringing the country back to normal, the amount of money the U.S. government had to spend because of WWII was far greater than the amount FDR ever planned on spending.

While Keynesian economic theory undoubtedly helped the economy, WWII is what brought the United States to the global forefront and helped it become a prosperous superpower afterward.

Legacy

By the time Roosevelt was elected to his fourth-straight term in office, a large number of Americans in their 30s and 40s had only ever voted for him. These voters, and the country at large, were encouraged by the prosperity FDR's presidency brought and wanted to continue his policies.

Roosevelt's success and popularity made Keynesian economics the standard economic theory up until the 1970s, when the American economy, again, stopped working as expected.

In the 21st century, more fiscally liberal economists and politicians, who see government spending as a means to prosperity, still practice Keynesian economic theory.

Continue on to the Got It? section to review this theory and how influential it was.