AP_Krugman_Textbook

Keynes’s ideas have penetrated deeply into the public consciousness, to the extent

that many people who have never heard of Keynes, or have heard of him but think they

disagree with his theory, use Keynesian ideas all the time. For example, suppose that a

business commentator says something like this: “Because of a decline in business con-

fidence, investment spending slumped, causing a recession.” Whether the commenta-

tor knows it or not, that statement is pure Keynesian economics.

Keynes himself more or less predicted that his ideas would become part of what

“everyone knows.” In another famous passage, this from the end of The General Theory,

he wrote: “Practical men, who believe themselves to be quite exempt from any intellec-

tual influences, are usually the slaves of some defunct economist.”

Policy to Fight Recessions

The main practical consequence of Keynes’s work was that it legitimized macroeco-

nomic policy activism—the use of monetary and fiscal policy to smooth out the busi-

ness cycle.

Macroeconomic policy activism wasn’t something completely new. Before Keynes,

many economists had argued for using monetary expansion to fight economic down-

turns—though others were fiercely opposed. Some economists had even argued that

temporary budget deficits were a good thing in times of recession—though others dis-

agreed strongly. In practice, during the 1930s many governments followed policies that

we would now call Keynesian. In the United States, the administration of Franklin

Roosevelt engaged in modest deficit spending in an effort to create jobs.

But these efforts were half - hearted. Roosevelt’s advisers were deeply divided over

the appropriate policies to adopt. In fact, in 1937 Roosevelt gave in to advice from

346 section 6 Inflation, Unemployment, and Stabilization Policies

The End of the Great Depression

It would make a good story if Keynes’s

ideas had led to a change in economic

policy that brought the Great Depression to

an end. Unfortunately, that’s not what hap-

pened. Still, the way the Depression ended

did a lot to convince economists that Keynes

was right.

The basic message many of the young

economists who adopted Keynes’s ideas in

the 1930s took from his work was that eco-

nomic recovery requires aggressive fiscal

expansion—deficit spending on a large

scale to create jobs. And that is what they

eventually got, but it wasn’t because politi-

cians were persuaded. Instead, what hap-

pened was a very large and expensive war,

World War II.

The figure here shows the U.S. unem-

ployment rate and the federal budget deficit

as a share of GDP from 1930 to 1947. As

you can see, deficit spending during the

1930s was on a modest scale. In 1940, as

the risk of war grew larger, the United States

began a large military buildup, and the budget

moved deep into deficit. After the attack on

Pearl Harbor on December 7, 1941, the country

began deficit spending on an enormous scale:

in fiscal 1943, which began in July 1942, the

deficit was 30% of GDP. Today that would be a

deficit of $4.3 trillion.

And the economy recovered. World War II

wasn’t intended as a Keynesian fiscal policy, but

it demonstrated that expansionary fiscal policy

can, in fact, create jobs in the short run.

fyi

30%

20

10

0

–10

War-time

deficit

spending

Unemployment rate,

budget deficit

(percent of GDP)

Year

1930 1933 1936 1939 1942 1945 1947

Unemployment rate

Budget deficit

Macroeconomic policy activismis the
use of monetary and fiscal policy to smooth
out the business cycle.