Keynesian Policy Keynes Policies

Keynesian Policy, Keynes Policy, Keynesian Policies

Keynesian economics subsumed policy argumentation and developed a model that had built into it the need for activist government policies. In this model, aggregate demand controlled the level of income in the economy, and the government had to control aggregate demand through monetary and fiscal policies.

During the 1950s and 1960s, Keynesian policy came to mean fine-tuning through monetary and fiscal policy. Abba Lerner (1903-1982) was an influential force in directing Keynesian analysis toward such fine-tuning. In his Economics of Control (1944), Lerner advocated that government not follow a policy of sound finance (always balance the budget); it should instead follow a policy of functional finance, which considered only the results of policies, not the policies themselves.

Functional finance allowed the government to "drive" the economy; in an oft-repeated metaphor, monetary and fiscal policy were portrayed as govern­ment's steering wheel. Lerner contended that fiscal and monetary policy were the tools government should use to achieve its macroeconomic goals: high employment, price stability, and high growth. The size of the deficit was totally irrelevant: if there was unemployment, the government should increase the deficit and the money supply; if there was inflation, the government should do the opposite.

Lerner's blunt statement of the "Keynesian" argument offended the sensibili­ties of many Keynesians and provoked considerable discussion, even causing Keynes to disavow Keynesianism.13 Evsey Domar, a well-known Keynesian at the time, said, "Even Keynesians, upon hearing Lerner's argument that the size of the deficit did not matter, recoiled and said, no he had it wrong, in no uncertain terms."14 But Keynes soon changed his mind and agreed with Lerner, as did much of the economics profession, and it was not long before Keynesian economic policy became synonymous with functional finance.Monetary and fiscal policies were, moreover, politically palatable. Many economists and others believed the Depression proved that the government had to assume a much larger role in directing the econorriy. The use of monetary and fiscal policy kept that role to a minimum. Markets could be left free to operate as before. The government would not directly determine the level of investment; it could simply affect total income indirectly by running a budget deficit or surplus. For many, the legitimization of deficits had a second desirable charac­teristic: it allowed government to spend without taxing.