Keynesian Demand Management

The notion of demand management is commonly used in the field of macroeconomics in relation to the adoption of government policies that facilitate the achievement of full employment equilibrium in the economy. The widely known scholar John Maynard Keynes first advocated such intervention in his classic 1936 work General Theory. The British economist was a stark critic of the classical orthodoxy, in particular of the culture of laissez-faire whereby market imbalances are best dealt by natural adjustments of demand and supply, which, under certain conditions, are expected to restore equilibrium prices and quantities. Keynes observed that such imbalances tend to occur cyclically as a consequence of lack of demand, and if left untreated, could degenerate in severe downturns or periods of prolonged recession. Since under such circumstances the private sector is unable to boost demand, Keynes argued that government should intervene directly and “spend its way out of a recession,” that is, run a budget deficit. Subsequently, as soon as private sector spending had been restored to normal levels, government should reduce spending and pay off the debts accumulated during the downturn.

Prolonged slumps in the economy carry the danger of triggering a virtuous circle: as unemployment rises and real wages fall, both consumer confidence and aggregate demand decrease thus creating a financial burden due to unemployment benefits (in economies [Page 830]like the United Kingdom) as well as diminished revenue from direct and indirect taxation. Government interventions following the Keynesian recipe are also known as counter-cyclical demand management policies: this is because if aggregate demand is lower than equilibrium levels, then government should pursue reflationary policies—such as cutting taxes or boosting government spending—to push demand up and boost employment and output. On the other hand, if aggregate demand is higher than the equilibrium level and there are risks of inflation, the prescription is adopting deflationary policies, such as tax increases or cutting public spending.

In the aftermath of World War II, Keynesian economics shaped policy in several advanced countries, which had set full employment as a primary target. Those strategies based on massive government intervention, however, had a mixed record. During the 1950s and 1960s, most nations enjoyed the strongest and most sustained period of economic growth and prosperity ever recorded before or since, with high real wages allowing more households to improve their lifestyles by purchasing expensive durable goods such as televisions and cars. These phenomena are at the root of the dramatic changes that characterized the emergence of the so-called affluent society. By the mid-1970s, however, a dramatic turn in macroeconomic conditions around the world due to the oil crisis led to generalized stagflation, that is, strong inflation combined with high unemployment levels. It has been observed that at the root of the recurring crises in international financial relationships in the postwar period were substantial price variations across economies and that such discrepancies tended to grow as inflation accelerated. By 1973, the Bretton Woods system of normally fixed exchange rates was replaced by a regime of fluctuating rates, which would eventually push inflation even more. Most national authorities sought refuge in monetary and fiscal policies aimed at containing inflation. However, inflation has proven stubbornly persistent everywhere. Germany, Switzerland, the Netherlands, and Japan managed to restore acceptable levels by the end of the 1970s followed by the United States in the early 1980s, but several other countries did not manage until the 1990s. Similarly, unemployment grew rapidly worldwide, also partly due to the reorientation of industrial production away from commodities and toward services.

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