Keynes and Classical Economics

Read this article for more information about these competing perspectives. This section contains four subsections: "Wages and Spending," "Excessive Saving and Interest Rates," "Active Fiscal Policy," and "Multiplier Effect". Focus your attention on the portions within the four subsections that emphasize the short-run. You may observe that the differences among the various subsections tend to deal with the underlying nature of change.

Keynes and classical economics

Multiplier effect

Keynes focused on consumption spending as the principal determinant of income growth, arguing that consumption releases purchasing power to producers and thereby validates their investment plans. Saving plays no positive role in supplying the funds for investment in Keynes' reasoning:

The investment market can become congested through the shortage of cash. It can never become congested through the shortage of saving

Saving has no special efficacy as compared with consumption, in releasing cash and restoring liquidity.

Consumption spending thus is the means through which an initial amount of expenditure creates a multiplier effect. In a simplified model,

  • [DELTA]Y = k[DELTA]Z = (1/s) [DELTA]Z,

where Y is nominal income (GDP), k is the multiplier, s is the marginal propensity to save, and Z is some "autonomous" expenditure, such as investment or government expenditure that does not depend on domestic savings. Keynes, by his elaboration of Richard Kahn's earlier argument, thus exalts consumption spending to a magical significance in macroeconomic analysis, contrary to the classical emphasis on production and saving for investment in order to promote the growth of output and employment. Such popular claims as "the current U.S. economic expansion is being driven by consumer spending" also reflects the Keynesian multiplier view.