Wages fell. Prices fell. The jobs did not come back.: The classical answer to a slump was wait. In the 1930s people waited for years and in some countries a quarter of workers still had no job.
John Maynard Keynes said the theory was wrong, not the world: an economy can sit stuck with too little spending and stay there.
Why waiting does not work
- Cutting wages cuts spending. Workers are also customers — pay them less and there is less demand for what they make.
- Fear feeds itself. Firms will not hire until sales rise; sales will not rise until people are hired.
- Saving is not automatically investing. Money put aside in a frightening year is money nobody is spending.
So somebody has to break the circle: If households will not spend and firms will not invest, Keynes said the government should — building things, paying wages, putting money into hands that will use it.
Not because deficits are good. Because a stuck economy does not restart itself.
This is where macroeconomic policy begins as a government job at all. Before Keynes, managing the whole economy was not something a treasury thought it did.
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Then the 1970s produced something Keynes did not predict: High unemployment and high inflation, together. The Keynesian toolkit treated those as opposites — you traded one for the other.
Milton Friedman argued the cause was the money supply growing faster than what the economy actually produced.
The new classical economists who followed went further: if people see a policy coming, they change their behaviour and it stops working.
Keynes
- Too little spending is the problem.
- Government spending can fix it.
- In the long run we are all dead — act now.
Friedman and the monetarists
- Too much money is the problem.
- Government spending mostly makes it worse.
- Control the money supply and let markets do the rest.
- New classical: people anticipate policy, which blunts it.
Notice what this is really an argument about: Not maths. Both sides can draw the other's diagram.
They disagree about how quickly markets right themselves — and therefore about whether waiting is prudent or cruel. That is 1.2.2's positive and normative split, in the wild.
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Nobody won. Both toolkits are on the shelf.: In 2008 governments cut interest rates hard and spent heavily at the same time — a monetarist lever and a Keynesian one, pulled together.
Today's arguments are about how much and for how long, not about which school is correct.
What almost everyone now accepts
- Demand can be too low, and that causes real unemployment.
- Printing money without output behind it causes inflation.
- Central banks matter enormously.
What is still fought over
- How fast markets correct on their own.
- How much government debt is too much.
- Whether the cure costs more than the disease.
This is the most useful thing in the topic: "Some economists would argue…" is worth nothing on its own.
Which economists, and why — because they expect markets to correct quickly, or because they do not — is an argument.