To What Extent Were the Rise and Fall of the Keynesian Consensus Driven by Events in the World Economy?

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English economist John Maynard Keynes was one of the most influential people of the 20th century. As described in The General Theory of Employment, Interest and Money that he published in 1936, Keynes believed that the free market could not be trusted to determine fair prices and provide employment during recessions, but rather that during hard times governments should intervene and create artificial aggregate demand at the expense of a balanced budget. Primarily as a result of world events, his theories became the dominant economic policies in developed countries of the western world for almost three decades, especially in the United States and the United Kingdom. This essay will examine how the Great Depression and World War II led to rise of the Keynesian consensus in the early 1940s, and how the end of the Bretton Woods system, the oil crises of the 1970s, and stagflation led to its unravelling just thirty years later. The failures of economic policies employed during the Great Depression left the American government more open to the ideas of Keynes. In the year 1929, the Wall Street stock market crash triggered a depression so severe, the likes of which have yet to be seen. The response by the American government at the time, led by president Herbert Hoover, was a ‘do nothing’ ‘laissez faire’ approach believing that the markets would right themselves, in allowing better businesses to take the place of the failed ones. This was not looked upon favourably because, as Clarke put it, “although market forces ensured a permanent tendency to a full employment equilibrium, market forces took time to operate”.[1] Where classical economists had argued that during a depression, governments should raise taxes and strive to balance the budget through reduced spending, Keynes contended that government should stimulate demand through reduced interest rates, tax cuts and
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