Keynesianism is a term that identifies both a school of economic theory and a distinctive approach to public policy. Regarding theory, it can be said that the English economist John Maynard Keynes (1883–1946) invented modern macroeconomics with the publication in 1936 of his masterwork The General Theory of Employment, Interest, and Money. That book shifted the focus of attention from the microeconomic actions of individuals and firms to the overall behavior of a capitalist economy.
Keynes argued that, contrary to the conventional wisdom embodied in Say's Law, the capitalist economy did not contain a self-correcting or homeostatic mechanism that would necessarily return it to a healthy equilibrium over the course of the business cycle. Rather, as the contemporaneous Great Depression seemed to demonstrate, a deficiency in effective demand could result in equilibrium at an intolerably high level of unemployment. In the Keynesian model, government policy to bolster aggregate demand, especially fiscal action (spending and taxing) to increase either consumption or the particularly volatile element of investment, could be used to drive an underperforming economy to full employment. Because of the so-called "multiplier effect" that Keynes invoked as a central element in his model, such action could have an ultimate economic impact several times larger than the magnitude of the government's initial corrective intervention.
In the period from World War II through the early 1970s, Keynesianism rose to ever greater influence as both a theory and a guide for public policy. The Keynesian analysis gained a prominent place in textbooks, and its terminology increasingly became the common language of both economists and policymakers. The experience of World War II, with its massive deficit spending, seemed to validate Keynes's approach, and the subsequent Cold War and the later expansion of social spending left the federal government with a sufficiently large presence in the U.S. economy to serve as a Keynesian lever. The size of postwar budgets meant that changes in federal spending and taxing had a powerful impact on the overall economy. Embraced most fervently by Democrats but influential also in Republican circles, the Keynesian policy approach gained its fullest expression in the liberal presidencies of the 1960s, most prominently in the Kennedy-Johnson tax cut of 1964. In 1965, Time magazine put Keynes's picture on its cover in a tribute to the influence of his economic vision.
With the onset of stagflation in the 1970s, Keynesianism began to lose influence both as a theory and as a policy. Unable to explain adequately the economic malaise of simultaneous stagnation and inflation, it came under theoretical assault by the monetarist and the rational expectations schools of economic thought. Suspected of being itself a primary contributor to inflation, Keynesianism was increasingly supplanted by policy approaches aimed more at the supply side of the economy.
At the end of the twentieth century, Keynesianism still provided much of the lingua franca of macroeconomics. However, both as a theory and as a policy, it lived on only in a much chastened and attenuated form, more a limited analysis and a special prescription for particular circumstances than the general theory Keynes had originally proclaimed it to be.
Collins, Robert M. More: The Politics of Economic Growth in Postwar America. New York: Oxford University Press, 2000.
Keynes, John Maynard. The General Theory of Employment, Interest, and Money. London: Macmillan, 1936.
Skidelsky, Robert. Keynes. Oxford: Oxford University Press, 1996.
Stein, Herbert. The Fiscal Revolution in America. Chicago: University of Chicago Press, 1969.