Keynesian Economics is a theory put forth by the British economist, John Maynard Keynes. It was used to analyze the Great Depression and was influential in the decision of the United States government to enforce interventionist economic policies.
According to Keyes, a healthy economy encourages spending, because whenever anyone makes any purchase—whether it be a product or a service—it actually supports another person’s income. In tough times, however, most people will hoard money, which will cripple industries. Shops will close down, and people will lose their jobs, which will further lead to lower spending. This leads to a sluggish economy, and an unemployment crisis where the government has to support formerly productive, independent citizens.
Keyes believed that the government should “prime the pump” or create situations where people would spend more. President Franklin Roosevelt followed his advice, and some people believe that his initiatives were one of the reasons behind America’s economic revival and the end of the Depression.
Such government intervention was a big step away from the common economic principle of laissez faire, or free-market capitalism. Basically, supporters of laissez faire believe that the government should not interfere with the economy, since the market would eventually find its own equilibrium. Any interventions would be disastrous, and its gains artificial and short-term.
Interestingly, one of the most prominent founders of free-market capitalism was a personal rival of Keynes: Friedrich von Hayek. Their debates were legendary, and long after their deaths, were continued by supporters of their very different economic theories.