Keynesian Economics Misconceptions

The confusion over what Keynesianism is; especially in its modern form, referred to as New Keynesianism, and what it's implications are is quite frustrating. Both sides, at least in popular discussion, seem to mistake Keynesianism for the idea that spending and bigger government is what drives growth. The left uses this as a justification for increased spending and redistribution as a means of growing the economy. The right scoffs at this idea as overly simplistic and a contradiction to Say's "Law." The problem is, this interpretation is completely wrong to begin with.


In reality, it has nothing to do with long-run growth. New Keynesian economics seeks to stabilize the business cycle. In other words; mitigating the risks of recessions, and reducing the length and severity of them when they do occur. The main stabilizing mechanism used is not even increased government spending, it is monetary policy. Specifically, New Keynesians generally support Central Banks setting inflation targets, and adjusting interest rates in order to achieve this level. Inflation is used as a proxy of demand, because when demand exceeds supply, inflation increases. This is why New Keynesians tend prefer a target of around 2% inflation growth per year. This level of stable demand growth is meant to protect the economy from sudden, rapid changes in demand, in which businesses may not have enough time to adjust wages and prices and thus face severe difficulties, and potentially leading to recession. So in general, that's what New Keynesian economics promotes. The main idea is to reduce interest rates to boost investment, inflation, and sending, when inflation is below target, and raise them when inflation is above target.


Spending only enters the equation when interest rates hit zero, and thus the central bank is considered unable to do anything (or much else) to stimulate the economy. Even then, there is no actual idea that spending or deficits are what is necessary to boost the economy. Greg Mankiw, a well known New- Keynesian, advocates for tax cuts in these circumstances. Others argue that government spending multipliers are higher than tax cut multipliers, so they can actually stimulate the economy without adding to the deficit, simply by hiking taxes and raising spending in proportion. Yes, in many cases large amounts of deficit spending are advocated for under these circumstances, but these are a particularly rare set of circumstances to begin with, and one in which interest rates are low enough that deficit spending will not result in large debt payments later on.


There are significant problems with New-Keynesian economics, as market monetarists (a newer school of thought that has a good deal of similarities to NK econ) have pointed out, but overall it is a solid, empirically backed, but often misunderstood school of thought. While it may appear competing schools of thought (I.E. Austrianism, MMT, Marxism) have a good deal of traction, they simply are near irrelevant in the economics profession. New-Keynesianism deserves to be taken seriously, and interpreted properly.