What is The Keynesian Theory？

Welcome to the Investors Trading Academy talking glossary of financial terms and events. Our word of the day is Keynesian Theory. Keynesian economics was developed by the British economist John Maynard Keynes during the 1930s in an attempt to understand the Great Depression. Keynes advocated increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the depression. Subsequently, the term Keynesian economics was used to refer to the concept that optimal economic performance could be achieved and economic slumps prevented by influencing aggregate demand through activist stabilization and economic intervention policies by the government. Prior to Keynesian economics, classical economic thinking held that cyclical swings in employment and economic output would be modest and self-adjusting. According to this classical theory, if aggregate demand in the economy fell, the resulting weakness in production and jobs would precipitate a decline in prices and wages. Keynesian economics refutes the notion held by some economists that lower wages can restore full employment by arguing that employers will not add employees to produce goods that cannot be sold because demand is weak. Similarly, poor business conditions may cause companies to reduce capital investment rather than take advantage of lower prices to invest in new plants and equipment. This would also have the effect of reducing overall expenditures and employment.