If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content
Current time:0:00Total duration:8:14

Video transcript

in the last video we'd had a little bit of a review of classical economics and then we talked about how Keynesian thinking was a departure especially and why it might have made sense in the context of the Great Depression where the economy was operating well below its potential what I want to do in the end it may be true anytime that the economy is operating well below its potential but what I want to talk about in this video is how Keynesian thinking can sometimes be dangerous and one thing I do want to emphasize over the course of this video is key Keynesian policies are often associated with people on the left with with policies on the left but Democrats in the United States but the Republicans also are for the most part especially mainstream Republicans especially the last several administration's they have practiced what are what can only be described as Keynesian policies when the economy started to recede they tried to stimulate it by shifting aggregate demand to the right somehow and we'll talk about that they tried to do it in a slightly different way through tax cuts instead of government increases the spending increases but it was Keynesian and its underlying thinking now just as a bit of a kind of back up I'm going to talk a little bit more about that cycle that we talked about in the last video so if you had person a person B person C and person D or maybe they're firms and B supplies a a supplies D D supplies C and C supplies B and for the sake of simplicity we said that they're also applying two units of their good and service to each other and let's just say that C has a bad dream feels pessimistic ate something bad and all of a sudden that isn't feeling good about the future and wants to buy less just out of caution maybe wants to hoard a little bit of cash and things this in case she needs it and so he buys a little bit less from D so he buys a little bit less than D but D says gee my business is bad now I can't afford as many goods and services buys less from AAA does the same thing from B and then bees business is bad so buys less from less stuff from C goods and services from C and now C feels like they're psychic but even though we see that it was actually a self-fulfilling prophecy that sees pessimism actually led to that reality actually occurring and in a worse case that actually could get worse and worse he could see wow I was pessimistic and I was right my business actually did get bad maybe even got worse maybe even it got worse than she had expected and then c-could then say well I'm gonna buy even less maybe I'm only gonna buy a half from D maybe I'm only gonna buy a half from D now and then D says maybe I'm only going to buy a half from E and that cycle could go down and down and down until each of them are just buying exactly just just what they need to get by even though they all could be producing more the economy could be producing more it could be wealthier and they all could be way better off and so this might this is at least in my mind a pretty good description of what happens in depressions especially the Great Depression and so there might be a rationale to say hey look why don't we why doesn't the government come here at some point in this economy and stimulate demand so why doesn't the government come here so let's say B is already buying one from C the government comes and says hey I'll buy another one I'll buy another one from C and then C says hey gee things are good again I can buy two from I can buy two from D D could buy two from a and then a can buy two from B and then B can buy two from C and so things have kind of gotten back to their potential state the economy is revving now in an ideal state the government would say hey my work is done now I can now take a step back I could take a step back and I don't want to overheat the economy I don't want to push aggregate demand too far to the right and cause inflation and so they will they will take a step back now the danger here is that this is not so easy for governments to do this was some type of stimulus some type of government spending although maybe it was a tax in maybe was a tax a decrease and maybe B could have increased their demand but either way once you do a policy like this and let's say it was government spending it's very hard to unwind this government spending might have been for project that some people like it might have employed many many people those people are voters they're not just going to sit there while you cancel this government project and so there's a risk that maybe there is a justification for Keynesian policy but when it's time to undo that Keynesian policy to undo that stimulus it's very hard to do it it's kind of a sticky policy and so what you might have is when times are bad you do is Keynesian stimulus stimuli but then when times are good not willing to undo it and that Keynesian stimuli involves more and more deficit spending or more and more government spending then the government size is just going to grow relative the economy or the deficit is just going to go around to the economy and you're never going to unwind it because the unwinding is unpopular and I want to be clear that this is true of both the left and the right in the stereotypical sense the left might say hey let's do a Keynes Ian's stimulus by spending more so the government spends more and let's hold our revenue constant our tax revenue let's hold it constant and so obviously the government would have to borrow more money to fund this but or sometimes they might even increase taxes if they actually want it to be more purist about it but this is the variety that you you see and this would be a true stimulus this is it using the fiscal lever to put more demand in the economy but on the right you often see the other side you see taxes being lowered essentially saying instead of the government spending it why don't we let people decide where to spend it and they might spend it in a more efficient way and but it's going to be a stimulus because spending is held constant and then you have the double where where you do both sides of it where you lower the taxes you lower the inbound revenue and you increase spending so and this is true this has been done by both Republican and Democratic administrations lowering taxes but then going and starting a hugely expensive war and obviously this will increase deficits and there might even be a justification for doing any of these Keynesian justification if the economy truly is operating well below its potential the tough thing is is it might be justified you actually don't know exactly where that potential is and you might not be able to unwind this once you get to your potential then you might overheat the economy might lead to inflation and that will that actually might undermine the productivity of the actual economy the other negative of a Keynesian mindset is what happens over the long run in the short run this might make a lot of sense let's let's prime the pump let's get the cycle to happen in the right way again but in the long run it's essentially just trying to get people to consume and consume more you'll often hear when the economy slows down a little bit you'll hear the president you'll hear politicians say hey we're just trying to get people to spend more through some combination of these Keynesian policies we're gonna lower taxes we're going to increase spending but they never say you ever hear them say hey we want people to save more so that we can invest more so that in the classical sense so in the classical sense we can increase our total productive capacity now the US has kind of gotten a free pass on this because the US has been doing essentially the deficit spending it's been able to do the Keynesian stimuli and and and that's why the US consumer keeps spending more and more saving less and less the government is doing the same thing but the US has also been getting investment because it's the foreigners who have been saving and then plowing that money and they've been essentially investing in the u.s. so that the US could increase its productive capacity but that is a risk for a country if it's not blessed with that kind of free pass that the US has gotten for the last several decades is that when you have some resources so in a given year you have some resources let's say it's your time you could either hunt you could either hunt and eat rabbits or you could use those or you could spend your time to invent new rabbit trapping devices so this is kind of the hunting and eating the rabbits and this is spending some time to go and figure out ways to be more productive at hunting rabbits building some bow and arrows or something like this you always have a trade-off between consumption and investment and Keynesian policies they're all about hey let's get consumption as high as possible and that might be a good idea in the short run especially if we are operating well below our potential well below our full capacity utilization but it could be a risk in the long run if you don't get the free pass because you might have under investment and in the classical sense you're never able to move your potential to the right