Briefly explain why Keynesian economics is most successful?

Hey, long time no see :)

So... this is a pretty hotly debated political question. In general, Democrats favor Keynesian economics, and Republicans favor supply-side economics. So you won't see universal agreement that Keynesian economics are more successful.

But basically, the idea is this. Adam Smith once wrote that free markets regulate themselves as though by an "invisible hand," and that was the guiding philosophy through most of the 1800s and early 1900s. But around the time of the Great Depression, Keynes observed that this isn't always true. It's possible to get to a point where there isn't enough demand for goods and services because people don't have enough money, which causes people to get laid off because businesses aren't selling enough to pay them, which causes demand for goods and services to drop even *further*, which causes more people to get laid off... it's basically a death spiral for the economy.

So Keynes theorized that the government should have a fiscal policy that does the exact opposite of the market. When the market's doing great and demand is high, the government should raise taxes and create a surplus, basically saving money for a rainy day, even if it means putting the brakes on the economy. And then when the market crashes and starts going into the "death spiral," the government should spend massive amounts of money, borrowing if it has to, to infuse money into the economy so that employees don't have to be laid off, so the death spiral can be stopped.

Supply side economics is basically the old-school "invisible hand" economics in a modern form: it's when people say "The best thing for everyone is if the government just gets out of the way and lets businesses do their thing." Supply side economics support tax breaks for corporations and lower regulations all around.

If you're a Democrat, you believe that supply side economics lead to "bubbles," where people get out of control speculating on something, and start buying it at way more than it's worth, just because the price keeps going up and up. But the price is only going up and up because people keep buying it. Eventually, a bubble hits a "bursting" point, and the whole economy falls to pieces and can even go into a "death spiral."

Democrats will argue that the Great Depression was caused by a general stock bubble; that the recession of the early 2000s was caused by a "dot com" bubble (too much overenthusiastic investing in early dot coms", and that the recession of 2008 was caused by a real estate bubble (the prices of homes just got utterly ridiculous because people weren't even buying them to live in). And Democrats will say that the government should have regulated this in the first place (by saying to the banks: no, you can't give a home loan to someone who obviously can't afford it), and that President Obama did the right thing by infusing the economy with trillions of dollars (which is Keynesian economics in action). They say that if he hadn't done that, the "death spiral" would have taken hold and perhaps more than half of all Americans would have been out of work - people might even starve in those circumstances.

But Republicans don't buy it. They think supply side economics would work fine and that the problem is that the government got too involved. They think - okay, I don't understand the supply-side theory as well, but I think it's something like "The Federal Reserve intentionally overprinted money in an attempt to artificially hold the economy above where it is, and the economy was essentially running on overborrowing by the government, and the suppliers of goods and services were victims of government greed and incompetence."

I... don't know, honestly. I'm a Democrat and a Keynesian, and the supply-side arguments have never made much sense to me. Supply-side economics cause periods of explosive growth where some people make massive fortunes - but then it all comes crashing down on our heads at regular intervals. It doesn't seem like any way to run an economy to me.

The answer depends on what kind of answer you want:

1. Keynesian economics works; supply side doesn't. Just look at all the predictions of each and check them out against what actually happened.

- Keynesian predicts that when the economy is depressed due to lack of demand, additional government spending boosts demand and stimulates the economy. Correspondingly, austerity on the part of the government will depress the economy.

http://www.voxeu.org/index.php?q=node/7601

- Supply side predicts that cutting taxes will boost the economy to the extent that tax cuts pay for themselves:

http://capitalgainsandgames.com/blog/bruce-bartlet...

http://www.washingtonpost.com/business/economy/sup...

http://rationalwiki.org/wiki/Supply_side_economics

http://delong.typepad.com/sdj/2012/05/supply-side-...

but increased government borrowing and debt will cause immediate inflation.

2. For the other meaning of "why", Keynes started by looking at reality. He saw that the classical economics model wasn't working and took that as his starting point.

http://ecologicalheadstand.blogspot.com/2011/02/se...

Classical economics assumes that prices (including wages - the price of labor) adjust almost instantaneously. Looking at the real world it is clear that prices and wages are sticky.

http://en.wikipedia.org/wiki/Sticky_(economics)

Keynes was willing to start with the reality of sticky prices and wages, and see where the logic took him. The result is that Keynesian economics is not built on a foundation of logic but a foundation of observations that no one has yet succeeded in "explaining" (other than to refer to "human nature",

http://worthwhile.typepad.com/worthwhile_canadian_...

which is not "rational" - at least in the sense of classical economics.).

Many have criticized Keynesian economics for this lack of a theoretical foundation, and there have been several attempts to build macroeconomics on top of a logical microeconomics foundation, but they have failed.

http://krugman.blogs.nytimes.com/2011/09/26/lucas-...

3. Note that there is a different definition of supply-side economics that all Keynesians would agree is good and works - government policies that really do improve the supply side. These would include:

- investment in human capital (education, etc.)

- investment in infrastructure (roads, etc.)

- effective regulation

etc.

These are what economists would call supply side policies, but are not what politicians call supply side economics.

Here's Brad DeLong and Larry Summers (both noted Keynesians, economists, and members of Democratic administrations) saying: "The long-run trend of productivity growth is the sole important determinant of the evolution of living standards"

http://econ.blog.us/pdf_files/Jackson_Hole.pdf