Keynesian economics is an economic term, developed by John Mayanard Keynes. He is acknowledged by economists as the chief economists of the 20th
century. John’s theory of interest, money, and employment was published in the year 1936. According to Keynes, monetary policies (interest rates) are the primary instruments to stabilize demand rather than the budget (fiscal policy). The Keynesian economic theory was developed during the post-war period when the nations were facing recession periods. The theory was put aside due to its inefficiency to solve the economic problems. Neoclassical economics theory was put into consideration to see if the economic problems would be solved. Neoclassical economics focuses on the fiscal policies to explain the effects on demand. Some of the ideas associated with the neoclassical are privatization, free trade, deregulation, austerity and the reduction on government expenditure so as to improve the role of the private sector in the society and economy (Dopfer, 2005). In this paper, we will discuss the differences between the Keynesian economics and the neoclassical economics in an Australian economy since the 1980s to explain the capitalist economy and the policy prescriptions. Some of the areas in which neoclassical macroeconomics differs from the modern Keynesian macroeconomics include the nature of expectations, the production model, the role of government, the equilibrium role, the need for micro-foundations and the role of money. In this research paper, discussions on the differences between the neoclassical economics and the Keynesian economics are explicit. The differences are aimed at introducing the neoclassical readers to the traditional thoughts of the Keynesian models.
The role of Money
The Australian economy has been a low inflation rate economy, this is attributed to role of their central bank in the regulation of money through monetary policies. According to a research conducted by Taylor, (2001), during the 1980s the Australian economy faced an increase in the inflation rates at a flat rate of 10 percent per year, which led to the value of money declining by 60 percent. According to the neoclassical economic theory, the neutrality of money is an essential aspect in an economy. The presence of financial institutions for example, the banking institutions affects macroeconomic simulations as cited by Friedman, (2017). In contrast, Keynesian economic theory, suggests that, debt and financial issues causes significant changes in unemployment. Neoclassical economist believes that variance in the monetary variables is a fallacy of money illusion and it is almost impossible to reconcile this theory with the reality in the economy. There are questions whether the experienced downturn price changes in the Australian economy under monetary neutrality was associated with the nominal shocks since the supply shocks caused an impact on employment and output. Keynes theory suggests that a monetary economy has varying views about the future and can influence the employment quantity and not its direction, therefore, making money uncertain. In addition, the applicability of the illusion of money in an economy that is credit centred with nominal debt was rejected. Money illusion would not be present in an economy if the debts were dominated in real terms. The Keynesian economists argued that all other nominal magnitudes (quantities of other assets, prices of goods and prices of liabilities) should also be expressed in monetary value. The banking institutions are expected to have a reserve with the central banks before they give out the loans. In the real world, banks create monetary uncertainty by giving out loans and look for the reserves later. According to Keynesian model, banks aim at supporting the entrepreneurs by giving them funds which results to the banks having added spending power instead of transferring cash from savers to borrowers. As recorded by Slaughter " Leslie (1997), it does not reduce the investors spending capacity as it creates both a deposit and a debt for the borrower. Entrepreneurs have the potential of transforming distribution and production on an economy as they enjoy supernormal profits. Entrepreneurs can either choose to save money so as to start a business which in return means reducing their consumption powers, this has a minor influence compared to the purchasing power created by banks. Therefore there is a correlation between the monetary aggregates and the changes in the economy. Banks are still the major source of finance for the investors, thus the banking sector is very critical for a growing economy (Slaughter " Leslie, 1997).
The nature of the Expectations
The Australian economy in the early 1980s was forced to have reforms after undergoing the recession period. The reforms were focused on being able to predict the future as cited by Cunningham, (2002). Keynesian economist strongly believes in the effects of uncertainty in the economy. His belief is described as one that tries to deal with the existing issues while having very little information about the future. The neoclassical economist replaced the Keynes theory with the rational expectations revolutions which stated, that the future could be predicted using rational expectations. According to Cunningham, (2002), Australian historical information could be used to predict the economic behavior by having in place the future policies, this was termed as rational expectations macroeconomics. Lucas conducted a research that aimed at natural rate hypothesis (NRH) which assumed that inflationary anticipations are accurate. Supposing the ‘anticipations are rational in the logic of Muth’, therefore totaling inflationary anticipations assumptions were true as a supplementary axiom. The Keynesian economists found the additional axiom too ambiguous, thus dismissed the claim. Rational expectations meant that it has to be very clear and direct (Fullbrook, 2004). The Keynesian economic model ignored the current statistics which proved that the future is very uncertain. Therefore, the model gave a loophole for the expectation to be founded on erroneous predictions of future results. The macroeconomic system cannot be understood independently as its behavior is dependent on the nonlinear relations between the economic agents as cited by Lawson, (2005).
The model of Production
During the 1980s, the Australian economy faced challenges in their production and labor market. The labor market reforms brought changes in the production sector. A more recent survey conducted by Lawson, (2005), where at least 200 firms were surveyed, firms accounted collectively for the 7.6 percent of the united states GDP. The bad news was that only 11 percent of GDP was created under circumstances of rising marginal cost and that more common marginal cost curves are downward sloping. Some of the key elements for neoclassical micro and macroeconomics on production include rising marginal costs, substitutability of inputs and diminishing marginal productivity. Keynesian economist assumes some fixed scopes between the inputs, falling or constant marginal overheads, and repudiate the significance of fluctuating marginal production. Keynes theory depends on the empirical research that had identified that the increasing marginal cost and the falling marginal productivity are the exemption rather than the regulation for industrial companies. The outcome is steadier as the inputs are being used in static quantities, and Keynesian macroeconomic simulations engage productivity as linearly linked to intermediate good inputs and labor (applying flexible utilization of static capital in some cases).
The need for Micro-foundations
After the recession period, the Australian economy faced some challenges which some of the economists tried to solve. For the economists to enhance their understanding of the macroeconomics, it was important for them to understand how microeconomics operates. According to Hamouda, " Harcourt, (1988), neoclassical macroeconomics could have evolved from the microeconomics, supported by the idea that its deep limitation could not be affected by the policy changes. The Keynesian economists disapproved of the argument that the macroeconomics could be derived from the microeconomics because the microeconomic deep parameters did not have linear relations between the agents. Therefore, it was a hopeless assignment to develop macroeconomics from the microeconomics. Neoclassical macroeconomics have acknowledged the dispute but not yet accounted in their economic research progress. Keynesian economists overruled the dispute that macroeconomics could be as a result of microeconomics (Holt " Pressman, 2001).
The Australian economy is not a lone market economy, even if it was, the law of demand could not apply in a lone market economy. Even if all the buyers in an Australian marketplace were assumed to be rational utility maximizers, there would always be an additional demand for a certain commodity in the marketplace, therefore, for each buyer in the marketplace, there will be an additional demand function. Due to the collaboration of the multiple objects in a system, there is a common occurrence among the objects identified as the theorem. The system cannot be understood independently as its behavior is dependent on the nonlinear relations between them. According to Rennings, (1998), the complexity experienced in a collection of particles should not be studied by the extrapolation of few particles but the complexity of the system should be evaluated at each level where there is a complexity. In its place, since at each level of complexity, there are new characteristics, the understating of the new characteristics is of the essence. Keynesian economists put more emphasis on the fact that macroeconomics is not the same as practical microeconomics (Omar " Harcourt, 1988).
The role of Government
The Australian government role in the economic reforms was evident during the 1980s reforms which were conducted by the salesman representative. There was a budget deficit in the early 1980s and 1990s due to the effects of the recession period which led the government to focus on policies for economic changes as cited by Garnaut, (1989). The neoclassical economist believes that the market economy is self-equilibrating and that the government cannot fool the public through fiscal policies. Neoclassical economists assume that all agents in an economy act rationally leading to rational expectations, therefore, the Philips curve cannot be violated even for one moment by the government. According to the Keynesian theory, full employment can be ensured in a market economy by insufficient collective demand. As a result, Keynesians argue that the government is capable and has a responsibility of enhancing collective demand throughout recession’s period. However, there are alterations in how operative such policies are projected to be. Thus we can be able to clearly identify how the post-Keynesian practices differ from the neoclassical economics.
The role of equilibrium
During the 1980s reforms, the Australian economist argued whether the economy was at equilibrium at all time or not. The equilibrium model was developed by economists identified as Hicks and later adopted as the Keynesian theory. The theory assumed that the economy was at equilibrium at all times. The neoclassical economists rejected the Keynesian theory because of its unacceptable assumptions as indicated by Harcourt, (2008). According to a research conducted by the Walrasian foundations on a demonstration of a three market structure with a two market. The Walrasian foundation assumed that if the two markets happen to be at equilibrium then the third market is also at equilibrium. However, if the correspondence was inversely applied in disequilibrium, that is, one of the markets was in disequilibrium and then necessarily the other was ignored or also in disequilibrium. If the assumption holds then, Keynesian theory assumed that the market was always at equilibrium. Keynesian theory was rejected because supposing equilibrium at all-time also destined assuming that anticipations were achieved always, whereas the economy was not in equilibrium. Therefore macroeconomics had to involve equilibrium as suggested by the neoclassical economists. If the economy is to remain in its equilibrium state then there will be no need for change in policies as recorded by Harcourt, (2008).
Conclusions
In conclusion, it is evident the neoclassical economic theory is more current compared to the Keynesian economic theory. The Keynesian theory is used by the economists to enhance their understanding of the various issues we can have in an economy. According to this paper, there is a correlation between monetary aggregates and the changes in the economy. Neoclassical economists believe that the government has a role in influencing the economy through the policies and regulations in place. Keynesian economists believe that the markets are always at equilibrium, this is against neoclassical economists.
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