Why is it that when the economy is sluggish, the government is actually encouraged to increase massive spending? In classical economics, this step may be considered risky.

But for John Maynard Keynes, that is the answer. This is the basis of Keynesianism, an economic thought that emphasizes the active role of government in maintaining economic stability and protecting society from the threat of recession.

So, how does this theory actually work? And is it still relevant in the era of crypto and the digital economy like today? To find out, see the following review.

You might also be interested in this: Keynesian Investment Theory Guide for Beginners and Experts

What is Keynesianism?

Keynesianism is an economic theory proposed by John Maynard Keynes, a British economist widely known for his revolutionary thinking amidst the global economic crisis in the 1930s.

This theory was officially introduced through his book entitled The General Theory of Employment, Interest and Money, which was published in 1936.

In this work, Keynes conveyed his idea that the market is not always able to balance itself, especially when the economy is sluggish or hit by a recession.

One of the cores of Keynesian thinking is the need for an active role for the government in managing the economy. For Keynes, state intervention is not only important, but also absolutely necessary, especially in times of crisis.

The government is advised to increase public spending and lower taxes to encourage aggregate demand, so that economic activity can move again, unemployment decreases, and market confidence recovers.

This approach directly contradicts the principles of a free market economy or laissez-faire, which believes that market forces will find their own balance without the need for state intervention.

Keynes actually showed that in certain situations, letting the market work on its own would only prolong the crisis and worsen the condition of society.

The main goal of Keynesianism is to address fundamental problems in the economy, such as mass unemployment, prolonged crises, and extreme economic fluctuations.

By placing the government as the main actor in maintaining economic stability, this theory changed the way countries responded to crises. Until now, Keynesian principles remain an important reference in modern economic policy.

Another interesting article for you: Dovish in Monetary Policy: Opportunities & Challenges

Key Principles of Keynesian Economics

Keynesian economic theory emerged as a response to the weaknesses of the free market in overcoming the economic crisis.

In contrast to the classical economic view, the Keynesian approach emphasizes the importance of the government’s active role in maintaining economic stability through the management of aggregate demand.

The following are five main principles that summarize the basic ideas in this approach, including:

1. The government must actively regulate aggregate demand

In the Keynesian view, economic equilibrium is not achieved automatically. When aggregate demand falls, the market tends to fail to respond efficiently.

Therefore, active government intervention is needed to maintain stable demand. The government, together with the private sector, is seen as the main actor that can maintain economic balance.

If public consumption decreases, the state must intervene, for example through infrastructure projects, to boost demand again.

2. Government spending increases during a recession to encourage consumption

Keynesian economics emphasizes that when the economy is sluggish, government spending must actually be increased. This is because government spending has a multiplier effect that can trigger overall economic activity.

For example, an additional $1 in spending can create an increase in output of more than $1. This strategy is important to fill the gap that the private sector cannot fill during a crisis.

3. Temporary budget deficits are normal in times of crisis

For Keynesians, budget deficits are not a problem as long as they are used to restore the economy.

In a recession, government revenues tend to fall due to lower taxes, while spending must be increased to stimulate the economy.

In Keynesian logic, budget deficits are a legitimate and effective policy tool to stimulate the economy and reduce unemployment.

4. Taxes can be adjusted to maintain people’s purchasing power

Keynesian fiscal policy also includes adjusting taxes to maintain purchasing power. When the economy is weak, tax cuts can be a stimulus to increase household consumption.

Lower taxes mean that people have more money to spend, which ultimately increases aggregate demand and helps the economy recover.

5. Markets cannot always balance themselves automatically

Unlike classical economics, which believes in the efficiency of free markets, Keynesianism argues that markets have structural weaknesses.

Prices and wages tend to be sticky in the short term, so they cannot immediately adjust to market conditions. That is why unemployment can persist for a long time during a recession.

Therefore, active government intervention is needed so that the economy does not get caught in a prolonged crisis.

Examples of Keynesian Applications in the Real World

The following are some real examples of the application of Keynesian economic theory in various countries, as quoted from kompasiana.com, namely:

1. New Deal (United States, Roosevelt era)

During the Great Depression, President Franklin D. Roosevelt launched the New Deal, a massive infrastructure project package, such as roads, bridges, airports, dams, and reforestation, through institutions such as the WPA and PWA.

This step opened up jobs for millions of people (more than 8,000,000 through the WPA and more than 3,000,000 through the CCC) and became a classic example of the implementation of Keynesian fiscal intervention.

2. COVID?19 Stimulus (various countries)

When the pandemic hit the world, many countries adopted a Keynesian approach by launching large stimulus packages in response to keep the economy running.

In the United States, for example, the government issued the CARES Act in March 2020 worth around $2,200,000,000,000 and the American Rescue Plan in March 2021 worth $1,900,000,000,000.

The packages included direct cash assistance to the public, unemployment subsidies, and massive investment in infrastructure, with the belief that government spending would boost aggregate demand.

Stimulus with a similar approach was also implemented in various other countries during the pandemic.

The Republic of China provided Triple Stimulus Vouchers to boost domestic consumption, while Ireland launched the July Jobs Stimulus program which combined direct assistance and credit ceilings.

In Germany, the government injected hundreds of billions of Euros through various measures, including fast loans and tax cuts, in an effort to stabilize the economy amid uncertainty.

3. Subsidies & Social Assistance during Inflation or Food Crisis

In Indonesia, food price stabilization measures follow Keynesian principles through subsidies, social assistance, and market operations to maintain people’s purchasing power.

For example, the National Movement for Controlling Food Inflation (GNPIP) program in collaboration with BI and Bapanas, has succeeded in reducing food inflation to 1.57% in 2024.

In addition, social assistance and food subsidies were launched to protect the community from the impact of inflation and maintain microeconomic stability.

Still on this topic, also see: Differences Between Microeconomics and Macroeconomics That You Need to Know

The Relevance of Keynesianism in the Crypto Era

The emergence of crypto is often seen as a challenge to the traditional centralized financial system, offering a more decentralized and transparent alternative.

However, in reality, the crypto market remains vulnerable to volatility, speculation, and major risks that can lead to financial crises.

Cases of platform failures and extreme volatility prove that without adequate regulation and user protection, market stability is difficult to maintain.

That is where the relevance of Keynesian thinking re-emerges, emphasizing the active role of government in maintaining economic stability through regulation and intervention when the market fails to balance itself.

In the digital and crypto economy, the government needs to implement appropriate fiscal policies, such as digital asset taxes and incentives to encourage sustainable blockchain innovation.

Several countries have begun to adopt Keynesian principles in the form of digital fiscal policies.

For example, tax regulations on transactions or ownership of crypto assets aim to increase transparency while reducing illegal practices.

Subsidies and fiscal support for blockchain technology can strengthen the digital ecosystem and create new jobs.

This is in accordance with the Keynesian principle which encourages government intervention to overcome economic fluctuations and increase aggregate demand.

Even as the world becomes more digital and economies move toward decentralization, the Keynesian approach remains fundamentally relevant.

The principle serves as the basis for policies to maintain stability and encourage economic growth in the crypto era.

Advantages and Criticisms of Keynesianism

In understanding Keynesianism, it is also important to know the advantages and criticisms inherent in this theory in order to see a more complete picture of its application in economic policy, including the following:

Advantages

1.Able to overcome unemployment and prevent economic collapse

Keynesianism encourages the government to actively intervene when the economy is sluggish, especially by increasing spending so that jobs are created and economic collapse can be avoided.

2.Encourage short-term economic growth, especially during a crisis

With the right fiscal intervention, such as increasing government spending and reducing taxes, this theory helps accelerate economic recovery during a crisis.

3.Very suitable for application in developing countries

Countries that are still in the development stage benefit from expansionary policies that can stimulate investment and consumption, thereby accelerating economic growth.

Criticism

Potentially causes national debt to swell due to budget deficits

Large government spending to stimulate the economy can increase the budget deficit and increase the burden of national debt in the long term.

Risk of misdirection if government spending is not managed efficiently

If the funds spent by the government are not on target or are less transparent, the positive effects of Keynesian policies can be reduced or even detrimental.

Too dependent on political intervention that can sometimes influence policy

Fiscal policy is heavily influenced by political decisions, which can lead to uncertainty or misuse of policies for certain interests, not merely for the sake of economic stability.

Conclusion

Well, that was an interesting discussion about Keynesianism: The Role of the State in a Sluggish Economy that you can read in full at the Crypto Academy at INDODAX Academy.

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In conclusion, Keynesianism places the government as the main player when the market fails. Amid global economic uncertainty, from recession to crypto market turmoil, this approach is still very relevant.

FAQ

1.What is Keynesian theory?
Keynesianism is an economic theory that emphasizes the role of government in managing demand to keep the economy stable.

2.Who originated Keynesian theory?
John Maynard Keynes, a British economist, through his 1936 book: The General Theory of Employment, Interest and Money.

3.When is Keynesian theory usually applied?
When there is a crisis, recession, or high unemployment – the government is advised to increase spending to encourage growth.

4.Is Keynesian against crypto?
Not entirely. Although crypto is decentralized, Keynesian principles remain relevant in terms of regulation & user protection.

5.What are the weaknesses of Keynesian theory?
The main risks are high budget deficits and dependence on government policies that are not necessarily effective.

Author: Boy