Adam Smith Vs. John Maynard Keynes Essay, Research Paper
Economics was a subject of which few thought about consciously until the eighteenth century. It is true that since the beginning of time people have used economics, but it was seldom given any thought. When a caveman traded a buffalo for a new club he did not have the knowledge that he affected the entire caveman economy and their way of life. Adam Smith is accredited as being the most influential economist of the eighteenth century and for all practical purposes one of the first economists that anyone has ever heard of.
Ironically, Adam Smith s great economic break-through is that no one should worry about the economy. The economy will take care of itself because it is driven by self-interest. Given that greed is a quality that drives just about everyone, this should not be a problem. Society has needs and wants, so the public will always demand goods. It is up to producers to supply the public with these goods and services. The goods that are demanded will be produced more and other products will not. It is the economic variation to natural selection. Competition in the market place will drive down prices and raise quality and efficiency. There is no need for government regulations because the market will always correct itself, eventually. The only elements needed are greedy profit driven producers and stupid people to buy their products.
Adam Smith believed the economy would always adjust itself during an inflation or recession. During prosperity, consumers will have confidence in the economy and this will bring on inflation and cause prices to rise due to the increase in spending the demand in goods. When the prices rise too high, then consumers will stop buying the goods. Slowly the prices will fall as the demand decreases. When the prices drop to affordable levels, consumers will buy the goods again and the economy will be stable. Unemployment will act much like the prices in the situation. Unemployment will be low while consumer confidence is high. Once the prices rise to an inflationary level, companies will lay off people in order to make up for the over production of the goods that are not being sold at the high prices. Once the prices stabilize, the companies will be looking to higher workers and increase production.
Adam Smith believed that the government should only tax a necessary amount as not to create a deficit or surplus. The government should also spend only what it has. This would reduce the worry of government deficits, which many are concerned. The government would not keep a surplus either, which would keep the money in pockets of the citizens and enable them to put the money back into the market by spending it. Adam Smith was in favor of a progressive tax, that is each person gets taxed in proportion to their income. Smith also advocated a constant tax in which there were no tax cuts or hikes. That way the public would know how much they will have to spend and could balance their own budgets accordingly.
With the invisible hand, as long as consumers keep buying goods the economy will stay in check. Consumers will buy what they want at prices they feel are acceptable. Companies will produce these goods at the lowest possible price and in quantities based on public interest.
According To Adam Smith, the economy does not have to be intervened in because it works on its own merits. It will always balance itself because the consumers will react accordingly in case of inflation or recession. As long as people are motivated by profits, the invisible hand will guide the economy. After all, people knew little about economics for centuries and they all survived.
In the twentieth century, the world had a new viewpoint on economic policies. These ideas were brought by John Maynard Keynes. His ideas were contradictory to those of Adam Smith. Keynes was in favor of government intervention to keep the economy in check. The government can be used as a tool to prevent inflation and recessions from even occurring. If the problem is stopped before it begins, then the invisible hand will not have the opportunity to correct itself.
John Maynard Keynes used fiscal policy in order to protect against inflation and recession. Fiscal policy uses government spending and taxes to regulate consumer spending and demand. In case of an inflationary risk the government would raise taxes and limit the amount that consumers are able to spend. This would lower demand and drive down prices. During a recession the government would cut taxes to help ease the financial burden and encourage spending.
Monetary policy can also be used to balance the economy. Monetary policy controls the amount of money in the market based on bank interactions. The FED has many tools to control the money supply. The FED controls the reserve requirement, which is the percentage of money that banks must keep in reserve. If the requirement is high, then it limits the amount that banks can lend out. This reduces the amount of loans and decreases the amount of expensive purchases such as cars and houses. Raising the requirement can fight against inflation and cause a tight money market.
The FED can also adjust the discount rate to influence the economy. The discount rate is the interest rate that banks pay to borrow money from the federal reserve. If the FED raises the discount rate, then banks must also raise their interest rates as to not lose money on the loans they give out. High interest rates discourage borrowing much like the federal reserve requirement.
The third monetary policy that the FED controls is open-market operations. The open-market is the buying the selling of government bonds. If the FED wants to create a tight money market, they can sell bonds to banks at discounted rates to encourage the sale. The bank gets the bond, while the reserve is given the money, which reduces the money that the bank has available to lend out.
Keynes was in favor of taxing citizens based on the operations of the economy. In a time of prosperity when inflation is a risk, raise taxes. During times of recession, it is necessary to lower taxes to encourage production and growth. Lowering taxes can cause a budget deficit, but Keynes would argue that deficits are vital and not an economic problem. It is better for the government to have a deficit and help the people prosper. The other alternative would be to have the government prosper and make society go into a deficit when they are forced to borrow money in order to survive. It is much better for the government to be in debt instead of its citizens.
Keynes favored the use of government policies to influence spending. How much people spend would be based on the dealings of fiscal and monetary policies. The FED can either encourage people to borrow and spend or save their money.
During the twentieth century, America has followed Keyensian economics. This is evident in examining the power that the FED has not just over America, but the rest of the world as well since the Untied States is an economic super power. The chairman of the FED, Alan Greenspan is said by many, to be the most powerful man in the world. Keyensian economics is much more precise than Smith s classic economics. The nation s economy is much too important to be left up to the invisible hand. Policies are required to make sure that the country continues to prosper.