What it is:
Keynesian economics is a school of thought named after economist John Maynard Keynes.
How it works/Example:
British economist John Maynard Keynes is one of the fathers of modern macroeconomic theory and is widely considered to be one of the three most important economists of all time, along with Adam Smith and Karl Marx.
Keynes' seminal work, General Theory of Employment, Interest, and Money, published in 1936, is the foundation for Keynesian economics. It challenged the established consensus of the time, which was that economies return to full employment after downturns.
The main idea behind Keynesian economics is that government interventionist policy is necessary to fight dramatic boom-and-bust cycles. Because he believed that the propensity to consume dictates savings rates and relative rates of return dictate investment, Keynes theorized that an economic downturn could create a never-ending spiral. This would occur, he said, because businesses would invest less, which would reduce employment, which would reduce consumer spending, which would reduce business investment, which would perpetuate the cycle.
Thus, Keynes thought, the government should at times stimulate investment and consumption by engaging in deficit spending. Reducing long-term interest rates, spending on public works projects and infrastructure, and similar policies would result. In turn, deficits could be a good thing for the economy, Keynes argued.
Why it matters:
Keynesian economics disrupted classical economics by advocating more than just minimal governmental involvement in the economy. These ideas gained favor during the Great Depression and became a dominant school of economic thought for the next 40-plus years. They fell out of favor during the 1970s but regained popularity near the onset of the financial crisis in 2008.