John Maynard Keynes argues that economies can get stuck in an underemployment equilibrium due to underconsumption leading to a "vicious spiral" of layoffs and production cuts. Full employment is not the only possible macro equilibrium. When an economy is in underemployment equilibrium, it requires external stimulus to boost demand and achieve full employment. Business investment is unlikely to restore full employment quickly because of the nature of investment decisions.
Keynes identifies the public budget and government expenditures as the fastest method to restore full employment. Financing deficits through borrowing from households and businesses directly injects funds to increase demand and achieve full employment, while simultaneously redirecting capital.
Key concepts
- Underemployment equilibrium — A macro equilibrium state where an economy operates below full employment due to insufficient aggregate demand.
- Vicious spiral — A cycle of decreasing production and increasing layoffs caused by overproduction or underconsumption.
- Public budget — The government's fiscal plan, specifically its expenditures and borrowing, as a tool for economic stimulation.