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3.2 The Orthodox Keynesian School

For the early post-war years the central distinguishing beliefs within the

orthodox Keynesian school can be listed as follows:

1. The economy is inherently unstable and is subject to erratic shocks.

These shocks are attributed primarily to changes in the marginal efficiency

of investment following a change in the state of business confidence, or

what Keynes referred to as a change in investors’ ‘animal spirits’ (see

Chapter 2, section 2.8).

2. Left to its own devices the economy can take a long time to return to the

neighbourhood of full employment after being subjected to some disturbance;

that is, the economy is not rapidly self-equilibrating.

3. The aggregate level of output and employment is essentially determined

by aggregate demand and the authorities can intervene to influence the

level of aggregate ‘effective’ demand to ensure a more rapid return to full


4. In the conduct of stabilization policy, fiscal as opposed to monetary

policy is generally preferred as the effects of fiscal policy measures are

considered to be more direct, predictable and faster acting on aggregate

demand than those of monetary policy. These beliefs found expression in

the orthodox Keynesian model, known as the IS–LM model, to which we

now turn.