The Big Depression and the Keynesian model

At the break of the century, after a phase of expansion favoured by the appearance of new technology and global markets, the First World War gave origin to a new phase of economic depression. The war mobilized millions of people, who were subtracted from production; but when the war ended and all the economies recovered, a major crisis of overproduction originated, aggravated by insufficient demand. Temporarily, the economy flourished during the roaring Twenties, but the short-term affluence could not hide the deeper structural problems in the most important developed countries. The disorder created by the disappearance of the gold standard and the lack of monetary regulation of subsequent international exchanges caused a new crisis in 1929, known as the Big Depression.  

Until then, the ideas of the liberal model reigned in the economic policy of the industrialized countries. Following this theory, liberal ideas recommended that governments should not intervene to try to correct economic imbalances. However, markets showed an inability to resolve mass unemployment and crisis on their own. It was precisely in this moment that seeing that the market did not guarantee equilibrium by itself, Keynes proposed that the State would take a new active role with an economic policy model that corrects the imbalances and compensates for the insufficiencies of private spending. During the 1930s, several governments started spending on public works or any type of activity to create jobs. This increase on public spending and the consequent expansion of the aggregate demand (expansive fiscal policy) was what allowed families to increase their consumption, which, in turn, made it possible for companies to sell their goods. Therefore, thanks to State intervention and the multiplier effect, it was possible to create employment and make productive activity recover. In fact, during World War II governments’ intervention in the economy increased tremendously all over the world.  

After the war  the Keynesian economic model became more and more popular as it fitted well in the new reality. The combination of post-war long term and unpreceded economic growth and the consolidation of what was called the Welfare State (characterized by the wide range of social needs covered by public spending), sealed the Keynesian school victory. Challenging the neoclassical model by pointing to its imperfections and the necessary new intervention mechanisms, Keynes became the guide for the execution of economic policy for more than thirty years in most developed economies.