The Galway East TD said it was now up to the Labour membership to decide if Eamon Gilmore was the right person to lead the party into the next general election.
Labour TDs gave a mixed reaction to his resignation from the party.
Mr Keaveney had already lost the whip after recently voting against the Government on education cuts.
His resignation from the party yesterday firmly puts him on the opposition benches.
In a letter to party members yesterday, whom he communicated with as Labour chairman, he warned: “I believe that Labour is now heading towards disaster.
“This current crisis is not simply economic but social and political too and all three need to be addressed. Failure in this regard is a failure of vision. I can no longer partake in any way in what has become a political charade.”
His resignation comes after Patrick Nulty resigned from the party last week.
Mr Keaveney said that in recent weeks he had come to oppose the Government’s abortion bill. However, he stressed that last week’s decision to cut special needs education resources was a breaking point for him.
“The partial reverse of some of those cuts is welcome. However, this is no way to run a country — proposing cuts, distressing people, and forcing them to engage in protest to secure the reversal of measures that should never have been decided on in the first place.”
He said he would continue to represent his constituents and was honoured to have served as party chairman.
But speaking to journalists, he attacked the party leadership: “I can’t hold the system to account with what I consider are erroneous decisions made by Government.”
He said many of Labour’s ministers at Cabinet were “enjoying their last hour in the sun”.
Dublin South party member Lorraine Mulligan now becomes chair of the party until the Labour conference in Kerry in November.
Reacting to Mr Keaveney’s resignation, Dublin TD Robert Dowds said: “It’s hugely disappointing and disloyal that he would behave like this. He’s let down his voters, Labour Party members and the country.”
He defended Labour, saying Mr Keaveney’s criticism was wrong: “He’s walked away because he doesn’t have the courage to face the difficult situation that we live in.”
Labour whip and TD Emmet Stagg said he welcomed the resignation: “Since he resigned the whip, he has consistently attacked Labour, thereby betraying the party members who elected him as chair.”