Macro Chapter 11
Fiscal Policy: The Keynesian View
and Historical Perspective
6 Learning Goals
1) List the key arguments in Keynesian
Economics
2) Describe the multiplier process then identify
potential problems with the process
3) Define a budget surplus and deficit
4) Differentiate between restrictive and
expansionary fiscal policy
5) Explain how fiscal policy is implemented
6) Discover timing issues related to fiscal policy
The Great Depression and
the Macroadjustment
Process
Watch Video: History Channel FDRdepression and 1932 election
John M. Keynes
Incredibly influential economist
Major points of thinking:
1. Resource prices and interest rates are
not very flexible so they won’t direct an
economy to equilibrium
2. Changes in output will direct an
economy to equilibrium
John M. Keynes
1935, about his forthcoming book The General
Theory of Employment, Interest and Money
“I believe myself to be
writing a book on
economic theory which
will largely revolutionize
not, I suppose, at once
but in the course of the
next ten years the way
the world thinks about
economic problems.”
Friedrich Hayek
1944, The Road to Serfdom
According to the views now dominant,
the question is no longer how we can
make the best use of the spontaneous
forces found in a free society. We
have in effect undertaken to dispense
with the forces which produced
unforeseen results and to replace the impersonal and
anonymous mechanism of the market by collective and
"conscious" direction of all social forces to deliberately
chosen goals.
Watch Video: Comm Heights 1-Keynes v
Hayek
For more about Keynes &
Hayek:
See Optional Video Free to Choose (FTC)
Keynesian economics
If you really want details, see optional
videos Commanding Heights 1, Chapters
1 through 8
For fun, check on the two videos “Fear the
Boom and Bust” and “Fight of the Century”
(lyrics also provided)
The Solution?
Y=C+I+G+X
If C, I, and X are stagnant or declining,
increase G
After the multiplier kicks in, C, I, and X will
increase
AD shifts right until full employment is
reached
This is not ancient economic
theory
President Obama in February, 2009
Watch Video: Obama-only government
can break cycle
Q11.1 A hail storm that breaks lots of windows in
buildings is
1. good for the economy because the spending on repairs
will expand net employment.
2. good for the economy because spending on the repairs
will drive up the general level of prices.
3. bad for the economy because the damage from the
storm will be subtracted from this year’s GDP.
4. bad for the economy because wealth was destroyed and
more spending on repairs will result in less spending on
other goods and services.
What are some problems
associated with the multiplier?
Watch Video: Stossel Macro 04- Gov’t
spending, jobs, and unemployment
Q11.2 Within the Keynesian model, the multiplier
effect tends to
1. smooth out the up- and down- swings of the
business cycle.
2. promote price stability.
3. magnify small changes in spending into much
larger changes in output and employment.
4. reduce the impact of an increase in investment
on output and employment.
Key Points:
The multiplier “works” with an increase in
C, I, G, or X
The multiplier is more potent when
1. Unemployment is unusually high
2. There is an increase in C, I, or X
The multiplier is less potent when
1. Unemployment is closer to natural rate
2. There is an increase in G (because of
secondary effects)
Note:
You do not need to remember the formula
for the multiplier
No quiz or exam questions will ask you to
calculate the multiplier or know the
relationship between MPC and M
The Keynesian View of
Fiscal Policy
What is fiscal policy?
Fiscal policy is simply the tools used by
Congress and the President to alter
economic activity
Primary tools are government spending
and taxes
Fiscal Policy and the Good
News of Keynesian
Economics
How does fiscal policy work?
Increase gov’t spending and/or decrease taxes
– Expansionary- try to increase AD
Decrease gov’t spending and/or increase taxes
– Restrictive- try to decrease AD
Q11.3 According to Keynesian theory, which of the
following would most likely stimulate an expansion
in real output if the economy were in a recession?
1.
2.
3.
4.
an increase in tax rates
a balanced budget
a budget deficit
a budget surplus
Q11.4 The government is pursuing an
expansionary fiscal policy if it
1. decreases government spending and/or
increases taxes.
2. increases government spending and/or
increases taxes.
3. decreases government spending and/or
reduces taxes.
4. increases government spending and/or
reduces taxes.
What are some common problems
of fiscal policy?
Even if you believe fiscal policy works,
there are still some potential problems
Let’s say we want to “fix” the
economy. What problems might
we encounter?
First, we have a recognition lag
Second, we have an implementation lag
Third, we have an effectiveness lag
Note:
You do not need to know the details of
automatic stabilizers
Question Answers:
11.1 = 4
11.2 = 3
11.3 = 3
11.4 = 4