Macro Chapter 11 Fiscal Policy: The Keynesian View and Historical Perspective

Important Note about the Chapter: Only read up to p.245 then stop at the section titled “The Keynesian Aggregate Expenditure Model” Nothing from that section will be on a quiz or exam

6 Learning Goals 1) 1)List the key arguments in Keynesian Economics 2) 2)Describe the multiplier process then identify potential problems with the process 3) 3)Define a budget surplus and deficit 4) 4)Differentiate between restrictive and expansionary fiscal policy 5) 5)Explain how fiscal policy is implemented 6) 6)Discover timing issues related to fiscal policy

The Great Depression and the Macroadjustment Process

Watch video: History Channel FDR 1- Depression 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 the question is no longer how we can make the best use of the spontaneous forces found in a free society. We forces found in a free society. We have in effect undertaken to dispense have in effect undertaken to dispense with the forces which produced 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: Commanding Heights 1- Keynes vs Hayek

For more about Keynes & Hayek: See Supplemental Video Free to Choose (FTC) Keynesian economics If you really want details, see supplemental videos Commanding Heights 1, Chapters 1 through 8

Output, Employment, and Keynesian Economics

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 Watch video: President Obama- only government can break cycle

What is the multiplier and how does it work? The idea behind the multiplier is that spending by one person results in income for another, which will create additional spending and additional income for others.

Q11.1 A hail storm that breaks lots of windows in buildings is

What are some problems associated with the multiplier? Watch video: Stossel Macro Clip 04- government 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

Let’s investigate where government gets its revenue Watch video: Stossel Macro Clip 12- is government too big

Federal government revenue $ 2,524 billion State & local government revenue $ 2,737 billion Sources of Government Revenue User charges 19.7% Property 13.1 % Interest earnings 2.6% Personal income 9.8% Corporate income 1.9% Sales & excise 15.1% From Federal government 16.5% Other 21.3% Payroll 35.7% Other 3.0% Customs duties 1.1% Personal income 45.4% Excise 2.7% Corporate income 12.1%

Let’s investigate where government spends its revenue

Q11.3 (PMA) What is the difference between the national deficit and the debt? 1.The deficit is a yearly amount 2.The debt is a yearly amount 3.The deficit is a cumulative amount 4.The debt is a cumulative amount 5.The deficit is the difference between exports and imports 6.The debt is the difference between revenues and imports

What’s the difference between the deficit and national debt? Deficit is a yearly amount Debt is the cumulative amount

Who does the U.S. owe? See national debt clock

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

Watch video to put federal budget in perspective: 10,000 Pennies- budget cuts

Q11.4 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.an increase in tax rates 2.a balanced budget 3.a budget deficit 4.a budget surplus

Q11.5 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.

Watch video to put federal budget in perspective (warning- this is politicized but effectively makes a point): 10,000 Pennies- national debt road trip

Fiscal Policy Changes and Problems of Timing

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 = = = 1 & = = 4