Fiscal Policy: The Keynesian View and Historical Perspective 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 List the key arguments in Keynesian Economics Describe the multiplier process then identify potential problems with the process Define a budget surplus and deficit (on your own) Differentiate between restrictive and expansionary fiscal policy Explain how fiscal policy is implemented Discover timing issues related to fiscal policy

The Great Depression and the Macroadjustment Process

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.

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

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

Sources of Government Revenue 7/24/2018 Sources of Government Revenue Personal income 45.4% Property 13.1 % User charges 19.7% Payroll 35.7% Personal income 9.8% Interest earnings 2.6% Sales & excise 15.1% Other 3.0% Excise 2.7% Customs duties 1.1% Corporate income 1.9% Corporate income 12.1% Other 21.3% From Federal government 16.5% Federal government revenue 2008 -- $ 2,524 billion State & local government revenue 2006 -- $ 2,737 billion

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

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

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 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