Classical View of Economies… © EMC Publishing, LLC

Fiscal Policy and John Maynard Keynes John Maynard Keynes wrote one of the most influential economic treatises ever written. He disagreed with the classical school view of economics, which states that the economy is self-regulating. Keynes believed that a sick economy cannot always heal itself. When the economy cannot recover on its own, the government should step in and enact an expansionary fiscal policy to stimulate spending. © EMC Publishing, LLC

Fiscal Policy Fiscal policy deals with changes the government makes in spending or taxation to achieve particular economic goals. Examples: Congress passes tax cuts to working families to boost their buying power The national budget increases 15% for the next year © EMC Publishing, LLC

Exhibit 13-1 from the Student Text © EMC Publishing, LLC

Two Types of Fiscal Policy Expansionary fiscal policy is an increase in government spending or a reduction in taxes. Expanding the buying power, or more purchasing power © EMC Publishing, LLC

How can Expansionary Fiscal Policy solve the Problem of Unemployment? Government can use expansionary fiscal policy to decrease the unemployment rate. This is how it works: Fact: A high unemployment rate is the result of people not spending enough money in the economy. If you accept this fact as true, then the next steps can be taken © EMC Publishing, LLC

Expansionary Fiscal Policy solves the Problem of Unemployment 1. The government increases spending or reduces taxes, or both, and consumers have more money to spend 2. As a result of the increase in total spending, business firms will sell more goods. 3.When business firms sell more goods, they have to hire more workers to produce the additional goods. The unemployment rate goes down because more people are working. © EMC Publishing, LLC

The Issue of Crowding Out Not all economists agree that it is that easy to lower the unemployment rate. They bring up the issue of crowding out. Crowding out occurs when increases in government spending lead to reductions in private spending. For example, if the government spends more on education, people may decide to spend less on education such as private schooling. © EMC Publishing, LLC

Crowding Out complete crowding out= When increased spending by the government exactly equals reduced spending by citizens Incomplete crowding out= when the reduction in consumer spending is less than the increase in government spending. In this case, total spending in the economy increases. © EMC Publishing, LLC

Two Types of Fiscal Policy Contractionary fiscal policy is a decrease in government spending or an increase in taxes. Contracting or reducing the buying power, or less purchasing power © EMC Publishing, LLC

Contractionary Fiscal Policy can lower Inflation Fact= inflation is caused by too much spending in the economy compared with the quantity of goods and services available for purchase. If you accept this fact, then the following steps can occur © EMC Publishing, LLC

Contractionary Fiscal Policy can lower Inflation The government can slow inflation by reducing the amount that it spends. Leads to a decrease in total spending firms initially sell fewer goods firms lower prices to reduce unwanted inventory © EMC Publishing, LLC

How can contractionary fiscal policy lower inflation? Write this question on the middle section of your handout with the Crash Course Questions. Then write an answer to the question in your own words This is an essay question on your test © EMC Publishing, LLC