Critiques of Keynesian PolicyCritiques of Keynesian PolicyMore Fiscal PolicyElias YannopoulosOctober 10, 2012Elias Yannopoulos More Fiscal PolicyCritiques of Keynesian PolicyProblems with KeynesThe single biggest criticism of Keynes fiscal policy is lagLag comes from 3 different places in the fiscal ploicymechanismRecognitionImplementationImpactRecognition lag - refers to the time between when theeconomy goes into a recession and when we know we are in arecessionRemember GDP releases every quarter and unemploymentevery monthNBER doesn’t declare it is a recession until there is twoconnsecutive quarters of negative growthElias Yannopoulos More Fiscal PolicyCritiques of Keynesian PolicyMore LagImplementation Lag - refers to the time between when thepolicy is decided on and when it is implementedHave you ever know Congress to do anything quickly?Even without Congress, if we decide to build roads we have todecide which roads and who is to build them, how much topay them etcImpact lag - refers to the time between when a policy isimplemented and when it actually effects the economyIf the government cuts taxes now people aren’t going to knowuntil they get a larger tax returnIf I don’t know that my taxes are reduced (or increased) I wontchange my behaviorElias Yannopoulos More Fiscal PolicyCritiques of Keynesian PolicyKeynes Fires BackThe Keynesian response to these criticisms is to adopt certainpolicies that will put the government into the fiscal policy itwants without further implementationThese policies are called Automatic stabilizersProgressive income taxesCorporate profit taxesUnemployment insuranceWelfare paymentsElias Yannopoulos More Fiscal PolicyCritiques of Keynesian PolicyCrowding OutThe second criticism of Keynesian fiscal policy is crowdingoutGovernment spending and private spending are substitutes, soincreasing government spending will decrease or ”crowd out”private spendingEx: Suppose we start with a government that has a balancedbudget and they want to engage in a expansionary fiscal policyExpansionary fiscal policy means cut taxes and increasespending, that means run a deficitRunning a deficit means borrowingWhat happens in the market for loanable funds? Ex: GraphElias Yannopoulos More Fiscal PolicyCritiques of Keynesian PolicyThe VerdictDoes Keynesian fiscal policy work?Economists - No, not reallyPoliticians - Hell Yes!Elias Yannopoulos More Fiscal PolicyCritiques of Keynesian PolicySupply Side Fiscal PolicySo far all the fiscal policy we have talked about (Keynespolicy) is demand side fiscal policyThere is another kind of fiscal policy and that is supply sidefiscal policyThinks classical economics. How would they use the budgetto help the economy?Make institutions that incentivize people towork/produce/supply moreTax credits for R & DEducation subsidiesLower corporate profit taxLower Marginal tax ratesNotice some of these are the exact opposite of Keynesianautomatic stabilizersElias Yannopoulos More Fiscal PolicyCritiques of Keynesian PolicyTax Rates and Tax RevenueWhat is the relationship between tax rates and tax revenue?The math: tax revenue = tax rate × incomeSo increase the tax rate and you increase tax revenueBut what is the tax rate is 1, i e the government takes all themonies? Would you work?Income is a function of the tax rate, as tax rate changespeople’s incentives to work change and their income changesThe graphical representation of tax revenue and tax rates iscalled the Laugher Curve Ex: graphThere is a point where raising taxes can actually lower revenueElias Yannopoulos More Fiscal
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