The Great Depression and the Macroadjustment Process 11 13 2014 1 Major components of Keynes macroeconomic thinking 1 Resource prices and interest rates not flexible 2 Changes in output will direct economy to equilibrium 2 How an additional 1 of spending by one person is multiplied through economy Your 1 increase of spending becomes the income of someone else This spending also increases their incomes too and they will save a portion of it and spend some on current consumption resulting in still more additional income generated and received by supplies 3 Two problems with multiplier process 1 During normal times with fewer unemployment resources much of additional spending will merely bid resources away from other activities and then upward pressure on prices The additions to income will be smaller then the multiplier analysis implies 2 If additional spending were the result of government project financed by taxes the higher taxes would reduce spending in other areas If increase in spending is financed by borrowing there will be an upward pressure on real interest rates also reducing spending in other areas Fiscal Policy Good news of Keynesian Economics 11 13 2014 4 When the government uses expansionary fiscal policy the budget deficit will increase to finance the enlarged budget deficit the government will have to borrow from either private domestics or foreigners 5 When the federal government uses restrictive fiscal policy the budget deficit will decrease or the budget surplus increases Spending reduction and or increase in taxes will shift the government budget toward surplus or towards a smaller deficit 6 The difference between discretionary fiscal policy and countercyclical policy Discretionary fiscal policy balances the budget annually while countercyclical policy goes in the opposite direction of the business cycle which stimulates demand during contraction and restrains demand during expansion 7 The best time to implement expansionary fiscal policy is when the economy is threatened by a recession increasing spending or reducing taxes 8 The best time to implement restrictive fiscal policy in response to a threat of inflation when the budget should be shifted toward a smaller deficit or larger surplus 9 3 Lags associated with fiscal policy 1 Recognition lag It might take a few months to realize there is a problem 2 Implementation lag It takes a while to process a bill 3 Effectiveness lag Once President signs bill it takes a while to fully come into effect Ch 11 Pre Post Quiz Qs As 11 13 2014 Keynes rejected lower wages back to full employment because power trade unions wages highly inflexible Expansionary increases government spending and or reduces taxes Inflationary Decreases government spending and or raises taxes Multiplier effect Change in spending will cause nominal output to rise by some multiple Multiplier principle important because Small shifts in investment have national income Long lags make discretionary less effective By the time the impact Corrected by market forces If government owes 10 trillion then borrows 700 billion more This leads to debt of 10 7 trillion 700 billion deficit In 1930s Depressed economic conditions and unemployment The larger the MPC Marginal Propensity to Consume the larger the multiplier Discretionary fiscal policy International change in taxation or government spending When the federal government running budget deficit Government expenditures exceeds government revenues Balanced budget government revenues government expenditures As the marginal propensity to consume MPC increases the spending multiplier increases
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