Keynesian Fiscal Policy on the U.S. Economy, Term Paper

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Keynesian fiscal policy on the U.S. economy, we first need to understand that basics of this macroeconomic model. It is also important to remember that this economic model came at a time when the Great Depression had a grip on the U.S. industry and economy.

Economists of the 1930s called for further wage cuts to reduce unemployment and supported higher taxes so people would not "overconsume." John Maynard Keynes's theory was the total opposite and quite simple and practical.

If companies believe they can sell extra output, then they will hire more laborers. Conversely, if demand for their products declines, then they will cut back on production and lay workers off. The downside of layoff workers is that these consumers will have less money to spend and have a negative impact on demand, giving rise to continued unemployment.

This puts the economy is a vicious cycle of lowered demand and high unemployment. Companies by themselves cannot reverse this pattern and that's when government intervention is required. The government needs to intervene and push the economy back into a cycle of high demand and employment.

Of particular importance in the early years of the role of fiscal policy was that many of the early Keynesians (including Keynes himself) objected to the claim that the monetary policy was enough by itself to promise full employment. Interest rates had fallen considerably during the 1930s but even that was no enough to spur private investment. The logic here was easily understandable because even with so much excess capacity, the incentives to build were very little, even with cheap financing. That's why Keynesian fiscal policy focused on increased government spending and lowering taxes to help fill the gap.

It really was the impact of the Great Depression that that got Keynes thinking about income vs. expenditure models and their affect on the U.S. economy. The macroeconomists of the 1930's thought of events like the Great Depression as a "business cycle." Keynes' believed that was that changes in the autonomous components in expenditure, and saving and investment are the precipitators of economic fluctuations. His basic premise was that unemployment and depression lower consumption and thus production, which leads to increased unemployment and deeper depression.

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An upturn can only occur after inventories are depleted. But unemployment and depression can plague an economy for an undefined period of time.

According to Laurence Seidman, "In the three decades following the publication of John Maynard Keynes's General Theory of Employment, Interest, and Money in 1936, counter cyclical fiscal policy achieved a gradual ascendancy within the economics profession and in the practical realm of economic policy. By the 1960s, it was widely agreed that fiscal policy should be used to counter fluctuations in the economy. To counter a recession, taxes should be cut, cash transfer payments (such as unemployment insurance benefits) increased, and government purchases of goods and services (such as public works construction) increased. But the past three decades have witnessed the decline and fall of counter-cyclical fiscal policy in both theory and practice. The majority of economists have concluded that monetary policy alone should be used to stabilize the economy, and a minority have argued that the government should not use either monetary or fiscal policy for that purpose. Whereas Congress enacted a major fiscal stimulus package to counter the 1975 recession, it did not even consider a serious package in the 1991 recession. "

Many of the Neoclassical economists disagreed with Keynes's theories and believed policies based on his ideas further distorted markets; radical economists regarded these policies as "Band-Aids" -- that would not sustain a healthy economy in the longer run. In Keynes model, changes in independent spending can shift the balance of income and so change the level of production and employment. Any of the three components of autonomous spending, including consumption, investment and net exports can have this effect. In each case, the change in equilibrium income will be larger than the change in the autonomous spending component.

In times of economic crisis, "it is crucial that the public believe that the government is able and eager to use aggressive fiscal policy should a depression threaten. If the economy is hit with a shock that throws it into a recession, will households and business managers expect the economy to recover, or will they expect….....

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