5.8 Government austerity policy and the paradox of thrift

austerity

government use of cuts in spending and increases in taxation to reduce its debt and borrowing

do economists often agree on when is the right time for the government to turn from supporting aggregate demand by borrowing to tightening its belt?

no - it’s hotly debated

paradox of thrift

if during a recession, a household tries to save money to improve their chances, tat might be fine but if everyone does that, the recession actually gets worse

fallacy of composition

what is good for one part of the economy may not be good for the entire economy

why is austerity sometimes bad?

if the economy hasn’t yet come out of the recession, it can reinforce a decrease in AD and further the recession - the timing of using austerity is really tricky

does this mean that gov should never impose austerity in order to reduce the extent of gov borrowing?

no, it just means a recession is a bad time to do it - running gov deficits under wrong ecnoomic conditions can be harmful but sometimes it works

John Maynard Keynes

predicted that the Versailles agreement would lead to a worldwide economic crisis - he was right, the Great Depression followed

• said that orthodox monetary policies would make it worse

• introduced idea of the multiplier

• said that if interest rates were already low, fiscal expansion was necessary to alleviate the depression

• designed bretton woods system of fixed exchange rates