Chapter 11- Fiscal Policy - The Keynesian View

What is the Keynesian view on economic recovery during recessions?

Keynesian Economics, founded by John Maynard Keynes, emphasizes government intervention to stimulate demand and recover the economy.

What economic conditions characterized the Great Depression?

The Great Depression was marked by low productivity and high unemployment.

How does consumer demand influence firms according to Keynes?

Keynes believed that firms are incentivized by consumer demand, and a fall in aggregate demand (AD) leads to pessimism, causing firms to cut supply.

What is the impact of minor shocks in the market according to Keynesian theory?

can be amplified into major disruptions, as all market participants react quickly to new information.

What is the multiplier principle in Keynesian economics?

The multiplier principle states that an increase in spending generates income for resource suppliers, leading to increased consumption and further income generation in a cycle.

How does government spending influence consumer spending in the multiplier effect?

When the government spends money, it pays workers, increasing their income, which in turn boosts consumer spending.

What is the Marginal Propensity to Consume (MPC)?

MPC is the additional consumption resulting from additional disposable income, focusing on unexpected income like bonuses.

How is the MPC calculated?

MPC is calculated by dividing the amount spent from a bonus by the total bonus amount. For example, spending $600 from a $1,000 bonus gives an MPC of 60%.

What happens to the multiplier effect when MPC increases?

An increase in MPC leads to a stronger multiplier effect, which in turn increases aggregate demand (AD).

What is the relationship between government spending and AD in Keynesian economics?

When the government spends, it creates an initial rightward shift in AD, which can lead to further shifts as the money circulates in the economy.

What was the economic situation during the Pandemic in relation to LRAS?

Real GDP was below the Long-run Aggregate Supply (LRAS), indicating underperformance in the economy.

What does a rightward shift in AD signify?

A rightward shift in AD signifies an increase in overall demand in the economy, often resulting from government spending.

What is the significance of the first stimulus check during the Pandemic?

It aimed to boost consumer spending and aggregate demand during a recession where output was below full-employment levels.

What does Keynes argue against regarding market self-correction?

Keynes argued against the belief that free markets could self-correct during severe economic downturns like the Great Depression.

What is the effect of government conducting expansionary fiscal policy?

Expansionary fiscal policy, such as government purchasing goods, shifts AD rightward, increasing economic activity.

What is the role of consumer confidence in Keynesian economics?

influences spending; if consumers are pessimistic, it can lead to decreased demand and economic downturns.

How does the Keynesian model view the economy's long-run potential?

suggests that the economy can achieve long-run potential (LRAS) with appropriate government intervention.

What is the significance of the FRED graph mentioned in the notes?

The FRED graph illustrates the relationship between real LRAS and short-run equilibrium output, showing economic stability over time.

What is the consequence of a leftward shift in Short-Run Aggregate Supply (SRAS)?

A leftward shift in SRAS indicates a decrease in supply, often due to falling aggregate demand and pessimism among investors.

What does Keynesian economics suggest about the timing of fiscal policy?

Suggests that ______ is crucial to counteracting economic downturns and stimulating recovery.

What is the expected outcome of increased consumer spending on the economy?

Increased consumer spending is expected to boost aggregate demand, leading to economic growth and recovery.

What is the primary goal of the first stimulus checks?

To encourage people to continue spending money and shift aggregate demand (AD) rightwards.

What happens to short-run output when the economy is stimulated beyond long-run sustainable output?

Short-run output (Y) exceeds the maximum sustainable output (LRAS; YF).

What is the Keynesian perspective on government intervention during economic downturns?

Keynesian economics argues that government intervention is necessary to bring short-run output into long-run equilibrium.

How did FDR's New Deal relate to Keynesian economics?

FDR's New Deal drastically increased public spending to address the Great Depression, aligning with Keynesian principles.

What is discretionary fiscal policy?

A change in laws or appropriation levels that alters government revenues and/or expenditures.

Define balanced budget.

Total government spending is equal to total government revenue.

What is a budget deficit?

Total government spending is greater than total government revenue.

What is a budget surplus?

Total government spending is less than total government revenue.

What is expansionary fiscal policy?

An increase in government expenditures and/or a reduction in tax rates, leading to a larger budget deficit or smaller budget surplus.

What is restrictive fiscal policy?

A reduction in government expenditures and/or an increase in tax rates, leading to a smaller budget deficit or larger budget surplus.

What is the Paradox of Thrift?

When many households try to save more simultaneously, actual savings may fail to increase due to reduced consumption and aggregate demand, leading to lower income and employment.

What is countercyclical policy?

A policy that tends to move the economy in the opposite direction from the forces of the business cycle.

What is the purpose of stabilization policies?

To stabilize aggregate demand by increasing it when the economy is under-performing and decreasing it when the economy is over-performing.

What is the Employment Act of 1946?

It states that it is the federal government's responsibility to promote full employment and production.

What are automatic stabilizers?

Built-in features that automatically adjust government spending and taxes to stabilize short-run output without congressional authorization.

What is a potential problem with automatic stabilizers?

They cannot stop a full-blown recession and may lead to a budget deficit.

How does Keynes view the role of government in economic downturns?

Keynes believed that government intervention is necessary to prevent uncontrollable economic spirals, as illustrated by the Paradox of Thrift.

What is the multiplier effect in Keynesian economics?

The idea that government spending can lead to increased aggregate demand beyond the initial amount spent.

What is the impact of restrictive fiscal policy on aggregate demand?

It leads to a leftward shift in aggregate demand due to decreased government spending or increased taxes.

What happens to aggregate demand during a recession with automatic stabilizers?

Income tax falls and welfare spending increases, stimulating aggregate demand.

What is the relationship between short-run output and long-run output in Keynesian economics?

Short-run output can exceed or fall short of long-run output, necessitating government intervention to stabilize the economy.

What does Keynes argue about the free market's ability to fix economic downturns?

He was against the idea that the free market could resolve the Great Depression without government intervention.

What is the effect of increased government spending on aggregate demand?

It causes a rightward shift in aggregate demand, reviving weak short-run output.

What is the effect of higher taxes on aggregate demand?

It causes a leftward shift in aggregate demand, potentially leading to recession.

What are the long-term goals of stabilization policies?

To set and achieve long-run economic stability while managing short-run fluctuations.

How does monetary policy relate to fiscal policy?

______ involves changing the money supply, which can impact interest rates and ultimately the economy.

What is a potential drawback of government policy in response to economic conditions?

Government policy can have a long time lag before it impacts the economy, leading to ineffective or excessive measures.

What does Keynes suggest about consumer behavior during economic downturns?

Consumers may try to save more, leading to reduced spending, lower aggregate demand, and further economic decline.