Keynes Fiscal

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Chapter 11 Fiscal Policy

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Chapter Title Compare Classical theory to Keynesian theory. Demand Side Fiscal Policy Chapter 11 Fiscal Policy Unemployment: the result of a short-lived adjustment period. Prices and wages adjust to restore full employment Unemployment: the result of long-term inadequate demand. Inflexible prices and wages result in persistent unemployment. Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy

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Chapter Title Introduce Keynesian theory. Chapter 11 Fiscal Policy The General Theory of Employment, Interest, and Money John Maynard Keynes (1936) Keynes argues that no self-correcting mechanism exists for restoring full-employment. Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy

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I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case . . . with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.

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Chapter Title Chapter 11 Fiscal Policy Keynesian Theory Assumptions: Businesses may resist lower prices. Unions and workers may resist lower wages. Suppose a recession . . . Introduce Keynesian theory. Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy

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Chapter Title Chapter 11 Fiscal Policy Decrease aggregate demand The price level remains at P1 Output decreases to y2 y2 Note: Connect points A and B Derive the Keynesian model. Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy

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Chapter Title Chapter 11 Fiscal Policy AD1 AS1 A P1 yF1 Keynes: The economy is driven by aggregate demand. B y2 1929 $103.1 b 1930 90.4 b 1931 75.8 b 1932 68.0 b The Keynesian model and the Great Depression. Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy

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Chapter Title Chapter 11 Fiscal Policy AD1 AS1 A P1 yF1 B y2 Recall: AD = C + I + G + (X-M) 1929 to 1934 The Keynesian model and the Great Depression. Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy

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What’s the Keynesian solution?

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Chapter Title Chapter 11 Fiscal Policy AD1 AS1 A P1 yF1 B y2 Recall: AD = C + I + G + (X-M) Keynes: Use government expenditures to stimulate aggregate demand to increase GDP. yF3 The Keynesian solution to the Great Depression. Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy

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Classical theory vs. Keynesian theory Fiscal Policy

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Fiscal Policy The use of government spending and taxes to influence GDP, employment, and the price level. Recall, AD = C + I + G + (X-M) Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Define fiscal policy.

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Classical theory vs. Keynesian theory Using Discretionary Fiscal Policy to Combat a Recession

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Expansionary Fiscal Policy Recessionary Gap T G Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Fiscal policy and recession.

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yF1 Recall: AD = C + I + G AD1 P1 yF1 yF3 Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Grraph fiscal policy: government spending.

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Government Spending and the Great Depression The Hoover Dam

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1931 (March) Bidding opens for the construction of Boulder (Hoover) Dam: $48,890,995.00 1935 (May) The last concrete is poured at the dam site.

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Built during the Great Depression, it drew men desperate for work to a remote and rugged canyon . An enormous mess hall served 6000 meals a day. Every week 12 tons of fruit and vegetables were shipped in, along with five tons of meat and two-and-a-half tons of eggs.

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The Kennedy/Johnson Tax Cuts 1964

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When Kennedy came into office: 1. The top marginal tax rate was 91% compared to 39.6% today. 2. The unemployment rate was 6.7% 3. A recession. 4. The expansion continued to 1969. Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Fiscal policy and tax cuts.

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Recall: AD = C + I + G yF1 AD1 P1 yF1 yF3 Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Graph tax cuts.

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Classical theory vs. Keynesian theory Using Fiscal Policy to Combat Inflation

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Expansionary Discretionary Fiscal Policy Recessionary Gap Inflationary Gap Contractionary Discretionary Fiscal Policy G T G T Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Fiscal policy and inflation.

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Recall: AD = C + I + G yF1 AD1 P1 yF1 AS1 A Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Graph contractionary fiscal policy.

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Classical theory vs. Keynesian theory Discretionary Fiscal Policy and Crowding Out

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Expansionary Discretionary Fiscal Policy Contractionary Discretionary Fiscal Policy G T G T G > T Deficit G < T Surplus Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Explain crowding out.

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G > T Deficit Gov’t borrows r Recall: AD = C + I + G Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Explain crowding out.

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yF1 AD1 P1 yF1 yF3 Full Partial None No change Some change Complete change Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Show effects of crowding out.

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Classical theory vs. Keynesian theory Automatic Stabilizers

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Suppose the economy is in recession: Real GDP Tax collections Transfer payments G > T The deficit grows Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Explain automatic stabilizers.

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Suppose the economy is in an inflationary gap: Real GDP Tax collections Transfer payments G < T The surplus grows Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Explain automatic stabilizers.

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Classical theory vs. Keynesian theory Supply-Side Fiscal Policy

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Supply-Side Fiscal Policy The use of tax changes influence GDP, employment, and the price level. Recall, AS = Land Labor Capital T Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Explain supply-side fiscal policy.

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Aggregate supply y AD1 P1 AS1 A Taxes Demand Side Fiscal Policy Keynesian theory Automatic Stabilizers Supply-Side Fiscal Policy Chapter 11 Fiscal Policy Graph supply-side fiscal policy.

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Classical theory vs. Keynesian theory The End