#11.02 -- Critiques of Fiscal Policy (9.12)

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Video #11.02 Critiques of Expansionary Fiscal Policy

Critiques of Fiscal Policy:

Critiques of Fiscal Policy Chapter Learning Outcomes Explain the criticisms of the Keynesian view of economics: Crowding out Time lags The possibility of destabilizing the economy Shifts in savings.

1st Critique of Expansionary Fiscal Policy: Crowding Out:

1 st Critique of Expansionary Fiscal Policy: Crowding Out The decrease in private expenditures that occurs as a consequence of increased government spending. Direct Effect : Government spending replaces private spending. Indirect Effect: The financing needs of the federal budget deficit raises borrowing costs and prevents business investment and consumer spending.

Crowding Out:

Crowding Out Complete Crowding Out – Decrease in private spending completely offsets the increase in government spending. Incomplete Crowding Out – Decrease private spending only partially offsets the increase in government spending.

Crowding Out:

Crowding Out

Expansionary Fiscal Policy Crowding Out, and Changes in Real GDP and the Unemployment Rate:

Expansionary Fiscal Policy Crowding Out, and Changes in Real GDP and the Unemployment Rate

2nd critique of Expansionary Fiscal Policy: Time Lags:

2 nd critique of Expansionary Fiscal Policy: Time Lags The data lag: Policymakers not aware of changes in economy immediately. The wait-and-see lag: After they are aware of a economic downturn they rarely enact counteractive measures immediately. The legislative lag: Policy changes take time to be turned into law. The transmission lag: Fiscal policy measures take time to be put into effect. The effectiveness lag: After a policy measure is actually implemented, it takes time to affect the economy.

3rd critique of Expansionary Fiscal Policy: Fiscal Policy May Destabilize the Economy:

3 rd critique of Expansionary Fiscal Policy: Fiscal Policy May Destabilize the Economy SRAS curve is shifting rightward (healing the economy of its recessionary gap), but policymakers don’t know this. Policymakers implement expansionary fiscal policy, and the AD curve ends up intersecting SRAS 2 at point 2 instead of intersecting SRAS 1 at point1'. Policymakers thereby move the economy into an inflationary gap, thus destabilizing the economy.

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4 th critique of Expansionary Fiscal Policy: Savings Shift A final critique of expansionary fiscal policy focuses on the public’s response to increases in government spending or decreases in taxation. At some point, the increases in spending and the decreases in government revenue will have to be paid for. So, the public may increase their current savings to pay for the higher taxes they will expect to see in the future to pay for the current expansionary fiscal policy. And if the savings rate increases, the expansionary fiscal policy may be ineffective.

Critiques of Fiscal Policy:

Critiques of Fiscal Policy Chapter Learning Outcomes Explain the criticisms of the Keynesian view of economics: Crowding out Time lags The possibility of destabilizing the economy Shifts in savings.

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