When the last recession hit, Congress agreed to increase government spending. Br

Question

When the last recession hit, Congress agreed to increase government spending. Briefly defend this choice referring to the Keynesian view of fiscal policy. (Please mention “aggregate demand” and “multiplier” in your answer).

b) Briefly explain the limitations of fiscal policy according to the “Crowding out” view of fiscal policy.

c) We have usually discussed the effects of fiscal policy on aggregate demand. But can fiscal policy also affect the long-run aggregate supply, e.g. shifting it to the right (i.e. increasing growth) or to the left (i.e. lowering growth)? Explain.

Explanation / Answer

A) When recession hits the economy usual market forces cannot correct the market on their own, Government intervention is mandotary in this situation.

This happened in US history once when roosevelt intervened economy got back to normal during the great depression.

If government spends money it will have multiplier effect, Money flows from one person to another and create growth. In some economies money multiplier is more than 2, so for every Dollar spent you will get $2 GDP growth.

B) Yes, If the economy is small enough than you can clearly see crowding out can happen almost immediately. Government creates growth by creating debt, which will increase interest rates. This will cause private investment to decrease. This further hampers recovery of the economy this phenomenon is called crowding out

C) If expansionary fiscal policies are pursued then certainly it will have positive impact in the short term, but long term demand migh actually come down due to inflationary pressure that occur due to this very policy. So balance is a must.

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