ECO403 GDB Solution

Raheel Raaj
M. Accounting & Finance

Requirement: Being student of macroeconomics, analyze the above case of American economy
and recall the Keynesian theory of income and employment, discuss why the tax multiplier is
smaller than the government spending multiplier in an economy in general

Solution:
The logic here is quintessentially Keynesian: as the economy sinks into recession, the
government is acting as the demander of last resort. The Obama stimulus proposal was
controversial among economists for various reasons. One criticism was that the stimulus was
not large enough given the apparent depth of the economic downturn.

Keynes contended that monetary policy was powerless to boost the economy out of a
depression because it depended on reducing interest rates, and in a depression interest rates
were already close to zero. Increased government spending, on the other hand, would not only
boost demand directly but would also set off a chain reaction of increased demand from
workers and suppliers whose incomes had been increased by the government's expenditure.
Similarly, a tax cut would put more disposable income in the wallets of consumers, and that too
would boost demand. Keynes contended, then, that the appropriate fiscal policy during periods
of high unemployment was to run a budget deficit. These ideas flew in the face of the
conventional wisdom that budget deficits were always bad.

Keynesian fiscal policy, the management of government spending and taxation with the
objective of maintaining full employment, became the centerpiece of macroeconomics both in
academic research and in the public debate over national policy. The Employment Act of 1946
committed the federal government in the U.S. to use fiscal policy "to promote maximum
employment, production, and purchasing power." Indeed, a course in macroeconomics until
quite recently was typically devoted almost entirely to the ideas of Keynes .

In addition, some economists thought that using infrastructure spending to promote

employment might conflict with the goal of obtaining the infrastructure that was most needed.

https://www.facebook.com/raheel.raaj.9