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Unemployment: Keynesian Ideas And Fiscal Policy

4099 words - 16 pages

Fiscal policy, as we know it today, is meant to mitigate unemployment and stabilize the economy through aggregate demand. Despite dismal unemployment numbers, politicians and policy-makers continue to use and be optimistic about the effectiveness of fiscal policy in this regard. Policy as we have seen over the past five years has had dismal effect on the unemployment numbers we are seeing today. It seems we need a policy that will tackle lagging aggregate demand as well as the employment problems. A direct-job creation effort will work to create the differences in aggregate demand and effective demand creating equilibrium and filling the void that the current Keynesian fiscal policy leaves.

Keynesian Ideas
The origins of many ideas seen in fiscal policy come from John Maynard Keynes a revolutionary economist who tackled the idea of aggregated demand through Keynesian economics. Aggregate demand is the demand for gross domestic product or goods and services that the country has to offer. It is represented by the formula GDP=AD= C + I + GS+ X or (C) Consumption, (I) Investment, (GS) Government Spending, (X) Net exports. Fiscal policy in essence is using tactics such as government spending and tax cuts in order to affect the right side of this equation and increase aggregate demand.
The general agreement across Keynesian theory is that boosting aggregate demand is the precise thing to do when facing an economy with lackluster growth and on the shores of recession. Leading up to most recessions there is a significant reduction in demand for goods and services offered in the country. This lower demand leads to inventory reductions, lower production levels, layoffs and increased unemployment. In order to stabilize the economy, the government must intervene and stabilize aggregate demand (Hahn, 1997, 47-60).
The idea of increasing aggregate demand finds grounds in Keynes multiplier phenomena. Keynes idea is that there is a spending multiplier model that shows that $1 introduced into the economy flows and circulates into smaller and smaller pieces; ultimately yielding a final aggregate impact number that is much larger than the original amount spent. This model can be applied to each variable of aggregate demand in order to increase the GDP. (GDP=AD=C+I+G+X)
In this model if government spending increases by $1, half of that dollar will circulate in the market, and the other half of that 50 cents or 25 cents with flow into the economy, in a continual process. That first 50 cents in additional consumption is the Marginal Propensity to Consume factor (MPC) . With that MPC of 50 cents, the multiplier of any new round of marginal spending, based on Keynes model would be, $1/ (1-mpc) or $1-.5) =$2 of increased spending. Therefore, $2 is created by each dollar introduced into the economy. Essentially if $400billion put into the economy through government spending brings back a rise in income of $600 billion, then the multiple would be 1.5 (Keynes,...

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