Keynesian Economics and Fiscal Policy

Introduction to Economics WS2024 - Lecture Eleven: Government Policies (Macro Perspective)

• The lecture was delivered by Assoc. Prof. Dr. Hebatallah Ghoneim
• The lecture covered government policies from a macro perspective.

Government Policies: Fiscal Policy and Monetary Policy

• Fiscal policy involves government choices related to government spending and taxes.
• Monetary policy involves actions taken by a central bank to manage money supply, interest rates, and financial conditions to meet economic objectives.

The Influence of Monetary and Fiscal Policy on Aggregate Demand

• Short-run aggregate supply falls.
• Policymakers can expand aggregate demand to accommodate the shift.
• This can cause the price level to rise while keeping output at its natural level.
• The lecture referenced the Great Depression (1929-1939).

Keynesian Theory

• In 1936, John Maynard Keynes attempted to explain short-term economic fluctuations, particularly the Great Depression.
• Keynes argued that recessions and depressions arise from insufficient aggregate demand for goods and services.
• Keynes famously stated "In the long run, we are all dead".
• Keynes advocated for policies to increase aggregate demand, including government spending on public works.

Government Policies (Detailed)

• Fiscal policy involves government decisions in the overall level of government purchases and taxes.
• Monetary policy is about central bank actions to manage a country's money supply, interest rates, and broader financial conditions to achieve specific economic objectives (inflation control, currency stabilization, full employment and fostering growth).

Expansionary and Contractionary Policy (Graphs)

• Graphs illustrate expansionary and contractionary policies using aggregate supply and demand curves.

Changes in the Money Supply (Graphs)

• Graphs show how changes in money supply affect interest rates and aggregate demand.

Extensive Use to Money Expansion (Graphs)

• Graphs illustrate the model of aggregate demand and supply and the Phillips curve showing the relationship between inflation and unemployment.

How Fiscal Policy Influences Aggregate Demand

• Changes in government purchases and taxes are central aspects of fiscal policy.
• Keynes argued that the Great Depression was due largely to a collapse in aggregate demand.
• Active fiscal policy involves increased government involvement for demand stimulation.
• Infrastructure investment (roads, bridges, schools) and welfare programs (e.g. unemployment benefits and aid to the poor) were proposed approaches to stimulate demand.

State's Budget Statement (Data)

• Data presented in a table format shows expenditure and resource details.

Extensive Fiscal Policies

• Budget deficits and national debt can result from large-scale fiscal policies.
• Fiscal stimulus can lead to inflation if the economy operates near full capacity.
• Increased government borrowing can lead to higher interest rates and crowding out of private investment.

Extensive Fiscal Policies (Continued)

• Dependency on government support can lead to disincentives for work and innovation.
• Inefficiencies and misallocation can arise due to red tape and bureaucracy.
• Fiscal policies can distort economic behavior, leading to unintended consequences.
• Shadow prices refer to a situation where market prices do not reflect true economic value due to subsidies or price controls.

Fiscal Policy vs. Monetary Policy

• A table comparing fiscal policy and monetary policy regarding their authority, tools, implementation speed, and focus..

Productivity of Labor

• Productivity is the amount of goods and services produced from a single unit of labor input.
• Determinants include physical capital, human capital, natural resources, and technological knowledge.
• These factors affect productivity differently based on levels of capital stock.

Economic Growth and Public Policy

• Public policy involves actions, decisions, and plans by governments to address social issues, meet needs and achieve desired outcomes.

Economic Growth and Public Policy (Saving and Investment)

• Capital is a crucial factor in economic growth.
• Investment in capital requires sacrificing current consumption.
• Diminishing returns to capital apply: increasing capital eventually has smaller impacts.

Catch-up Effect

• At lower capital levels (per worker), an extra unit of capital has a significant output impact.
• At higher levels of capital (per worker), additional capital yields lower extra output.

Investment from Abroad

• Foreign direct investment is when a company or individual invests in a business in a foreign country.
• Portfolio investment is where residents invest in foreign stocks or other financial assets.
• Investment from abroad boosts a country's capital stock, productivity and wages.
• It allows poor countries to incorporate leading edge technologies from richer nations.

Education

• Education (investment in human capital) is vital for long-term economic growth, but it has opportunity costs.
• Human capital creates positive externalities impacting the broader economy.

Health and Nutrition

• Health and well-being (another type of human capital) are linked to productivity.
• Malnutrition, in contrast to obesity, remains a significant obstacle for productivity gains and improved living standards in many developing nations.

Property Rights and Political Stability

• The protection of property rights and political stability are essential for encouraging investment and economic growth.
• Unstable political climates and unclear property rights discourage foreign and domestic investment.

Free Trade

• Inward-oriented policies, where countries try to shelter their domestic industries, are less effective than outward-oriented policies.
• Outward-oriented approach that integrates nations into the global economy leads to economic benefits.

Research and Development

• Technological advancements are the primary driver of the rise in income standards compared to the past.
• Increased knowledge (public good) encourages further innovation.
• Governments have a role in encouraging research and development, often using their patent system.

Population Growth

• Economists debate how population affects society.
• Malthusian theory suggested population growth outpaces resources, leading to poverty.
• Some economists believe that a growing population can promote innovations and technological advancements.

Sustainability

• Sustainability is a triple concept with environmental, economic and social components.
• These need to be considered in tandem. The goals of sustainability are often visualized as interconnected circles overlapping within the space of sustainability.

This quiz explores the principles of Keynesian economics, focusing on government intervention, fiscal policy, and its implications on economic stability and productivity. Test your knowledge on concepts such as the crowding out effect, inflation effects of government spending, and the differences between fiscal and monetary policy.