The Keynesian Doctrine: Utilizing Public Budget as a Fiscal Policy Instrument

The Keynesian Doctrine: Utilizing Public Budget as a Fiscal Policy Instrument

The Keynesian doctrine, named after the renowned British economist John Maynard Keynes, revolutionized the way governments interact with the economy. This doctrine introduced the idea that the public budget could be used as a fiscal policy instrument, a concept that contrasted strongly with the prevailing economic concepts at the time.

Keynes postulated that during times of economic recession, the government could intervene and stimulate the economy through increased public spending. This intervention could take various forms, such as direct investment in infrastructure or reducing taxes to encourage private consumption and investment. This approach, known as expansionary fiscal policy, aims to increase aggregate demand and consequently stimulate production and employment.

On the other hand, during times of economic expansion, the government could use the public budget as a fiscal policy instrument to prevent overheating of the economy. This could be done by reducing public spending or increasing taxes to decrease aggregate demand. Keynes argued that these government interventions are necessary to stabilize the economy and avoid large fluctuations in the business cycle, which can lead to prolonged periods of recession or high inflation.

According to Keynesian theory, the Aggregate Supply is horizontal, with prices and wages being rigid. This means that changes in demand have a direct impact on output and employment levels. In a simple Keynesian model, which includes consumption, investment, government, and the external sector, the multiplier effect of government spending increases when there is a decline in imports and an increase in consumption.

In the given simple Keynesian model, the consumption function is represented by C = 100 + 0.2Y, where C is the level of consumption and Y is income. Considering a closed economy, where autonomous investment and autonomous government spending are both equal to 10, if the marginal propensity to consume is 40% of income, the equilibrium income of the model and the tax rate applied to income will be determined.

In the Keynesian model, with consumption, investment, government, and the external sector, an increase in the marginal propensity to import and a decrease in the marginal propensity to consume lead to a decrease in aggregate demand and a decrease in equilibrium income.

According to the New Keynesian theory, menu costs explain the stickiness of prices in the short run. These costs refer to the expenses incurred by firms when changing prices, such as printing new menus or updating price tags. The higher the menu costs, the slower the adjustment of prices to changes in demand.

In Keynesian logic, if there is excess demand in the goods market, the adjustment occurs solely through an increase in production and income. This means that firms will increase their output to meet the higher demand, leading to an increase in income.

In the Keynesian model of income determination, which includes consumption, investment, and government, the equilibrium income will be higher when there is an increase in the marginal propensity to consume. This is because a higher marginal propensity to consume leads to a larger increase in aggregate demand and, therefore, a higher level of output and income.

Actionable Advice:

• 1. During times of economic recession, governments can use expansionary fiscal policy to stimulate the economy. This can be done through increased public spending on infrastructure projects or by reducing taxes to boost private consumption and investment.

• 2. In order to stabilize the economy and avoid large fluctuations in the business cycle, governments should carefully manage their public budgets. This includes using fiscal policy instruments, such as reducing public spending or increasing taxes, during times of economic expansion to prevent overheating.

• 3. Understanding the key concepts of the Keynesian doctrine, such as the multiplier effect and the role of aggregate demand in determining output and employment levels, can help policymakers make informed decisions to promote economic stability and growth.

In conclusion, the Keynesian doctrine revolutionized the way governments interact with the economy by introducing the concept of using the public budget as a fiscal policy instrument. This approach, known as expansionary fiscal policy, aims to stimulate the economy during times of recession and prevent overheating during times of expansion. Understanding the key concepts of the Keynesian doctrine can help policymakers make informed decisions to promote economic stability and growth. By implementing effective fiscal policies, governments can contribute to a more stable and prosperous economy for their citizens.