The Keynesian Doctrine and its Implications on Public Budgeting

André Gonçalves de Freitas

André Gonçalves de Freitas

Mar 18, 20244 min read

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The Keynesian Doctrine and its Implications on Public Budgeting

Introduction:

The Keynesian doctrine, named after 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 tool for fiscal policy, a concept that contrasted with prevailing economic theories at the time. Keynes proposed that during economic recessions, the government could intervene and stimulate the economy by increasing 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 boost aggregate demand and stimulate production and employment. Conversely, during economic expansions, the government could use the public budget as a fiscal policy tool to prevent overheating the economy. This could be achieved by reducing public spending or increasing taxes to decrease aggregate demand. Keynes argued that these government interventions are necessary to stabilize the economy and prevent significant fluctuations in the business cycle that could lead to prolonged periods of recession or high inflation.

The Keynesian Model:

According to the Keynesian theory, the aggregate supply curve is horizontal, with rigid prices and wages. In a simple Keynesian model that considers consumption, investment, government, and the external sector, the spending multiplier increases when certain conditions are met. In this model, the consumption function is given by C = 100 + 0.2Y, where C represents the level of consumption and Y is income. Assuming an economy is closed, with autonomous investment and autonomous government spending equal to 10 each, and a marginal propensity to consume of 40% of income, the equilibrium income in the model and the tax rate applied to income would be determined.

The Role of Import and Consumption:

Considering the Keynesian model that includes consumption, investment, government, and the external sector, an increase in the marginal propensity to import and a reduction in the marginal propensity to consume would have an impact on the equilibrium income. The exact effect would depend on the specific values of these propensities and the other variables in the model.

The New Keynesian Theory:

The New Keynesian theory introduces the concept of menu costs to explain certain economic phenomena. Menu costs refer to the costs associated with adjusting prices. According to the New Keynesian theory, these costs can lead to price stickiness and result in deviations from the efficient equilibrium. This theory provides insights into the dynamics of inflation and the role of price adjustments in the economy.

Adjustment in the Market:

According to the Keynesian logic, if there is excess demand in the goods market, the adjustment occurs only through an increase in production and income. This implies that in the short run, changes in demand have a direct impact on output and income, while prices remain relatively stable. This idea is central to the Keynesian belief in the effectiveness of expansionary fiscal policy during recessions.

Conclusion:

The Keynesian doctrine transformed the way governments approach economic management, emphasizing the use of the public budget as a tool for fiscal policy. By intervening in the economy through increased public spending during recessions, governments aim to stimulate production, employment, and aggregate demand. Conversely, during economic expansions, the public budget can be used to prevent overheating and maintain stability. The Keynesian model provides insights into the relationship between consumption, investment, government spending, and the external sector. Moreover, the New Keynesian theory explores the effects of menu costs on price adjustments and inflation dynamics. Overall, understanding these concepts helps policymakers make informed decisions to stabilize the economy and promote sustainable growth.

Actionable Advice:

1. During economic downturns, consider implementing expansionary fiscal policies by increasing public spending on infrastructure projects or reducing taxes to stimulate private consumption and investment.

2. In times of economic expansion, be mindful of the potential risks of overheating and consider adjusting the public budget by reducing government spending or increasing taxes to moderate aggregate demand.

3. Regularly assess and analyze the key variables and parameters in the Keynesian model, such as the marginal propensity to consume, import, and invest, to understand their impact on the equilibrium income and make informed policy decisions.

By incorporating the Keynesian doctrine into public budgeting practices, governments can play a crucial role in stabilizing the economy and promoting sustainable growth.

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