Explain the basic logic of Keynesian fiscal policy.

Question

What will be an ideal response?

Answer 1

Public budgeting is a critical element in regulating demand and thereby managing the economy. If government wants to stimulate the economy (i.e., increase economic growth and reduce unemployment), it should run a budget deficit. Such a deficit places more money in circulation than the government has removed from circulation, thereby generating greater demand for goods and services by citizens, who have more money to spend. This additional money, as it circulates through the economy, multiplies in magnitude to an extent that depends on the propensity of citizens to spend their additional income rather than save it. Likewise, if a government wants to reduce inflation in an overheated economy, it should run a budget surplus, removing more money from circulation in taxes than it puts back in through public expenditures. The budget surplus leaves citizens with less money than they had before the government’s action and so should lessen total demand.