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Can Expansionary Fiscal and Monetary Policies Counter Recessions?

CAN EXPANSIONARY FISCAL AND MONETARY POLICIES COUNTER RECESSIONS?

When signs of economic weakness emerge, most economics experts are quick to embrace the ideas of John Maynard Keynes.

For most economists the Keynesian remedy is always viewed with positive benefits- if in doubt just push more money and boost government spending to resolve any possible economic crisis.

In this way of thinking, economic activity is presented in terms of the circular flow of money. Spending by one individual becomes a part of the earnings of another individual, and spending by another individual becomes a part of the first individual’s earnings.

So if for some reason people have become less confident about the future and have decided to reduce their spending this is going to weaken the circular flow of money. Once an individual spends less, this worsens the situation of some other individual, who in turn also cuts their spending.

Following this logic, in order to prevent a recession from getting out of hand, the government and the central bank should step in and lift government outlays and monetary pumping, thereby filling the shortfall in the private sector spending.

Once the circular monetary flow is re-established, things should go back to normal and sound economic growth is re-established, so it is held.

Can government really grow an economy?

The whole idea that the government can grow an economy originates from the Keynesian multiplier. On this way of thinking an increase in government outlays gives rise to the economy’s output by a multiple of the initial government increase.

An example will illustrate how initial spending by the government raises the overall output by a multiple of this spending. Let us assume that out of an additional dollar received individuals spend $0.9 and save $0.1. Also, let us assume that consumers have increased their expenditure by $100million. Individuals now have more money to spend because of an increase in government outlays.

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