Running Head: EXPANSIONARY POLICY 1
Expansionary Economic Policy ECO203 April 8, 2013
EXPANSIONARY POLICY 2
Expansionary policy is a macroeconomic policy that seeks to expand the money supply to encourage economic growth or combat inflation. One form of expansionary policy is fiscal policy, which comes in the form of tax cuts, rebates and increased government spending. Expansionary policies can also come from central banks, which focus on increasing the money supply in the economy. The U.S. Federal Reserve employs expansionary policies whenever it lowers the standard fed funds rate or discount rate or when it buys Treasury bonds on the open market, thereby injecting capital directly into the economy. I will focus this paper
on these policies and theories, and how the federal government would engage them
in an effort to move the economy out of a recession. The Great Depression challenged the classical model with the reality of a long depression and high unemployment. In The General Theory, Keynes attacked the classical model in two important ways. First, he identified some flaws in the model. Second, unlike the business cycle theorists, he offered a well-developed alternative model of the macroeconomy. This model was the basis for the Keynesian revolution, the change in macroeconomic theory and policy that occurred when Keynes's ideas displaced the classical explanation of how output and employment are determined. The Keynesian model begins with aggregate demand and works from there to employment, instead of the other way around (Amacher & Pate, 2012). In the 1930s Unemployment was high because planned spending was too low to generate the level of output that would result in full employment. Thus, too little spending was identified as the cause of unemployment. To reduce unemployment, planned spending had to increase. In the language of aggregate supply and aggregate demand (a model developed after Keynes), aggregate demand had to shift to the right. In attempting to identify the cause of employment, Keynes reasoned as follows: EXPANSIONARY POLICY 3
The level of employment is directly related to the level of production, or output. In a market economy, planned spending on the output of the business sector will determine the level of production. Firms adjust their levels of production to meet demand for their products. Put simply: Supply adjusts to demand. (In contrast, Say's law said that supply creates its own demand). Because employment depends on production and production responds to spending, the level of employment in a market economy depends on the level of planned spending in the economy (Perry, 2009). Before Keynes balanced budgets were generally accepted by politicians and the public as the responsible thing. Keynesian view challenged the desirability of balanced budgets. Argued that federal budget should be used to promote AD/full employment. Federal Budget influences AD two ways:
Government spending on goods and services stimulates AD. National defense, highways, education, etc. Tax policy influences AD. Tax cut increases disposable income, increases PCE - C goes up. Business tax cut increases business investment on equipment, etc.
Keynes argues that fluctuations in AD are the source of economy disturbances and create the bus cycle - "Animal Spirits." Policy...
References: Amacher, R., Pate, J., (2012). Principles of Macroeconomics. San Diego, California:
Bridgepoint Education, Inc.
Investopedia US. (2013). Expansionary Policy
Perry, M. (2009). ECONOMICS
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