to a more desirable level. This production cutback decreases income, however, setting the multiplier process in motion and pushing the economy toward a recession. We should forecast a downturn in the economy.
When inventory levels are unusually low or are falling rapidly, firms should react by increasing production to build inventories up to a more desirable level. The production increase also increases income, however, setting the multiplier process in motion and thereby pushing the economy to an even higher level of income. We should forecast an upturn in the economy.
4.5 Policy Implications
Although our earlier example of the multiplier process was couched in terms of a policy of increasing government spending, any policy that influences aggregate demand has similar effects. An alternative way of increasing aggregate demand is to decrease taxes, which increases aggregate demand indirectly by increasing consumers' disposable income, thereby enticing them to increase consumption demand C.
Changing government spending or taxation is referred to as fiscal policy because each involves a direct change in the government budget deficit, calculated as government spending G less tax receipts T. (Fiscalis is Latin for "pertaining to the public purse.")
In particular, an expansionary fiscal policy (an increase in government spending or a decrease in taxes) creates a government budget deficit. Keynesians believe this is a natural side effect of a fiscal policy designed to maintain an economy at full employment a side effect that should be reversed when in boom times governments cut back on spending or increase taxes to cool off the economy. In the Keynesian view, running a deficit is a small price to pay for jump-starting the economy so that the multiplier process can pull it out of a recession. They believe that the deficit can be offset later by a budget surplus when the economy is strong.
Keynesians also believe that an economy can become stuck in a recession when its natural recovery forces operate far too slowly, creating prolonged periods of high unemployment. They further believe that the government is able to move the economy out of a recession through fiscal policy and that it should do so. This advocacy of government intervention in the economy has been opposed by others who believe that as a matter of principle the government has no business interfering in the economy, and that government intervention, however well-intentioned, too often makes things worse, not better.
Another facet of this debate concerns the issue of whether fiscal policy should be undertaken through increases in government spending or decreases in taxes: The former involve more government influence over the production and distribution of goods and services in the economy, whereas the latter involve less. Those on the left of the political spectrum liberals, socialists, and Democrats believe that more control by the government over resource allocation in the economy is a good thing because they do not believe that market forces
