Expansionary Economic Policy
ECO203: Principles of Macroeconomics
Instructor: Thomas Westover
Monday, March 9, 2015
In economic terms, a recession is classified as a slow growth or lack of growth in economic activity; in order for the economy to get out of the recession, the government must implement expansionary economic policies. The role of government in the American economy extends far beyond its activities as a regulator of specific industries. The government also manages the overall pace of economic activity, seeking to maintain high levels of employment and stable prices. “The activities of government are grouped into three categories: allocation, redistribution, and stabilization. Stabilization and redistribution are conducted primarily through governments in all economic systems. Allocation is a microeconomic activity that is shared by the government and the market to different extents in different systems (Amacher & Pate 2012, chapter 2.4)”. The US economy is the largest economy in the world, with one of the highest GDP per Capita. However, despite its position as the most powerful economy, it now faces many serious economic problems. Some of these are short term, but some of them reflect an underlying weakness. Every ten years or so the United States goes through some sort of recession for various reasons like the internet bubble of the late 90's to early 2000's and the mortgage bubble crisis of the late 2000's to currently. Historically, the degree to which the government has played a role in the economic structure of the country has defined the large differences in the outlook and well-being of the citizens of the United States.
Two economic schools of thought are classical and Keynesian. Each school takes a different approach to the economic study of monetary policy, consumer behavior and government spending. “In a Keynesian model, financial markets are linked to aggregate supply and aggregate demand primarily through changes in planned investment, which is a highly volatile component of aggregate demand (Amacher & Pate 2012, chapter 14.1)”. The classical view, also known as laissez-faire, or the free market involves little to no government intervention and relies on individuals to act according to their self-interest. Expansionary policy can be broken down into two areas, the fiscal policy as stated above and monetary policy; both of these policies have an effect on the economy such as taxes and government spending, aggregate demand, GDP, and employment. To understand the expansionary economic policies is to first understand both the Classical view of economics and the Keynesian theory of economics. Economists that follow the classical view maintain that the economy is fully capable of attaining the natural level of output or real GDP through and economy that is self-regulating. That means that there are self-adjustment mechanisms that exist within the market system that when the economy falls below or exceed a certain natural level of real GDP, the economy will come back to a natural level. “Relies closely on the self-correcting power of automatic market adjustment to improve macroeconomic instability and exorbitant unemployment. Economists using this reasoning would rely primarily on market forces to cure an ailing economy, with government intervention to be used as a last resort (Investor Dictionary 2015, paragraph 1)”. In regards to unemployment, classical economists believe that unemployment results when there is an additional supply of labor at a higher wage level; if the unemployed would accept lower paying jobs, in time demand for labor with increase and so with wages. The classical theory of economics is based on four assumptions, all wages, markets and wages are flexible, any setback in the macroeconomic is short lived, government involvement in the economy should be minimal, and the market will correct and rescue itself. The opposite of the...
References: Amacher, R., Pate, J., (2012). Principles of Macroeconomics. San Diego, California:
Bridgepoint Education, Inc.
Gorton, G., & Metrick, A. (2013). The Federal Reserve and Panic Prevention: The Roles of
Financial Regulation and Lender of Last Resort
27(4), 45-64. doi:10.1257/jep.27.4.45
Investor Dictionary (2015)
McCallum, B. T. (1987). The Development of Keynesian Macroeconomics. American Economic
Review, 77(2), 125.
Tas, B. O., & Cunedioglu, H. E. (2014). How Can Recessions Be Brought to an End? Effects of
Macroeconomic Policy Actions on Durations of Recessions
Please join StudyMode to read the full document