The Theory Of Government Spending And Fiscal Policy

F. A. Hayek, the "other" economic thinker of the twentieth century, believed that the way to stabilize a broken economy was to find solution from the boom that preceded the current bust. The Hayek-supported Austrian theory sought a connection among business cycles, capital theory, and monetary theory. Hayek believed an economy started going downhill when people did not coordinate their actions. The spontaneous order of the free market and price system usually does a fantastic job of coordinating people's actions. Hayek said that the credit market becomes distorted when the money supply increases, interest rates go down, and the credit becomes artificially cheap (Friedrich). This causes an artificially high rate of investment and malinvestment." [Malinvestment is ]...too much investment in long-term projects relative to short-term ones, and the

This policy is results in faster results to speed up the economy for the short term. Fiscal Policy is later used to develop a plan of yearly actions and is a long term way to stabilize the economy. The next idea to stabilize the economy is a theory called monetarism which is the belief that if government did not interfere with the market economy that employment would be high and inflation low. Followers believe the government is the reason of downturns such as the recent recession.

This essay aims to explain Minsky’s Financial Instability Hypothesis (FIH) and then explain the wide influence of expectations in the operation of the financial system within this model. Minsky’s FIH argues that tolerance for risky assets within the financial system rises during times of stability and leads to the level of investment to rise to a too high a point and causing a recession or crisis [6]. This essays will first summarise the FIH before demonstrating how expectations determines the level of investment within the financial system through an analysis of Minsky’s theory of investment and also examining two extreme cases where expectations also impact the level of investment within the financial system.

To appreciate why certain events that led to the financial crisis were allowed to continue, one must understand economic theories put forth by Adam Smith. In 1776, Adam Smith wrote about the ‘invisible hand’ of the market, that is,

On the other does Minsky theory tell us the whole story about the financial crisis, most notably from Engelbert Stockhammer and his theory of “Rising inequality as a cause of the present crisis” (Stockhammer, 2012). His theory has four main points why growing inequality has led to the financial crisis. Firstly, with growing inequality can have an adverse effect on aggregate demand because consumer’s marginal propensity to consume (MPC) will increase. By deregulation, occurring it allows governments to have a larger deficit for a longer period creating two new modules, which are a debt lead model and an export lead model. The penultimate cause was that with the new debt lead model, households are maintain the same consumption even though real

The most effective policy is the fiscal policy. Before I explain why the fiscal policy is more effective, I need to explain the differences between the two policies. First, I will be explaining the monetary policy. According to the website “The Economic Times,” it clearly explains that the monetary policy is made up of actions of a central bank, regulatory committee, and a currency board. They are involved in determining the size and the interest rate of money supply. The policy maintained actions such as buying or selling government bonds and change the amount of money banks are required to keep in the bank. The federal reserves are in charge of the monetary policy. There are two types of monetary policy, which are called contractionary and

Hyman Minsky was a relatively unknown economist. I only heard of Minsky because of the “Masters in Business” podcast by Barry Ritholtz and reading The Economist. However, I found his “financial-instability hypothesis” to be fascinating. Minsky was not some child prodigy growing up, unlike some of the historical figures we meet this semester. Instead he had humble beginnings, Minsky was born in Chicago in 1919. He is by all means a contemporary economist. Minsky received his bachelor’s degree in mathematics from the University of Chicago and he went on to receive his P.H.D in economics from Harvard. Minsky would go on to teach at Brown University, UC Berkley, and Washington University.

Smith’s metaphor has been hijacked in recent years, particularly by wealthy Republicans, to mean minimal government intervention and widespread deregulation. This has had destructive consequences in the years leading to the 2008 Financial Crisis. Critics often blame the functioning of private market and decentralized environment as the primary driver of the crisis. Factors such as information asymmetries in financial markets along with a lack of checks and balances on destructive market practices encouraged excessive risk taking in the form of predatory and subprime

Monetarists connection with the financial crises has its origins on the most influential economist since 1970, Milton Friedman. Friedman and Schwartz (1963) argued that financial crises are largerly exogenous phenomena and connected them with banking panics. As they documented, bank panics lead to decline in money supply because depositors withdraw their deposits and banks move to reserves rather than loans (Mishkin, 1992, pp. 122-124). The decline in money supply follows the contraction of aggregate economic activity and the price level. It is worth mentioning, in the early view of monetarism, decreasing asset prices and increasing business failures cannot characterized as financial crisis, if no bank panic occurs (Mishkin, 1992, p. 116).

In the year of 2007 Americans were plagued with a recession that negatively impacted the US economy and it’s citizens. Economic activity slowed down, a downturn in the business cycle occurred, and the amounts of goods and services produced were reduced (Census). Many individuals will take their own opinion on this crisis, and the root cause. The truth is, there are many causes of the 2007 recession: the actions of the banks and their consistent lends on mortgages, the actions of humans and their inability to save and invest, and the unresponsiveness of higher authorities all contributed to this mess in several ways (Thomas, Bill). However, the main causes of the financial crisis are due to the optimism of experts, investor and human behavior, and the theory of evolution.

The contractionary fiscal policy tends to bring down the total income to its equilibrium. This is shown in the following figure that illustrates how the contractionary policy affects the aggregate demand curve.

The Wall Street crash of 1929 was one of the most unexpected and devastating financial collapses in the history of the world. On October 28th, known as “Black Monday”, the Dow Jones Industrial Average dropped a record high 38 points, or 13%, in one day. The next day, known as “Black Tuesday”, the market continued its decline as it dropped another 30 points, or 12%. A total of 16.4 million stocks were also traded on the Black Tuesday, which was a record that was not broken for almost 40 years. Many people consider this crash to be a leading cause of the great depression, but it was really just an extreme example of a normal economic cycle. The crash accelerated the depression while the real problem was a result of a few major economical mistakes made by the people, banks, and other outside sources before the crash occurred. The first mistake was that inexperienced investors poured tons of borrowed money into the market, due to speculations that the market would continue its consistent success and growth. The idea of “buy now, pay later”, also known as credit, influence consumers to take out loans in order to purchase goods that weren’t necessarily a smart economically plan. Lastly, the failure of banks destroyed the economy and was ultimately the nail in the coffin. Although the crash had an influence on great depressions start, it was not the leading cause. The great depression was bound to happen due to the countries irresponsibility, not the Wall Street crash of 1929.

In essence, expansionary fiscal policy can be used to raise income, stimulate spending and increase levels of production in a given economy, be it open or closed. Gradually, as unemployment falls, this sequence allows the economy to move towards full employment.

The Keynesian economics model was developed by the British economist John Maynard during the 1930s in an effort to comprehend how the Great Depression occurred. Keynes economic model discusses the total spending of the economy. The Keynesian model states that an economy can operate below full capacity due to presence of market imperfections, therefore there would be needs for expansionary fiscal policies or government intervention in regulating the market. Keynes developed the theory of money illusion; a theory that states “that many people have an illusory

In a system of indicative planning reliance, fiscal policy plays an instrumental role in the economy of any country. Planning Commission of India had pointed out in the Seventh Five Year Plan that, the “Fiscal policy has a multi-dimensional role” which “particularly aims at improving the growth performance of the economy and ensuring social justice to the people. However, when a fiscal policy is not used discreetly, it is likely to create a fiscal mess.....A fiscal imbalance requires immediate corrective measures because a large fiscal deficit is non-sustainable.”