9.6 Debates over Fiscal Policy

Notes

Economists agree on many facts about fiscal policy but disagree about how and when to use it.

• Keynesian economics, based on John Maynard Keynes's General Theory (1936), holds that during recessions total demand falls short and government spending or tax cuts can restore output and jobs.
• Classical and many free-market economists argue that markets correct themselves over time and that government borrowing can crowd out private investment.
• Supply-side economics, influential in the 1980s under President Reagan, emphasizes cutting tax rates to increase incentives to work, save and invest. The Laffer curve suggests that if tax rates are very high, cutting them could raise revenue; economists disagree about where actual rates fall on that curve.
• Time lags: recognizing a problem, passing a law and seeing its effects take time, so a policy may take effect after the economy has already changed.
• Debates also include how large the multiplier is in practice and how much debt is safe.