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Analysis of the Keynesian Model, Part Two
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Strategic Business Management - Macroeconomics
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從本節課中
The Keynesian Model and Fiscal Policy
與講師見面
Dr. Peter NavarroProfessor
Paul Merage School of Business
In the last module,
we took a close look at the consumption element in
our GDP growth equation and aggregate expenditures formulation.
In this module, we'll finish that discussion
with an analysis of the three remaining elements,
business investment, government spending and net exports.
Investment expenditures include, investment in business plant and equipment.
And such expenditures range from those to building factories and buying
machinery to purchasing computers and software.
Investment expenditures also include those involved in
building up the inventory of the products a company might produce.
In fact, inventory is a really important category of investment expenditures.
Because when business executives over forecast
aggregate demand and build up too much inventory,
they may begin to cut back on production and even begin laying off workers.
This slashing of inventory and slowing of production can set in
motion a process whereby the economy starts to slow down.
And that's why both business executives and economic forecasters,
follow the data very carefully,
on inventory levels both at the company and national levels.
Now here's a plot twist for you.
In the Keynesian model,
investment expenditures are assumed to occur independently of the level of income.
Algebraically, this means that investment,
I is simply equal to autonomous investment, I knot.
So, here's a fun question for you,
what kind of line would you draw to
represent the investment function in your Keynesian model,
given that investment is assumed to be equal to autonomous investment?
Please jot down your answer before moving on,
maybe even draw that line.
In fact, once you assume that investment equals
autonomous investment and is not determined by
the level of income that means you can draw the investment function as a horizontal line.
Did you get that right? Now, let's ask the bigger question,
does it really makes sense to assume in the Keynesian model that
business investment is autonomous and does not
depend on the level of income like consumption does.
Let's tackle that question by looking at this figure which
depicts the plunge in business investment during the Great Depression.
In this figure, the investment expenditures curve I1,
shows annual business investment in
1929 just prior to the stock market crash at $16 billion.
In contrast the investment expenditures curve I2,
shows investment after it has precipitously fallen to $1 billion by 1933.
So here's a question for you as you look at this figure,
if investment is not determined by the level of income,
what might be the determinants of investment?
Take a minute now to think about that and jot down some ideas before we get
into the mind of John Maynard Keynes for an answer.
So how did John Maynard Keynes see investment expenditures being determined?
To Keynes there were at least two important factors.
First, Keynes quite logically
believe that investment is sensitive to changes in the interest rate.
To Keynes, when interest rates fall,
this fall and the price of financial capital results in an increase in investment.
Contrast when interest rates rise,
investment expenditures fall as it becomes
more expensive to undertake capital investment.
But here's yet another important Keynesian plot twist.
While Keynes believe the interest rate was important in determining investment,
he decidedly did not embrace the classical economists notion
that falling interest rates and increased investment
would necessarily lead back to a full employment equilibrium.
That's what Keynes's second factor driving
investment expenditures comes into play and it's
captured by two of the most famous words in macroeconomics, animal spirits.
Yep, I just said animal spirits.
Just what exactly did Keynes mean by the term animal spirits?
Well, Keynes believed that investment was in large part driven by the expectations or
business confidence that businesses had regarding potential sales and profits.
And if business executives believe the economy was about to go bad,
it could become a self-fulfilling prophecy.
The reason, fearful business executives would cut back on investment and production,
run down inventory levels and possibly lay off people.
And enough fearful executives did that.
These negative animal spirits might indeed help trigger
or at least further amplify a downward recessionary spiral.
And that is precisely why economic forecasters
even today closely watched economic indicators
like business confidence and consumer confidence that
capture the animal spirits of key economic actors.
And here it should be clear that confident businesses will
tend to invest more and confident consumers will tend to spend more.
And that typically means a faster growing economy and a more bullish stock market.
The third component of
aggregate expenditures in the Keynesian model is government spending.
This includes everything from the purchase of missiles,
ships and bombers for national defense to roads bridges courthouses and school yards.
It also includes payment for the services of
the soldiers civil servants and judges and teachers most nations hire.
Unlike private consumption and investment,
this government expenditures component of aggregate demand,
is determined directly by the government's spending decisions.
And as with business investment,
the Keynesian model assumes government expenditures to be autonomous.
That is determined outside the market.
This means algebraically that government expenditures,
G simply equals autonomous government expenditures, G knot.
And as with the investment function,
the government expenditures function can be graphically portrayed as a horizontal line.
In general government expenditures exhibit much less volatility than investment.
Although episodic events such as wars and natural disasters can
lead to huge fluctuations.
Note that in the Keynesian model,
increased or decreased government expenditures together with tax cuts or tax increases,
serve as the primary tools of fiscal policy that are
used to counterbalance changes in investment and consumption spending.
In fact, through a Keynesian lens,
that's how government expenditures are at least partly viewed.
Not just as a means to provide public goods and public works and government services,
but also has a macroeconomic balance wheel that uses
fiscal policy to offset any shortfalls in
consumption or investment that might lead to a recession.
And just to test your knowledge here.
If you are the chief economist of a country
facing a recession and you were a Keynesian disciple,
what would you recommend in terms of discretionary fiscal policy?
Committed now to jot down your answer, before moving on.
Well facing a recession,
a Keynesian economist would recommend expansionary fiscal policy.
This could involve increased government expenditures,
tax cuts or some combination of the two
to stimulate the recessionary economy and close the recessionary gap.
In contrast, as I have already noted
contractionary fiscal policy involves reduced government expenditures,
tax hikes or some combination of the two to cool
down an overheated economy.
Now, in addition to discretionary changes in government spending and taxes,
there are also important non-discretionary government expenditures,
such as unemployment compensation for workers,
welfare payments and subsidies to farmers
that automatically rise or fall depending on economic conditions.
Thus, for example, if the economy goes into recession,
unemployment compensation paid out to workers will rise because
more and more laid off workers become eligible for such compensation.
In this way, government transfer programs like unemployment compensation,
automatically help stabilize the macro economy.
And that observation leads us to this key definition.
An automatic macroeconomic stabilizer is a program that will
automatically boost government expenditures in the event of an economic downturn
to offset its effects and automatically reduce government spending as
an economy grows more rapid.
The fourth and final component of aggregate expenditures is net exports.
In this key definition,
net exports represent the value of the nation's exports minus the value of its imports.
Exports and imports include everything from shoes and toys and electronics,
to soybeans, corn and semiconductors.
And the abiding macroeconomic accounting truth and fact here is this,
because exports create domestic production income and employment for an economy,
they must be added to aggregate expenditures.
In contrast, when one nation purchases imports from a foreign country,
no such domestic production income and employment is created.
So that means, imports must be subtracted from aggregate expenditures.
And know these two key definitions.
When a nation exports more than it imports,
it is said to run a trade surplus.
Conversely, when a nation imports more than it exports it is said to run a trade deficit.
Now, here's a key point in
general trade rule that follows directly from our GDP equation.
Trade deficit subtract from GDP growth while trade surpluses add to GDP growth.
I will repeat that,
trade deficit subtract from GDP growth while trade surpluses add to GDP growth.
That is a very important macroeconomic observation
because the world is increasingly interconnected in a global web of trade.
And for many nations,
the difference between poverty and prosperity may be found in
the health of the net export segment of their GDP equation.
Despite the imports of trade in the real world,
however that won't stop us in this lesson from
making the simplifying assumption of a closed economy,
meaning an economy closed to trade.
We want to make that assumption now so we can focus in our next module
solely on the role of government spending in the conduct of fiscal policy.
Don't worry, we will deal with international trade and
the implications of trade deficits and surpluses in a subsequent lesson.
