Problem Set 3
Complete all questions listed below. Clearly label your answers.

1. Will increases in government spending financed by borrowing help promote a strong recovery from a severe recession. Why or why not?

Answer: Keynesians believe that increases in government spending will add to total demand, and thereby help stimulate both production and employment. “Keynesians economists believe that increases in government spending financed by borrowing will increase aggregate demand” (Gwartney, 247). They believe that stimulus borrowing will lead to higher interest rates and higher taxes in the future, both of which will weaken, if not totally eliminate, the positive consumption and investment effects of the additional government spending. “argue that Keynesian policies will lead to higher future interest rates and taxes inefficient use of resources, and wasteful rent-seeking that will both retard recovery and slow future economic growth. (Gwartney, 247)

2. Does fiscal policy have a strong impact on aggregate demand? Did the shift of the federal budget from deficit to surplus during the 1990s weaken aggregate demand? Did the government spending increases and large budget deficits of 2008–2011 strengthen aggregate demand? Discuss

Answer: ”An appropriate dose of expansionary fiscal policy, if timed properly, will stimulate aggregate demand” (Gwartney, 281). The shift of the federal budget from deficit to surplus during the 1990s did not weaken the aggregate demand, it in fact strengthened it. Government spending increases and large budget deficits of 2008-2001 weakened the aggregate demand.

3. What is the current rate of unemployment (See bls.gov and indicate the month you are reporting)? How rapidly has GDP grown during the past 3 quarters? (See bea.gov and state the quarterly growth rate for each of the last three quarters) Is the economic growth high enough to validate the Keynesian view? Explain.

Answer: The current rate of unemployment in May 2015 is 5.5%. The value of production of goods and services in the US decreased at an annual rate of 0.7% in the first quarter, with an increase of 2.2% in the 4th quarter of 2014, and an increase of 3.5% in the 3rd quarter of 2014. Because of the decrease in economic growth in the 1st quarter of 2015, it would not be considered high enough to validate the Keynesian view.

4. Are changes in discretionary and fiscal policy likely to be instituted in a manner that will reduce the ups and downs of the business cycle? Why or why not?

Answer: Today, most economists do not believe that persistent discretionary shifts in fiscal policy are likely to help promote stability, particularly in a country like the United States. States with its system of checks and balances built into its political process. The problem is timing. If changes in fiscal policy are going to promote stability, they must add stimulus during recessions and restraint during booms. But it takes time for both Houses of Congress and the President to first decide on and approve the appropriate changes. They then need to institute them. Even more time is required before the stimulus spending impacts demand in the targeted areas of the economy. Moreover, Congress, the President and others’ ability to forecast the future direction of the economy is limited. Timing lags and forecasting limitations reduce the likelihood that fiscal changes can effectively promote economic stability.

This assignment is due by 11:59 p.m. (ET) on Monday of Module/Week 4.