Keynesian fiscal policy

Keynesian fiscal policy refers to the theories developed by John Maynad Keynes during the mid-1930s. Keynes argued that a market economy never can reach full employment, the unemployment rate was due to low demand in the economy and the state must intervene to reduce unemployment.

Keynesian fiscal policy means that the government should increase public spending or cut taxes in a recession and cut public spending or raise taxes in a boom. Keynesian fiscal policy assumes that there can not be inflation and unemployment simultaneously. During the 1970s, however, there was problems with stagflation, high unemployment and high inflation at the same time.

The problem with Keynesian fiscal policy is said to be that there is a time lag between an action and the effect. When it is a boom and the state tries to cool down the economy, these measures will have an effect first when there is a recession and therefore exacerbate this. The Keynesian fiscal policy will therefore create increased volatility in the economy. The Keynesian fiscal policy also works poorly when a country has a fixed exchange rate, expansionary measures will increase inflation, thereby reducing exports.