Keynes and Hayek on federal government spending (Essay Sample)

MACROECONOMICS 202
Name
Course
Instructor
Date
Keynes and Hayek on federal government spending
According to Keynes, the government has a big role to play in the economy, since it was not possible for the economy to achieve full employment especially during recessions. As such, government intervention is vital to increase the aggregate demand in the economy. To Keynes, governments were hard pressed to deal with the unemployment in the 1930’s since they were not involved in the economy through printing of money. Besides having cheap money in the economy, other strategies were proposed by Keynes to help the economy including: slashing the economy and expanding government programs (Koehn, 2011). Hence, the government role in the economy would be use of fiscal policies including tax cuts, deficits and spending.
On the other hand, Hayek had a differ take on the economic situation stating that the persistent inflation that affected the Austrian economy was detrimental to the economic well being of the country. As such, Hayek pointed out that there was no need for inflation as a strategy to improve the economic plight of countries. At the same time, those who were in favor of large-scale public spending ignored the fact that this would lead to inflation and the government having too much control over the lives of people. Hayek equated government intervention with interference of economic freedom, and this meant that an economic system where central planning played a prominent role tended to be less efficient (Koehn, 2011).
Relevance of Hayek today
Even though, Keynes has received more attention because of his focus on the role of the aggregate demand in the economy, Hayek assertions highlight on the perils of overspending by the government. The recent bailout of banks and other financial institutions is merely a reward of bad decisions made by the institutions, given that the taxpayers paid for these bailouts. Governments may overinvest in projects and ventures even if they do not have the approval of the public. Hence, there is a need to liquidate over investments and focus more on improving the business environment. Nonetheless, the notion that consumer saving is an essential component of improving the economy ignores the fact that during recession, consumers are less likely to save as unemployment is higher. Nonetheless, austerity measures should not be ignored as they also encourage efficiency as businesses and people are more likely to account for how they spend their investments. In other words, too much government intervention may exacerbate the problem of unemployment because of inefficient allocation of resources. Steering on a Difficult Course, 1997–1998 Asian financial crisis and fear of recessionary gap in the U.S.
A recessionary gap occurs when the actual real GDP falls below the potential output in an economy. During the Asian financial crises there were fears that the Asian economies would have a contagion on the global economy and particularly that of the U.S. as the financial crisis spread to the Southeast region it became apparent that it was no ordinary crisis since, the contagion would spread out to other regions of the world. Given that the international financial markets started to feel the effects of the Asian financial crisis there was a need for the U.S. government to use various policies in order to manage the effects of the financial situation in Southeast Asia. At the same time, there was increased volatility in stock markets throughout the world including in New York, and investor confidence. In any case, fears that volatility in the global financial institutions was not unfounded, as various countries were affected, and the Fed’s use expansionary and then contractionary monetary policies was seen as being effective to avert another crisis (Rittenberg & Tregarthen, 2009).
Coordination between monetary and fiscal policy measures after the 2008 recession
Fiscal- monetary coordination is important, given that the legislators influence the passage of various fiscal measures, while the Fed chooses monetary polices suitable to improve the economic conditions. Coordination is beneficial since it affects effectiveness of both policies, where there could be duplication or negation of policies in cases where there is no coordination. Gridlock related to budgetary issues means that it could be difficult to effectively use fiscal policies especially since there has been increased interest on the role of the government in the economy. Legislators across the political divide have become less cooperative on fiscal matters, and there is a greater need to coordinate both fiscal and monetary issues. For instance, the use of quantitative easing (QE) by the Fed is one of the policies that would be derailed if there is no fiscal–monetary policy coordination, since QE mostly utilizes stimulus strategies. Reagan 1981 tax reductions vs. Kennedy–Johnson tax cut of 1964
As a conservative, Reagan was a staunch supporter of tax cuts as he favored the supply side economics. The rationale behind the tax cuts was that it would be an incentive to businesses and individuals to supply goods and work respectively rather than an incentive for consumption of goods. This marked a departure from the long held view that the tax policy was mostly effective when utilized to affect demand during the time of recession (Ippolito, 2012). The tax cuts were proposed to be an incentive for growth in the economy, with particular emphasis on entrepreneurship and innovation.
Even though, the Kennedy- Johnson tax cut of 1964 was also meant to improve the sluggish economy just like the 1981 tax cuts, there were differences. The 1964 tax cuts focused on spurring demand and the results was no different from intended purpose. President Reagan did not explicitly state that the spending cuts were meant to stimulate demand, given his support for supply side economics (Ippolito, 2012). In other words, the 1964 tax cuts did not focus o the trickle down effects of tax cuts resulting from growth in investments, but rather an increase in demand which would result to an increase in output.
The basic idea behind the support of the 1981 tax cuts was that it would be an incentive for investments and growth. However, in order to garner broad appeal for the tax cuts, the Reagan administration associated the government with wasteful spending. As such tax cuts were depicted as being vital to eliminate government waste. Hence, tax cuts were seen as being vital to allow individuals to keep more of their money, with the government having less power over their choices on investment, spending and consumption (Ippolito, 2012). Additionally, proponents of the tax cuts argued that it would help to bring fiscal responsibility in comparison to big governments where spending would increase ...