Economics and Finance 4

·         The market is imperfect and not self-sustaining

·         There may be unemployment even when the market is in equilibrium. Full employment was not the nature state of affairs ensured by the operation of market forces. The Economy could settle at an equilibrium position where there was high unemployment. Unemployment was the result of a deficiency in demand that could be corrected by expansionary fiscal policy. An expansionary fiscal policy is higher government spending and/or a reduction in taxation.

·         Consumer income stimulates demand which causes economic growth.

·         Key role for government – If ‘animal spirits’ are low leading to reduced consumption and investment government should take up the slack in AD. This means that when economic growth is lacking, the government should stimulate demand. Expansionary fiscal policy government spending was advocated. During a recession trying to stimulate demand with monetary policy has been likened to trying to push something forward with a piece of string.

Why was this policy approach largely abandoned in the…