Question

4. Explain why Keynes felt “deficit spending” was an appropriate action for government if the goal is to get out of the recession, even though it may hurt the standard of living of the average worker.

Answer 1

Under keynesian theory there is no crowding out because increase in government expenditure and the resultant budget deficit does not raise the rate of interest and reduce the amount of funds available for private investment. This indicates that government can increase its spending without the fear of reducing investment by private sector and therefore the multiplier effect will be full. The standard of living of average worker decreases when borrowing is increased from the government but it is necessary to bring the economy out of recession in order to increase the per capita GDP of average citizen. Therefore deficit financing is considered an appropriate fiscal policy tool.