Fiscal Policy

1. Keynes:
a. Policy was for a major depression
b. In the 60s Keynesian’s believed they could fine tune the economy.

Tax cut of 1964 was hit point of fine tuning.

2. Buchanan: Nobel Prize for creating Social Choice Theory
a. Politicians pursue their self-interest not the public good. Great example is the military
b. If you assume that politicians enjoy the exercise of power then politicians will do what is necessary to get reelected. They need a war chest of campaign finance so they must court rich interests who have PAC money.
c. Before tax cut of 1964 politicians felt that they must balance the budget. After 1964, politicians felt they could use Keynesian policy to get reelected--give their constituents new goodies.
d. Since the Reagan administration Congress has become more conservative and not passed any major social programs--Congress rejected Hilary’s Medical Program.

Keynes, himself, might have been surprised that economists would recommend using his ideas to fine tune the economy. Today almost no economists believe that fine tuning the economy is possible.

Keynes’s contribution:
Consumption function
Multiplier
Idea that in a major depression government must act.

3. Supply Siders:

Supply Siders are probably correct in that the government worries too much about aggregate demand and not enough about aggregate supply. The supply siders policy prescription is based on the Lafer Curve



This famous curve indicates that the Tax revenue peaks and then rapidly declines as the tax rate t increases.

Empirical evidence: Lafer curve vastly overstates this effect. People shift to barter, keep activities off the books, and obtain increasing number of loopholes.

Reagan tax cut:

Supply sider interpretation: Tax cut stimulates population to work harder and invest the money. This so stimulates the economy that overall tax revenue will actually increase.
Cynical Republican position: Increased deficit will force the Democrats to cut government spending.

Keynesian interpretation: Reagan tax cut sent population on a spending spree that snapped the economy out of a recession and onto a major period of growth.

Check the investment data: Did investment increase much during the Reagan administration.

Reagan administration did create a business renaissance. Alternative explanation:

Blow Torch in the Ass Incentive System: Volker successfully created a major recession that eliminated inflation and he kept interest rates high in order to prevent reoccurrence of inflation. With the economy taking off and consumers on a spending spree, imports were very cheap. If you were a manufacturer, you either had to cut costs of production or get out of business. The pressure of cheap imports created the business renaissance. Reagan and Volker were like the cartoon character Mr. Magoo.