Question

Frightened by the recession and the credit crisis that produced it, the nation’s mainstream economists are embracing public spending to repair the damage — even those who have long resisted a significant government role in a market system.

But there is not much agreement yet on what type of spending would produce the best results, or what mix of spending and tax cuts.

“We have spent so many years thinking that discretionary fiscal policy was a bad idea, that we have not figured out the right things to do to cure a recession that is scaring all of us,” said Alan J. Auerbach, an economist at the University of California, Berkeley, referring to the mix of public spending and tax cuts known as fiscal policy.

Hundreds of economists who gathered here for the annual meeting of the American Economic Association seemed to acknowledge that a profound shift had occurred

At their last annual meeting, ideas about using public spending as a way to get out of a recession or about government taking a role to enhance a market system were relegated to progressives. The mainstream was skeptical or downright hostile to such suggestions. This time, virtually everyone voiced their support, returning to a way of thinking that had gone out of fashion in the 1970s.

“The new enthusiasm for fiscal stimulus, and particularly government spending, represents a huge evolution in mainstream thinking,” said Janet Yellen, president of the Federal Reserve Bank of San Francisco. She added that the shift was likely to last for as long as the profession is dominated by men and women living through this downturn.

The few sessions that dealt with fiscal policy were packed with economists, mostly from academia. Nearly all argued that public spending can be more effective than tax cuts in getting out of a bad recession. Still, they said the present crisis required, as a tonic, a mix of the two, and they debated what that mix should be, just as President-elect Obama’s transition team is now doing.

Their proposals were all over the lot. But at the formal sessions and in more than a dozen interviews, many said that once the recession ended, the nation should not go back to the system that held sway from Ronald Reagan’s election in 1980 to the present crisis. It was one in which taxes, regulation and public spending were minimized.

For Peter Gottschalk, a labor economist at Boston College, who earned his Ph.D. in 1973, the transition has not been easy. Keynesian economics, with its emphasis on a government role in the marketplace, was losing its grip when he started his career. Indeed, the present upheaval has been outside the theoretical boundaries of mainstream economics as practiced for a generation by most of the nation’s economists.

“Our models are built on the assumption that on average people behave rationally and they do the right thing,” Mr. Gottschalk said, “but this time people did very much the wrong thing. It’s like thinking you have a disease under control and then being hit with a new strain of it.”

Since the 1970s, the Federal Reserve has dealt with recessions by lowering interest rates, thus reviving demand by making it less expensive to borrow and to spend. But this time, the credit system is broken, and those who can borrow at relatively low rates are reluctant to spend. That shifts the burden of lifting the economy to fiscal policy, namely the $600 billion to $800 billion mix of tax cuts and spending that the Obama administration and Congress are likely to agree on early this year.

Nearly every economist who spoke here agreed that a dollar invested in, say, a new transit system or in bridge repair is spent and respent more efficiently than a dollar that comes to a household in a tax cut. A bigger percentage of the latter is saved, they said. There was concern, however, that the nation lacked enough “shovel ready” projects that could be ramped up quickly, generating jobs.

What is more, the economists did not agree on the best projects to pursue. As Mr. Auerbach pointed out, after a generation of ignoring public spending in their research, the nation’s mainstream economists lacked the expertise to help guide the process. “We have not figured out the right course of action,” he said.

There were plenty of proposals at the three-day convention. Some argued for a big investment in broadband. Others proposed recruiting young people for two-year stints weather-stripping and upgrading privately owned and public buildings. Still others argued that government should step up subsidies for basic research and product innovation

And Daniel J. B. Mitchell, a professor emeritus at the University of California, Los Angeles, proposed that Washington channel money to cities with the proviso that they purchase municipal buses from General Motors, which makes them, or yellow school buses. The Ford Motor Company manufactures the school bus chassis.

“That is a better fiscal stimulus than to bail out the auto companies,” Mr. Mitchell said.

No one illustrated the conversion to fiscal stimulus more vividly than Martin Feldstein, a Harvard economist and a well-known conservative who served for a time as a top economic adviser to President Reagan. In a paper, Mr. Feldstein noted that the usual method of reviving the economy — lower interest rates — was failing to work because of “a dysfunctional credit market.”

That left fiscal stimulus to offset what he described as a decline of $400 billion a year in consumer spending. “While good tax policy can contribute to ending the recession, the heavy lifting will have to be done by increased government spending,” Mr. Feldstein said.

He pushed for big spending, carried out quickly. Among his proposals: replace depleted military supplies and equipment and step up financing for “useful research.” He also said that the shortage of “shovel ready” projects should not be a deterrent in a recession that is likely to last long enough to plan and execute new projects.

“It is of course possible that the planned surge in government spending will fail,” Mr. Feldstein said. But he expressed the “hope that the new program of fiscal spending in combination with mortgage market reforms will be sufficient to return the economy to full employment.”

I need answers for Questions 2-4 please:

Read the article: Economists Warm to Government Spending but Debate Its Form (see above.) and then answer the questions below.

Question 1 Explain what is meant by the multiplier principle

Question 2 Explain the reasons why there has been a shift in the thinking of many leading economists about the merits of fiscal policy.

Question 3 Using aggregate supply and demand diagrams, examine the factors that determine the size of the multiplier effect following an increase in government spending.

Question 4 Assess whether an increase in government spending and taxation by equivalent amounts will leave national income unchanged?

Answer 1

Question 2 Explain the reasons why there has been a shift in the thinking of many leading economists about the merits of fiscal policy.

Fiscal policy is a tool used by government either by changing government spending or the levels of taxation. Government has to opt for fiscal policy as it helps in preventing. Due to recession and financial crisis, most of the economists embraced government spending which is a tool of fiscal policy for economic growth and bring stability in the economy. The argument exists on which tool to use for economy’s betterment. Most of the economists squabble about government spending being better tool than tax cut during recession times.

Question 4 Assess whether an increase in government spending and taxation by equivalent amounts will leave national income unchanged?

As per the Keynesian economists, an effect on national income can be countered which occurs due to increase in government spending and taxation. Balanced budget is referred as the combination of the effects, government spending and taxes altogether. It states that the change in government spending should match the level of change in taxation. The concept of balanced budget multiplier (BBM) will be used to evaluate the expansionary effect. If government spending and taxes increase by the same amount then there will be a net increase in national income by the same amount.