Question

If there is a reduction in government spending in the Keynesian sticky wage model, show what difference it makes if the reduction is temporary or permanent. What do you conclude about how fiscal policy should be used as a stabilization device?

Answer 1

The main point of Keynesian economics is that: Capitalism has so call natural instability, which commonly called crises, recessions, depression., business cycles. Basically, it is inevitable that in some time industries will produce more, then consumers want to consume. That cause mass closing of companies that fire workers. that additionally reduce consumption. In theory that should lead to the closure of inefficient companies and renewing capitalism. Eventually, demand raises again and economy resume grows base on more efficient base. In practice, because all companies interlinked, in time of crisis all good and bad companies go down and it is extremely destructive to society. Keynesian idea was, we need to make it softer by increasing consumption by the government in time of crisis. By spending a lot of money government give people jobs, building infrastructure for example which let workers buy good and services and that soften the worsted effect of the business cycle. On another hand, in time of growing government cut off spending, saving money, reducing demand and slow down economy in order to prevent to fast overproduction.
That was explained from the position of aggregate demand and investment. I do not know either in order to distance himself from Marx or from the lack of understanding he did not analyze why Great depression happened. So, why he pretty effectively softened small business cycles, he did not answer how to stop great depressions and why they happened. Lately, his work was even more subverted by the claim that Tax cuts for rich can be used as a stimulus, instead of government spending. That is cardinally wrong. Now, let's look at the problem from the position of class and money circulation in society.

Roots of Great depressions lying in Capitalism contradictions.
Biggest one which responsible for it is:
It is absolutely rational for each individual capitalist to struggle to achieve the greatest profit. It is absolutely rational For each individual to struggle to get the greatest wealth, but if Capitalists achieve that - great depression is a result.

Explanation:

What is profit? It is a difference between added value worker produce and the amount it gets paid for that. Workers always get paid less, then he produces. So, How this portion of what was produced can be sold? At the end of the day, Someone has to borrow. It could be government, other capitalists or housing, education, and consumer debt.
Some part of that debt gets recycled, by Capitalists buying new means of production, personal consumption, Government spending. But the purpose of each capitalist is an accumulation of wealth and they struggle to maximize this accumulation. But what is wealth? In the end, all wealth is someone debt, in one form or another.
If you own 10 houses is that your wealth? Only if you have a demand for them. If someone will buy or rent this houses. If they buy you get money, which is basically debt of society, which promised you good and services for that money.

In addition, most licky this money was created by private banks, by an act of lending to people who want to buy your house. They now have monetary debt.
Or you can lend this house. That is a debt to, someone borrows the house from you and will pay rent, which typically much bigger than interest on the monetary cost of the house.
Wealth = debt. And debt need to be serviced, rent, interest has to be paid. In normal time most of this debt is rolling over, extended, more borrowing done to service existed debt and obtain new debt in order to consume profit part of capitalists production.

So, as debt accumulated eventually workers can no longer service this debt and banks stop lending because of indebtedness to high. That brings all economy to long and deep crush.
That create big problems for banks. People do not pay the debt back, so banks go bankrupt together with the huge amount of workers and companies. No one has money to buy what companies produce.

The main point why the Keynesian economy was effective for about 30 years because of 90% taxes on rich together with the high corporation taxes recycle by government spending excess of capital capitalists can not productively invest or consume. Recycling was not perfect, the debt was gradually accumulated, making each subsequent stimuli less effective. Neoliberalism stop debt recycling and went into the direction of unlimited wealth-debt grow, resulting in 2008 crush we are still in.