Question

During the period of the “Great Moderation” (the mid-1980s through the mid-2000s), discussion of the Keynesian expenditure multiplier had largely gone out of fashion. After all, if business cycles were largely tamed, the effects of a significant demand shock seemed irrelevant. When the Great Recession hit at the end of 2007, the expenditure multiplier became a hot topic again for discussion among macroeconomists.

• Why does the size of the expenditure multiplier matter in the real world? Why does it matter to businesses, employees, consumers and policy makers?
• Based on what you know about the multiplier, do you think the government took the appropriate response to the Great Recession? Was the fiscal stimulus response to the recession enough, just right, or too much? What evidence can you provide for your conclusion? Find a news article (and include the link in your response) to support your opinion.

Answer 1

Keynesian economics believedi that the level of economic activity is driven, in the short term, by changes in aggregate expenditure (or aggregate demand). Keynes pointed out that even though the economy starts at potential GDP, because aggregate demand tends to bounce around, it is unlikely that the economy will stay at potential. Relevance in context of recession                          In 2007,when the world endured from recession, U.S. investment expenditure had collapsed with the fall of the housing market. The housing market bubble had bursted and it was essentially a subprime mortgage crisis . As a result, the U.S. economy went into the Great Recession. But how much did GDP fall? Suppose fall in investment was 200 million dollar . We may expect the result would be that GDP would fall by exactly $200 million too. It won't be so as what was expected . It turns out that changes in any category of expenditure (Consumption + Investment + Government Expenditures + Exports-Imports) have a more than a proportional impact on GDP. Or to say it differently, the change in GDP is a multiple of (say 3 times or 2 times ) of the change in expenditure. This is the idea behind the multiplier.
Households buy from firms, firms pay workers and suppliers, workers and suppliers buy goods from other firms, those firms pay their workers and suppliers, and so on. In this way, the actual change in total expenditures is actually spent more than once. This is called the expenditure multiplier effect: an initial increase in spending, cycles repeatedly through the economy and has a larger thrust than the initial amount spent. Working of expenditure multiplier

Suppose government purchase $300 billion worth of goods and services, perhaps because they feel optimistic about the future. The producers of those goods and services forsee an increase in income by that amount. They made use of that income to pay their bills, wages and salaries to their workers, rent to their landlords. The rest of income left over is profit, which becomes income to their stockholders. Each of these economic agents takes their new income and spend it. Those purchases become new source of income for the sellers. This process continues... Since , economic agents spend only a part of their income, the numbers get smaller in each round. When the dust settles the amount of new income generated is multiple times the initial increase in spending , thus the name the spending multiplier.                                             Fiscal policy responses to recession.               Actually governments across the world did better compared to that in 1930s , but the fiscal stimulus packages weren't sufficient . In the beginning in 2008 many nations of the world enacted fiscal stimulus plans in response to recession . These nations proclaimed different combinations of government spending and tax cuts to boost the sagging economies. Most of these plans were based on the Keynesian theory that deficit spending can re inject some of the demand lost during a recession and prevent the waste of economic resources idled by a lack of demand. The International Monetary Fund recommended nations to implement fiscal stimulus measures equal to 2% of their GDP to offset the global contraction.

Us economy and fiscal stimulus
In 2008, then President George W. Bush signed—the Economic Stimulus Act of 2008, a $152 billion stimulus enabled to stave off recession. The bill primarily consisted of $600 tax rebates to low and middle income citizens of America.
The United States combined many stimulus measures into the American Recovery and Reinvestment Act , a $787 billion bill covering a variety of expenditures including rebates on taxes to business investment.