State Intervention and Fiscal Policy: Economic Principles

State Intervention and Fiscal Policy

Keynesian Economics

Keynesians argue that the state must intervene in the economy, as fiscal policy alone does not always reach full employment.

Monetarism (Classics)

Monetarists believe the economy naturally reaches full employment through wage and price flexibility over the long term. This school of thought emerged at the University of Chicago under the guidance of founder Milton Friedman.

Fiscal Policy

Fiscal policy refers to government decisions regarding revenues and expenditures. It depends on income taxes and the state's obligations to pay individuals and businesses. Public expenditures include transfers, infrastructure projects (bridges, roads), and government contracts.

Types of Fiscal Policy

• Expansionary Policy: Aims to increase Aggregate Demand (AD) by lowering taxes (T) and increasing government spending (G). This raises production and employment but may lead to inflation.
• Restrictive Policy: Aims to lower AD by increasing taxes (T) and decreasing government spending (G). This policy is often used to combat inflation, though it may reduce production and employment.

Recession and Public Deficit

During a recession, unemployment rises, leading to increased government transfers and unemployment benefits.

The public deficit is categorized as:

• Cyclical: Occurs during recessions and expansions.
• Structural: A permanent deficit present in both boom and recession periods due to underlying structural issues.

Discretionary and Automatic Stabilizers

Governments use discretionary measures to influence income, such as public works programs to create temporary jobs or transfer programs like unemployment benefits. However, these policies are not always stabilizing, as they can be poorly timed or inefficient.

Crowding-Out Effect

When a public deficit causes private investment to decrease, it leads to a rise in interest rates and a scarcity of financial resources.

Public Deficit Financing

The government can finance a deficit through:

1. Increasing taxes.
2. Creating money: Borrowing from the central bank (often associated with expansionary policy, though it risks inflation).
3. Issuing public debt: Selling securities to collect debt from the public.