The Keynesian model of economics is based on the assumption that a free market is most likely to fail to optimally utilize the economy’s capacity because of its inability to create enough aggregate demand. The model suggests that in case of a recession, the public sector can redeem itself through deficit spending. However, this is not the case using the fiscal policy as suggested by Keynes. Economic stabilization using the fiscal policy involves several complications.
First, deficit spending is very sensitive to speculation and fear. With the increase in deficits, the public become uncertain about the future. This leads to fear and worry hence the public decide to save most of their income. This will lead to a big government debt-to-GDP ratio which results into a low economic growth rate. The small economic growth rate will not help the economy out of a possible recession; in any case, it results into more turmoil. Therefore, deficit financing using the fiscal policy should be used only to a certain limit so as to stimulate the economy to grow faster hence avoid a possible recession.
The fiscal policy involves use of taxation to stabilize the economy. In case of inflation, the government can decide to impose higher tax rates so that the public’s purchasing power of the public reduces. This will reduce the aggregate demand for goods and services, which results into a fall in the prices of goods and services. This policy is very complicated because the government has to consider the public’s consumption patterns and relate it to their income. Then there has to be a consideration on the effects of the policy on the economy, this is because it may end up not stabilizing but causing more problems on the economy.
Contrary to the basic Keynesian model, the fiscal policy is complicated in that the government does not have the capacity to implement this policy on its own. The government has to involve the public in applying some of the fiscal policies for example, borrowing of money from the public and public expenditure. For the government to get deficit finances, it may opt to borrow from the public. The public may not be willing to offer their money to the government especially when the economy is not stable. This will leave the government with the option of external borrowing or printing paper money to get money, which is not a good step to take during economic instability periods.
Therefore, the fiscal policy is a complicated procedure that should be handled with a lot of expertise. This is contrary to the suggestions of the basic Keynesian model which suggests that deficit government spending will help stabilize the economy.
Froyen, R. T. (2008). Macroeconomics: Theories and Policies (9, illustrated ed.). Indianna: Prentice Hall.
