Assignment:
I need help with an article. I need a two to three paragraph real people explanation on this article and what he is saying about the theories of using fiscal policy and which theory would be the most supportive and why? The article is listed below:
While Keynes revolutionized economic thinking in the 1930s, his theories were subsequently eclipsed by new ideas such as monetarism and supply- side. But the tumultuous 1990s have seen the re- emergence of Keynesianism as a policy prescription of choice. This is the third and final part of our article on economic schools of thought.
AS I have described in my last two articles, John Maynard Keynes, a British economist, captivated the world in the 1930s with fresh ideas that revolutionized economic thinking following the Great Depression. His arguments for an active government role in stabilising economic cycles became an eye-opener for policy-makers who, at one time, were obsessed with the classical ideology, which believed in market efficiency.
In spite of the emergence of this new and appealing economic thinking, some remained sceptical. Monetarists like Milton Friedman and many other `Chicago Boys' from the University of Chicago were not impressed and opposed to the idea of government messing around with the free- market system.
Later, economists like Robert Lucas with his rational expectations idea strongly argued against Keynesianism by insisting that government intervention would do nothing but harm to the economy. While economists were debating over a suitable policy recommendation, the United States economy was deteriorating towards the end of the 1970s.
Inflation induced by two oil shocks (in 1975 and 1979) remained high and productivity slumped. Distortions and lack of incentives created by over-regulation and high taxes were partly blamed for the drop in productivity. The criticism of Keynesian economics and the lack of success in monetarism as an alternative policy tool led to a search for new economic ideas. That was the time Ronald Reagan was swept into the White House. Reagan was a lucky man. By the time he challenged Jimmy Carter in the presidential election of 1980, the US economy was badly in need of new and bold ideas to overcome problems of escalating inflation and declining productivity. Reagan took this opportunity to push for supply- side economics or Reaganomics which was (and still is) not in line with mainstream ideas.
Supply-side economics, arguably, were ideas that emerged in the 1970s. As described by its name, the supply-siders disagree with the notion that demand-side policies are important. Monetary policies are not seen as effective in helping economies recover.
According to its proponents, supply will create its own demand (what economists often refer to as Say's Law) because money has to be spent on something. Therefore, there should not be such cases as demand failure as proposed by Keynesian economics.
The other startling argument is related to the claim by supply- siders that there would be a dramatic rise in work incentive if taxes were substantially lowered. Conventional ideas would say that tax revenue would decline if taxes were cut. That would make sense. In other words, total revenue should have a positive correlation with the tax rate.
But this new group of economists argued the other way round - that tax reduction would drastically boost economic activity up to a point that tax revenue would actually increase! This may initially sound incomprehensible, but the proponents actually came up with a graphical representation (known as the Laffer Curve) that supported their argument. The curve, named after economist Arthur Laffer, depicts a relationship between tax rate and revenue.
According to supply-siders, at an initial phase, tax revenue would naturally rise in tandem with the increase in tax rate, producing an upward-sloping curve. At one point, however, people would get discouraged when tax rates get too high. Hence, they would reduce their working hours and, as a result, tax revenue would fall. This would cause the upward-sloping curve to turn downward.
Subsequently, within this range of a backward-sloping curve, it would be beneficial to cut taxes to increase tax revenue. Laffer scored some points there. But even as a graduate student back in the 1980s, I was asking the same question that the man-in-the- street would ask: how do we know when the economy is in this downward-sloping range? It would be tough to determine this.
Secondly, with the benefit of hindsight, we can now argue that cutting taxes did not increase tax revenue during the Reagan years. In fact, the budget deficit, which was at a manageable level prior to 1980, started to bloat under the Reagan Administration and became a hot topic of presidential debates in 1984 and 1988.
The supply-side proponents, however, maintained that the Reagan years were a successful period and that George Bush's defeat to Bill Clinton in 1992 was due to his failure to continue with Reagan's economic policy. After a deep contraction in 1982, the economy managed to post a growth rate in excess of 6% in 1984. Robert Mundell, an economist well- known for his Mundell-Flemming model (a basic ingredient for international economic studies), is widely regarded as the person behind the supply- side theory that Reagan used to turn the economy around from the allegedly disastrous Carter policies.
There is, however, a lot of disagreement among economists as to whether Reaganomics actually brought any significant changes to the US economy. In spite of this, supply-side was indeed one of the most popular subjects among economists in the 1980s, not only because of its fresh new approaches but also because of the controversy that it brought to the world of economics.
By the 1990s, most people thought Keynesian would no longer be a popular subject among economists. But things soon went the opposite direction again. The love affair with Keynesian economics began to blossom again and policy-makers started to fiddle with its policy prescriptions. For instance, many Asian countries resorted to public spending after their economies succumbed to the financial crisis in 1998, leading to a significant rise in budget deficits.
Malaysia, for instance, has incurred budget deficits for five consecutive years following the economic slowdown and pump- priming by the government. Thailand and the Philippines also experienced the same thing. In northern Asia, Japan's economic malaise resulting from the property burst in 1990 also led to an increase in public-work spending. How and why did Keynesian policies re-capture the hearts of so many policy-makers? My opinion is that Keynesian is too irresistible to ignore, especially by politicians.
When an economy is in bad shape, voters would expect politicians to do something. Those who believe in totally free market forces would be tempted to just sit around and let nature take its course. Unfortunately, voters will not vote for this kind of people. Policy-makers have to, at least, be seen to do something.
Secondly, in the early 1990s, the so-called new Keynesian economics emerged, arguing against rational expectations, while proposing government ntervention.
Basically, this new idea believes that most irrational outcomes in the marketplace are a result of an interaction between imperfect competitive markets and less than perfectly rational individuals - people are simply not rational in their decision-making.
In such circumstances, active monetary policy is required because recessions represent a market failure that can be corrected by government action. It is quite interesting to see how all these theories and their applications have evolved over time. Most of these economic ideas were tested over and over again before they became acceptable to policy-makers. Most were also subjected to constant challenge as time went by.
Those that got into trouble usually either worked in theory but not in practice or worked in practice but not in theory. As time goes by, more new ideas will emerge while some old ideas will re-emerge. Time will tell whether these ideas can really explain how the economy works.