According to traditional Keynesian economics, an expansionary fiscal policy initiated by the federal government is an appropriate way to prevent recessions and depressions (Option B).
This is because an expansionary fiscal policy like tax cuts increases consumption and investment as well as increases government spending. This shifts the aggregate demand (AD) curve to the right.
In the diagram below, if the initial AD was ADR indicating that the economy is suffering from recession, then the suitable policy for the government would be to shift the AD curve to the right. As the AD shifts to ADF, the economy would be at full employment level and potential GDP.
According to Keynesian economics, aggregate income = aggregate expenditures.
Aggregate expenditures are classified into two basic types – consumption (spending on goods and services) and investment (expenditure on means of production).
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According to traditional Keynesian economics, an expansionary fiscal policy was initiated by the federal government.
A) will always fail due to crowding out effects.
B) is an appropriate way to prevent recessions and depressions.
C) is never appropriate.
D) is an appropriate way to slow down an over-heated economy.
