Day 5: Fiscal Policy

If Keynes were to take a peek at the economic scenario of the recent past, what would he see?

Most households reduced spending in a bid to repay mortgages which were larger than the values of their houses. Though businesses acquired large amounts, they were hesitant to invest owing to decline in the value of assets. Student debt increased, while consumption decreased. Most importantly, governments reduced their spending in light of austerity policies that aimed to reduce public debt. As a result of an overall decrease in spending, national income decreased and so did jobs, which adversely affected global incomes and employment as well. Central banks increased money supply to stimulate spending, but reluctance to spend was at an all-time high. 

We were experiencing a Keynesian liquidity trap.  

This situation calls for a fiscal policy rather than a monetary policy. The government's bid to increase money supply rendered ineffective as the policymaker's attempt to influence nominal interest rates in the economy by altering the nominal money supply is frustrated by private agents' willingness to accept any amount of money at the current interest rate. The Keynesian fiscal policy expansion will benefit the economy both in the short run and the long run. For example, President Franklin Roosevelt used such a fiscal policy during the New Deal in 1933, increasing spending through a public works program. The Japanese government also spent 100 trillion yen on public programs over a ten-year period.