Question

Cut Taxes and Boost Spending? Raise Taxes and Cut Spending? Cut Taxes and Cut Spending? This headline expresses three views about what to do to get the U.S. economy growing more rapidly and contribute to closing the recessionary gap. Economists from which macroeconomic school of thought would recommend pursuing policies described by each of these views?

Short answer

Keynesians: Cut Taxes and Boost Spending. Classical: Raise Taxes and Cut Spending. Supply-Siders: Cut Taxes and Cut Spending.

Step-by-step solution

- Understand Different Macroeconomic Schools of Thought

The main macroeconomic schools of thought include Keynesians, Monetarists, Supply-Siders, and Classical economists. Each of these schools has distinct ideas on how to best handle economic growth and recessions.

- Identify Policies for Cutting Taxes and Boosting Spending

Keynesian economists would recommend cutting taxes and boosting government spending. They believe that increasing aggregate demand is crucial during a recession. This approach stimulates consumption and investment, leading to economic growth.

- Determine Who Recommends Raising Taxes and Cutting Spending

Classical economists, often advocating for limited government intervention, might recommend raising taxes and cutting spending. They argue that reducing government deficits and encouraging private sector activity fosters a healthier long-term economy.

- Identify Policies for Cutting Taxes and Cutting Spending

Supply-side economists suggest cutting taxes and cutting government spending. They believe that lowering taxes increases incentives for production, investment, and employment, leading to economic growth. They also argue that reduced government spending is necessary to avoid large deficits.

Key concepts

Keynesian economics

At the heart of Keynesian economics is the belief that the government plays a central role in stabilizing the economy, especially during a recession. According to Keynesians, the key to economic growth is stimulating aggregate demand.
They argue for policies that encourage spending and investment, such as cutting taxes and boosting government expenditure. By doing so, they aim to increase consumer purchasing power, which in turn drives up overall economic activity.
During a slowdown, people and businesses tend to save more and spend less. Keynesians believe that without government intervention, this can lead to a downward spiral of reduced demand and higher unemployment. Therefore, they recommend measures like:

• Lowering taxes to increase disposable income for households
• Increasing government spending on infrastructure, education, and health
• Offering incentives to businesses to invest and hire more workers

In summary, Keynesian policies are centered around boosting demand to spur economic growth and effectively manage the recessionary gap.

Classical economics

Classical economics is grounded in the idea that free markets, with minimal government intervention, are the most efficient way to allocate resources and drive economic growth. Classical economists emphasize the importance of supply and believe that economies are self-regulating.
They argue that during downturns, any government interference might distort the market processes that naturally correct imbalances over time. As a result, classical economists often advocate for policies such as raising taxes and cutting government spending to reduce deficits and debt.
According to this school of thought, reducing government expenditure encourages private sector activity, leading to more sustainable economic growth. Some key points include:

• Maintaining balanced budgets to avoid large deficits
• Encouraging private investments by reducing public sector dominance
• Allowing market forces to address unemployment and price levels naturally

In essence, classical economics relies on the belief that economies have a natural capacity to adjust and stabilize, and government intervention should be limited to avoid long-term inefficiencies.

Supply-side economics

Supply-side economics focuses on boosting economic growth by increasing the supply of goods and services. Proponents believe that lower taxes and reduced government spending create more incentives for businesses to produce, invest, and hire.
Supply-side economists argue that high taxes can disincentivize production and innovation, leading to slower economic growth. Therefore, they favor substantial tax cuts for individuals and businesses. These tax cuts are intended to leave more money in the hands of producers and consumers, stimulating overall economic activity.
Supply-side policies also stress the importance of reducing government spending to avoid large deficits and promote efficient resource allocation. Their recommendations typically include:

• Lowering income and corporate tax rates to spur investment
• Reducing regulatory burdens on businesses to promote entrepreneurship
• Encouraging savings and investments by providing tax advantages
• Implementing fiscal discipline to ensure a balanced budget

In summary, supply-side economics aims to create an environment where businesses can thrive, driving economic growth through increased production and innovation.