What is the Keynesian solution to a recession or depression?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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The typical Keynesian solution to a recession or a depression is to cut taxes and/or increase government spending.  Keynesians argue that this will stimulate aggregate demand (AD) and cause gross domestic product (GDP) to rise.

Keynesians argue that the government must spend more and/or tax less in bad times.  The reason for this is that it will put more money into the hands of consumers.  Keynesians believe that recessions and depressions are caused largely by inadequate AD and, therefore, that increasing AD will get the economy out of the slump.  In this view, the government starts to pay people to do things like, for example, building roads.  Importantly, the money the government spends will multiply itself and have a much larger impact on the level of AD.  If the government spends $100 million on road building, the people who get that money will save a bit, but they will spend most of it.  That means businesses will have gotten perhaps $90 million (if people saved 10%).  The businesses will save some of that, but they will also spend most of it.  This cycle keeps on occurring over and over and the original government spending is multiplied many times (the exact multiplier depends on how much people save).  In this way, the AD curve will be shifted to the right and GDP will rise.

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