5.2. Classical and Keynesian views of Fiscal Policy

The classical view of expansionary or contractionary fiscal policies is that such policies are unnecessary because there are market mechanisms—for example, the flexible adjustment of prices and wages—which serve to keep the economy at or near the natural level of real GDP at all times. Accordingly, classical economists believe that the government should run a balanced budget each and every year.

The belief that expansionary and contractionary fiscal policies can be used to influence macroeconomic performance is most closely associated with Keynes and his followers. Keynesian theories of output and employment were developed in the midst of the Great Depression of the 1930s, when unemployment rates in the U.S. and Europe exceeded 25% and the growth rate of real GDP declined steadily for most of the decade. Keynes and his followers