K E Y N E S I A N

  S T I M U L U S   P L A N  
Macroeconomics  (ECON211)  
 

   
 Keynesian  Stimulus  Plan   2  

  According  to  an  article  in  the  New  York  Times  by  Paul  Krugman  titled,  

“Depression  Economics  Returns,”  the  current  recession  is  more  severe  than  the  past  

two  U.S.  recessions  in  1990-­‐1991  and  2001.  In  the  past,  in  order  to  boost  the  

economy,  the  Federal  Reserve  had  the  ability  to  cut  interest  rates.  Now,  with  the  

effective  federal  funds  rate  at  an  average  of  less  than  0.3  percent,  there  is  nothing  

left  to  cut  (Krugman,  2008).    

With  the  U.S.  economy  plummeting  and  unemployment  rates  rising,  

consumers  are  spending  less.  As  a  result,  businesses  will  be  forced  to  cutback  on  

investment  plans,  which  will  result  in  further  layoffs  (Krugman,  2008).  

Keynesian  economists  believe,  that  in  order  to  jumpstart  the  economy,  the  

government  will  need  to  pump  large  amounts  of  money  into  it.  Unfortunately,  this  

will  lead  to  a  greater  budget  deficit.  However,  with  the  economic  recession  as  bad  as  

it  is,  caution  at  this  point  is  risky.  The  government  needs  to  do  something  big,  

regardless  of  how  much  our  budget  deficit  will  increase  (Krugman,  2008).    

The  American  Recovery  and  Reinvestment  Act  of  2009  ($787  billion  U.S.  

Stimulus  Package)  was  approved  on  February  13th,  2009  and  signed  into  law  on  

February  17,  2009  by  President  Barack  Obama.  The  Democratic  Party,  for  the  most  

part,  carried  out  development  of  the  plan  with  the  help  of  three  Republican  

Senators.    When  the  bill  was  presented,  61  percent  of  the  Senate  and  57  percent  of  

the  House  of  Representatives  voted  for  it  (About.com,  2009).  

The  $787  billion  U.S.  Stimulus  plan  was  devised  based  on  the  beliefs  of  John  

Maynard  Keynes.  His  ideas  have  come  to  be  known  as  the  Keynesian  theory.  

 
 Keynesian  Stimulus  Plan   3  

According  to  Keynes,  the  economy  is  unstable  and  is  not  self-­‐regulating.  He  believed  

that  governments  should  intervene,  during  a  recession,  by  increasing  the  money  

supply  (Arnald,  2008).  

The  stimulus  plan  uses  expansionary  fiscal  policy,  which  includes  two  main  

tactics,  increased  government  expenditures  and  tax  cuts,  to  help  stimulate  the  

economy  (About.com,  2009).  In  

order  to  decrease  the  

unemployment  rate,  according  to  

Keynesian  economists,  the  

government  should  increase  

spending  (John  Maynard  Keynes,  

2009).  The  increased  spending  by  

the  government  will  increase  the  

economy’s  money  supply,  which  will  

encourage  more  consumer  

spending,  and  more  jobs  will  be  created.    

Tax  cuts  will  be  introduced  in  order  to  increase  disposable  income  (income  

minus  taxes).  The  increase  in  disposable  income  will  have  a  direct  effect  on  

consumption  (Arnald,  2008).  

The  government  will  need  to  determine  how  much  money  to  inject  into  the  

economy  in  order  to  bring  it  out  of  the  current  recession.  To  determine  this,  

according  to  the  article,  “Obama  Gives  Keynes  is  First  Real-­‐World  Test,”  the  

 
 Keynesian  Stimulus  Plan   4  

government  will  have  to  figure  out  how  much  money  the  economy  should  be  

producing  and  how  much  it  is  actually  producing.  Once  this  is  done,  the  amount  of  

money  needed  to  stimulate  the  economy  can  be  calculated  (Davidson  &  Blumberg,  

2009).    For  example,  if  the  economy  is  producing  $14  trillion  and  should  be  

producing  $15  trillion,  another  $1  trillion  is  needed  to  get  the  economy  back  on  

track.  However,  this  does  not  mean  that  the  government  will  have  to  pump  another  

$1  trillion  to  get  economy  going  again.  Instead,  a  multiplier  will  be  used  to  

determine  the  required  amount.  The  multiplier  is  determined  by  taking  one  minus  

1
marginal  propensity  to  consume  (MPC)  and  dividing  it  by  one,  ( m = )  
1" MPC

(Arnald,  2008).  The  government  used  the  multiplier  to  determined  that  it  will  need  
!
to  inject  $787  billion  into  the  economy  in  order  to  pull  us  out  of  the  recession.  

Unfortunately,  this  theory  has  never  really  been  tested,  so  no  body  knows  for  sure  if  

it  will  work.  

  Many  analysts  believe  that  the  $787  billion  stimulus  plan  is  failing.  Stephen  

Gandel,  in  an  article  from  Time.com,  states,  “[Barack  Obama’s]  chief  economic  

advisers  predicted  that  the  passage  of  a  large  economic-­‐aid  package  would  boost  the  

economy  and  keep  the  unemployment  rate  below  8%.  [However,]  Last  month,  the  

jobless  rate  in  the  U.S.  hit  9.5%...”  (Gandel,  2009).  Additionally,  only  150,000  of  the  

predicted  3  to  4  million  jobs  have  been  saved  or  created.  In  defense,  officials  claim  

that  the  severity  of  the  economy  is  much  worse  than  originally  anticipated  and  that  

the  stimulus  bill  is  on  track;  it  just  needs  more  time  to  work.  

 
 Keynesian  Stimulus  Plan   5  

According  to  Treasury  Secretary  Timothy  Geithner,  the  U.S.  economy’s  

decline  rate  has  decreased  since  the  stimulus  package  was  introduced;  an  indication  

that  the  plan  is  working.  Other  indicators  include,  improved  consumer  confidence  

and  a  growing  financial  system  (Flaherty  &  Kuhnhenn,  2009).  

Many  economists  say  the  economy  is  much  worse  than  originally  expected  

and  are  suggesting  an  additional  stimulus  package.  Some  analysts  believe  the  9.5  

percent  unemployment  rate  will  rise  into  the  double  digits  by  year’s  end.  However,  

the  Obama  administration  has  denied  any  plans  for  a  second  package  (The  Early  

Show,  2009).    

Shortly  before  President  Obama  came  into  office,  the  economy  began  to  fall  

into  a  recession.  Many  economists  believed  that  a  large  stimulus  package  would  be  

needed  in  order  to  keep  the  U.S.  from  falling  into  a  depression.  As  a  result,  president  

Obama  signed  The  American  Recovery  and  Reinvestment  Act  of  2009.  

The  idea  behind  this  $787  billion  stimulus  plan  was  based  on  the  beliefs  of  

John  Maynard  Keynes,  also  known  as  the  Keynesian  theory.  Keynesian  economists  

are  convinced  that  in  order  to  stimulate  an  unstable  economy,  the  government  must  

introduce  expansionary  fiscal  policy.  In  other  words,  increased  government  

expenditures  and  tax  cuts  are  needed  to  increase  Real  GDP  and  decrease  

unemployment.  

In  my  opinion,  signs  that  the  current  stimulus  plan  is  working  are  beginning  

to  surface.  The  Keynesian  theory  suggests  that  when  the  money  supply  increases,  as  

it  had  in  the  U.S.  with  the  stimulus  bill,  interest  rates  fall.  This  causes  investment  to  

 
 Keynesian  Stimulus  Plan   6  

increase  and  the  aggregate  demand  curve  to  shift  to  the  right.  Thus,  Real  GDP  will  go  

up  and  unemployment  down  (Arnald,  2008).    

When  the  money  supply  was  increased,  interest  rates  did  not  fall,  which  

contradicts  the  Keynesian  theory.  However,  interest  rates  were  already  very  low;  

the  only  place  for  them  to  go  is  up.  With  the  stock  market  beginning  to  rise,  there  

are  some  signs  of  increased  investment.  As  for  the  remainder  of  the  formula,  only  

time  will  tell.  Yet,  my  prediction  is  that  Real  GDP  will  begin  to  increase  and  of  

course,  unemployment  will  fall.  

   

 
 Keynesian  Stimulus  Plan   7  

References  

About.com.  (2009,  February).  American  Recovery  and  Reinvestment  Act  of  2009  H.R.  

1,  The  2009  Economic  Stimulus  Package.  Retrieved  July  21,  2009  from  About.com:  

http://uspolitics.about.com/od/economy/tp/2009_economic_stimulus_bill.htm  

Arnald,  R.  A.  (2008).  Economics.  Mason,  Ohio,  USA:  Cengage.  

Balz,  D.,  &  Cohen,  J.  (2009,  June  23).  Confidence  in  Stimulus  Plan  Ebbs,  Poll  Finds;  

Obama's  Approval  Rating  Remains  High,  but  Shift  in  Public  Outlook  Has  Political  

Implications.  The  Washington  Post  ,  p.  A.4.  

Davidson,  A.,  &  Blumberg,  A.  (2009,  January  29).  Obama  Gives  Keynes  His  First  Real-­‐

World  Test.  Retrieved  July  21,  2009  from  npr.org:  

http://www.npr.org/templates/story/story.php?storyId=100018973  

Flaherty,  A.,  &  Kuhnhenn,  J.  (2009,  July  10).  Geither:  Stimulus  is  working  and  on  right  

path.  Retrieved  July  22,  2009  from  AP.org:  

http://hosted.ap.org/dynamic/stories/U/US_FINANCIAL_OVERHAUL?SITE=AP

&SECTION=HOME&TEMPLATE=DEFAULT  

Gandel,  S.  (2009,  July  14).  Obama's  Stimulus  Plan:  Failing  by  Its  Own  Measure.  

Retrieved  July  21,  2009  from  Time.com:  

http://www.time.com/time/business/article/0,8599,1910208,00.html  

John  Maynard  Keynes.  (2009).  Encyclopedia  Britannica.  Retrieved  July  22,  2009  

from  Encyclopedia  Britannica  Online:  

http://www.britannica.com/EBchecked/topic/315921/John-­‐Maynard-­‐Keynes  

 
 Keynesian  Stimulus  Plan   8  

Krugman,  P.  (2008,  November  14).  Depression  Economics  Returns;  [Op-­‐Ed].  The  

New  York  Times  ,  p.  A.33.  

The  Early  Show.  (2009,  July  8).  Second  Stimulus  Needed?  Retrieved  July  22,  2009  

from  CBSNews.com:  

http://www.cbsnews.com/stories/2009/07/08/earlyshow/main5144004.shtm

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