Chapter 25: The Keynesian Perspective
Keynesian economics focuses on aggregate demand as the primary driver of short-run economic fluctuations. When demand falls, sticky wages and prices prevent the economy from self-correcting quickly, leading to prolonged recessions. This chapter examines how the Keynesian perspective explains recessions, introduces the expenditure multiplier, and explores the famous Phillips curve trade-off between unemployment and inflation.
Table of Contents
1. Aggregate Demand in Keynesian Analysis
The Keynesian AD/AS Model
Core Keynesian Idea: Firms produce output only if they expect it to sell. While the factors of production determine potential GDP, real GDP depends on how much demand actually exists. If demand is insufficient, the economy operates below its potential.
In the Keynesian version of the AD/AS model, the SRAS curve is:
- Horizontal at levels of output below potential GDP (prices don’t fall in a recession)
- Vertical at potential GDP (the economy cannot produce beyond capacity)
This creates two important concepts:
| Concept | Definition | Implication |
|---|---|---|
| Recessionary gap | Equilibrium output is below potential GDP | High unemployment; economy stuck in recession |
| Inflationary gap | Demand pushes economy past potential GDP | Rising prices as demand exceeds capacity |
Keynes argued that the economy would tend to stay in a recessionary gap for a significant period of time—it would NOT self-correct quickly. This was his key break from classical economics, which assumed markets would clear rapidly.
Determinants of the Four Components of AD
Consumption Expenditure (spending by households on durables, nondurables, and services):
Keynes identified three factors:
| Factor | Effect |
|---|---|
| Disposable income | The most powerful determinant—more take-home pay → more spending |
| Expected future income | Optimism → spend more; pessimism → pull back |
| Wealth and credit | Rising wealth (e.g., stock market boom) → save less, spend more; declining wealth (e.g., 2008 crash) → save more, spend less |
Investment Expenditure (new capital goods: equipment, structures, inventories, residential construction):
| Factor | Effect |
|---|---|
| Expected future profits | Most important driver—U.S. investment surged from 18% of GDP (1994) to 21% (2000) during the boom, then sank back to 18% (2002) |
| Interest rates | Lower rates → more investment; higher rates → less investment |
| Energy prices, tax incentives | Lower energy prices or investment tax credits → more investment |
Keynes noted that business investment is the most variable of all components of aggregate demand. Expectations can swing wildly, making investment inherently unstable—Keynes called these swings “animal spirits.”
Government Spending:
- Government provides public services (defense, infrastructure, education)
- Keynes recognized the government budget as a powerful tool for influencing AD
- During extreme recessions, only the government has the power and resources to restore AD
- Example: 2020 pandemic — federal government gave money to state/local governments and households
Net Exports (exports − imports):
| Factor | Effect on Net Exports |
|---|---|
| Foreign economies grow | More demand for U.S. exports → NX rises |
| Foreign economies shrink | Less demand for U.S. exports → NX falls |
| U.S. income rises | More imports → NX falls |
| U.S. goods become cheaper (productivity gains) | Exports rise → NX rises |
| Exchange rate makes U.S. goods expensive | Exports fall, imports rise → NX falls |
Summary Table: What Shifts AD?
| Component | Decreases AD | Increases AD |
|---|---|---|
| Consumption | Tax rises, income falls, interest rates rise, desire to save more, wealth falls, pessimism | Tax cuts, income rises, rates fall, save less, wealth rises, optimism |
| Investment | Expected profits fall, interest rates rise, confidence drops | Expected profits rise, rates fall, confidence rises |
| Government | Spending cuts, tax increases | Spending increases, tax cuts |
| Net Exports | Foreign demand falls, U.S. goods become relatively expensive | Foreign demand rises, U.S. goods become relatively cheap |
2. The Building Blocks of Keynesian Analysis
Keynesian economics rests on two key building blocks:
Building Block 1: Aggregate Demand Causes Recessions
Recessions occur when the level of demand for goods and services is less than what would be produced at full employment. The economy’s productive capacity doesn’t disappear—factories, workers, and technology remain—but insufficient demand means they go unused.
The Great Depression (1929–1933):
- No flood, earthquake, or natural disaster destroyed factories
- No disease decimated the workforce
- No key input price (like oil) soared
- The U.S. economy in 1933 had essentially the same factories, workers, and technology as in 1929
- Yet the economy had shrunk dramatically — the problem was a collapse in aggregate demand
This contradicted Say’s Law: production capacity existed, but markets could not sell their products.
Building Block 2: Sticky Wages and Prices
Sticky wages and prices: Wages and prices that do not respond quickly to decreases or increases in demand. This sluggish adjustment prolongs recessions and prevents the economy from self-correcting.
Why are wages sticky?
| Reason | Explanation |
|---|---|
| Coordination argument | Workers might accept lower wages if everyone else did too, but a market economy has no mechanism for coordinated wage reductions |
| Morale effects | Firms avoid wage cuts because they depress morale and hurt productivity |
| Minimum wage laws | Legal floor prevents wages from falling below a threshold |
| Implicit contracts | Employers develop informal understandings with workers about stable pay |
Why are prices sticky?
Menu costs: The costs a firm faces in changing prices, including:
- Internal costs: analyzing competition, updating sales materials, changing billing records, relabeling products
- External costs: risk of confusing or angering customers who find prices have changed
Sticky Wages and Prices in the AD/AS Model
When AD declines with sticky wages and prices:
- In the labor market: demand for labor shifts left, but the wage stays at its original level → excess supply of labor = unemployment
- In the goods market: demand shifts left, but prices stay → excess supply of goods = unsold inventory
- Across the entire economy: this produces a flat SRAS curve below potential GDP
Macroeconomic externality: What happens at the macro level differs from what happens at the micro level. Individual firms should cut prices to boost demand, but menu costs prevent this. Individual workers should accept lower wages, but coordination problems prevent this. The result: the entire economy gets stuck below potential GDP.
The Expenditure Multiplier
Expenditure multiplier: A change in autonomous spending causes a more than proportionate change in real GDP.
Mechanism: One person’s spending becomes another person’s income, which leads to additional spending and additional income. The cumulative impact on GDP is larger than the initial increase in spending.
How the Multiplier Works:
Suppose the government spends an additional $100 million:
- Workers who receive this income spend, say, 80% = $80 million
- Recipients of that $80M spend 80% = $64 million
- Those recipients spend 80% = $51.2 million
- And so on…
Total GDP increase = $100M × $ \frac{1}{1 - 0.8} $ = $100M × 5 = $500 million
The multiplier works in both directions: when investment collapsed during the Great Depression, it caused a much larger decrease in real GDP.
The Multiplier Formula
Marginal Propensity to Consume (MPC): The fraction of each additional dollar of income that is spent on consumption.
Marginal Propensity to Save (MPS): The fraction of each additional dollar of income that is saved.
\(MPC + MPS = 1\)
The simple expenditure multiplier is:
\[\text{Multiplier} = \frac{1}{1 - MPC} = \frac{1}{MPS}\]The total change in GDP from an initial spending change $\Delta G$:
\[\Delta Y = \Delta G \times \frac{1}{1 - MPC}\]Not all multipliers are equal! Research shows:
- Government spending on infrastructure can have multipliers greater than 1
- Tax cuts for the wealthy may have multipliers less than 1 (because wealthy households save a larger share)
- The multiplier’s size depends on how much of each round of income gets spent vs. saved
3. The Phillips Curve
Discovery of the Phillips Curve
Phillips Curve: Named after A.W. Phillips (London School of Economics, 1950s), it shows the short-run trade-off between unemployment and inflation. When unemployment is low, inflation tends to be high, and vice versa.
Phillips analyzed 60 years of British data and found this negative relationship. The logic follows from the Keynesian AD/AS model:
- Recessionary conditions (far left of SRAS, Keynesian zone) → high unemployment, low inflation
- Boom conditions (far right of SRAS, neoclassical zone) → low unemployment, high inflation
Reading the Phillips Curve:
| Point | Unemployment | Inflation | Economic Condition |
|---|---|---|---|
| A | 4% | 5% | Boom — strong demand, tight labor markets |
| B | 7% | 2% | Recession — weak demand, slack labor markets |
Moving from B to A: Government stimulates economy → unemployment falls but inflation rises. Moving from A to B: Government tightens policy → inflation falls but unemployment rises.
The Instability of the Phillips Curve
During the 1960s, economists treated the Phillips curve as a policy menu: choose low unemployment with high inflation, or low inflation with high unemployment. Then it fell apart.
Stagflation of the 1970s: The U.S. experienced both high unemployment AND high inflation simultaneously — something the original Phillips curve said shouldn’t happen. The Phillips curve had shifted outward.
Two factors caused the shift:
- Supply shocks (oil crisis of 1973–74) — shifted SRAS left, raising prices while reducing output
- Changes in inflation expectations — when people expect inflation, they build it into wage demands and pricing decisions, eliminating the trade-off
Key insight: The downward-sloping Phillips curve is valid for short-run periods of several years. Over longer periods, the curve can shift:
- 1970s–early 1980s: Both unemployment and inflation were high (shifted right)
- 1990s–2000s: Both unemployment and inflation were low (shifted left)
Keynesian Policy Prescriptions
| Economic Problem | Keynesian Prescription | Mechanism |
|---|---|---|
| Recession (AD too low) | Expansionary fiscal policy: tax cuts, increased government spending | Shifts AD right → higher output, lower unemployment |
| Inflation (AD too high) | Contractionary fiscal policy: tax increases, government spending cuts | Shifts AD left → lower price pressure |
The “Goldilocks” Principle: Keynesian economics seeks the right level of aggregate demand — not too much (inflation), not too little (recession), but just right (potential GDP with full employment).
Keynes even suggested, somewhat tongue-in-cheek, that if the government couldn’t agree on practical spending projects during a depression, it could bury money underground and let mining companies dig it up — the point being that any spending increase helps when demand is desperately low.
4. The Keynesian Perspective on Market Forces
What Keynes Actually Believed About Markets
Keynes was careful to separate two issues:
- Individual markets for goods and services → work well and should be left alone
- Aggregate demand → sometimes too low, requiring government intervention
He argued that individual markets may do a perfectly good job allocating resources among 9 million employed workers — the problem is that with insufficient AD, there should be 10 million workers employed. Government’s role is to ensure the overall level of AD is sufficient, NOT to set prices, wages, or manage individual industries.
Practical Questions with the Keynesian Approach
Even if one accepts Keynesian theory, important practical challenges remain:
| Challenge | Issue |
|---|---|
| Measuring potential GDP | Can economists identify it accurately to know the gap? |
| Tax cuts vs. spending | Which is more effective at stimulating AD? |
| Policy timing | Given delays in legislation, can government act fast enough? |
| Simplicity | Is fixing a recession really as simple as boosting AD? |
| Political will | Can governments actually implement contractionary policy during booms? |
The Pandemic-Induced Recession (2020): A Keynesian Case Study
The 2020 pandemic recession was unique but had strong Keynesian elements:
- Demand collapse: Over 20 million unemployed by April 2020 → massive decline in consumption and AD
- Investment decline: Businesses pessimistic or uncertain → investment fell
- Government response (Keynesian prescription):
- Small business loans (PPP)
- Direct aid to state and local governments
- Expanded unemployment insurance
- Stimulus checks to households
- Result: Economy bounced back somewhat over the remainder of 2020
However, the pandemic also had supply-side features (worker shortages, supply chain disruptions) that complicated the purely Keynesian diagnosis. Millions remained out of work into 2022 as new variants threatened further disruption.
5. Key Takeaways
- Keynesian economics focuses on aggregate demand as the primary cause of short-run economic fluctuations, especially recessions.
- The Keynesian SRAS curve is flat below potential GDP (sticky prices prevent self-correction) and vertical at potential GDP.
- Recessionary gap = equilibrium below potential GDP; inflationary gap = demand pushing past potential GDP.
- Sticky wages (coordination argument, morale effects) and sticky prices (menu costs) prevent the economy from self-correcting quickly.
- The expenditure multiplier means a change in spending causes a more-than-proportionate change in GDP, amplifying both booms and busts.
- The Phillips curve shows a short-run trade-off between unemployment and inflation, but this trade-off can break down due to supply shocks or changing inflation expectations (stagflation).
- Expansionary fiscal policy (tax cuts, more spending) combats recessions; contractionary fiscal policy (tax increases, spending cuts) combats inflation.
- Keynes supported government intervention at the macro level (managing AD) but NOT micro-level control of prices, wages, or industries.
6. Practice Questions
Q1. What is the difference between a recessionary gap and an inflationary gap? How does each appear in the Keynesian AD/AS model?
Answer
A recessionary gap occurs when equilibrium output is below potential GDP — the economy can produce more but doesn't because aggregate demand is insufficient. In the Keynesian AD/AS model, the AD curve intersects the flat (horizontal) portion of the SRAS curve, to the left of potential GDP, resulting in unemployment. An inflationary gap occurs when aggregate demand pushes the economy past potential GDP. The AD curve intersects the vertical portion of the SRAS curve, and since the economy cannot produce more, the excess demand drives up prices (inflation).Q2. List the three factors Keynes identified as determinants of consumption expenditure and explain why disposable income is the most important.
Answer
The three factors are: (1) disposable income (income after taxes), (2) expected future income, and (3) wealth or credit availability. Disposable income is the most important because it directly determines what a household can afford to spend right now. Future income expectations and wealth changes may influence spending at the margins, but for most people, current take-home pay is the single most powerful determinant of how much they consume — it sets the practical budget constraint.Q3. Explain the coordination argument for why wages are sticky downward.
Answer
The coordination argument states that most workers might be willing to accept a wage cut during a recession IF everyone else also accepted one (so that relative wages and purchasing power stayed roughly the same). However, a market economy has no practical mechanism for implementing coordinated wage reductions across all workers and firms simultaneously. No individual worker wants to be the first to accept a cut when others haven't. The result is that wages remain stuck at their original level even when demand falls.Q4. What are menu costs, and how do they contribute to recessions?
Answer
Menu costs are the costs a firm faces when changing prices: analyzing the market, updating labels and marketing materials, reprogramming billing systems, and potentially confusing or angering customers. Because of these costs, firms don't adjust prices immediately when demand changes. When aggregate demand falls, menu costs cause prices to remain sticky rather than declining. If prices fell, lower prices would stimulate some demand (movement along the AD curve). But sticky prices prevent this adjustment, so the economy remains stuck at a lower level of output — prolonging the recession.Q5. Using the expenditure multiplier concept, explain why the Great Depression was so severe.
Answer
When the stock market crashed in 1929 and household wealth plummeted, consumption spending fell. This reduced income for businesses, who then cut investment and laid off workers. Those laid-off workers had less income, so they spent less, which reduced income for other businesses, which cut more jobs. The expenditure multiplier amplified the initial decline: each dollar of reduced spending caused MORE than one dollar of reduced GDP, because the spending cuts cascaded through the economy. The multiplier worked in reverse — the initial decline in investment and consumption was multiplied into a much larger decline in real GDP, turning a recession into a full-scale depression.Q6. If the government increases spending by $50 billion and the marginal propensity to consume is 0.75, what is the total expected change in GDP according to the simple multiplier model?
Answer
The simple expenditure multiplier = $ \frac{1}{1 - MPC} = \frac{1}{1 - 0.75} = \frac{1}{0.25} = 4 $ Total change in GDP = $50 billion × 4 = **$200 billion** The initial $50B in government spending becomes income for workers and suppliers, who spend 75% of it ($37.5B), which becomes income for others who spend 75% ($28.1B), and so on, until the total cumulative increase in GDP reaches $200 billion.Q7. Describe the Phillips curve. Why did economists in the 1960s treat it as a “policy menu”?
Answer
The Phillips curve shows a negative (downward-sloping) relationship between the unemployment rate and the inflation rate. When unemployment is low, inflation tends to be high; when unemployment is high, inflation tends to be low. Economists in the 1960s treated it as a policy menu because it appeared to offer a stable trade-off: policymakers could use fiscal and monetary policy to "choose" a point on the curve — accepting some inflation in exchange for lower unemployment, or tolerating higher unemployment to keep inflation down. The curve seemed to present a reliable set of options between these two macroeconomic concerns.Q8. Why did the Phillips curve break down in the 1970s? What replaced the simple downward-sloping relationship?
Answer
The Phillips curve broke down because the U.S. experienced stagflation — simultaneous high unemployment AND high inflation — which the curve said shouldn't happen. Two factors caused this breakdown: 1. **Supply shocks:** The 1973–74 oil crisis shifted SRAS left, raising prices while reducing output. This moved the economy to a point with both high unemployment and high inflation. 2. **Changing inflation expectations:** As people came to expect ongoing inflation, they built it into wage demands and pricing decisions, shifting the Phillips curve outward. The original simple curve was replaced by the understanding that the Phillips curve trade-off holds only in the **short run** (a few years). Over longer periods, the curve shifts based on supply shocks and inflation expectations. The long-run Phillips curve may be vertical at the natural rate of unemployment.Q9. During the Great Depression, the physical productive capacity of the U.S. economy was essentially unchanged from 1929 to 1933. How does this fact support the Keynesian perspective rather than Say’s Law?
Answer
Say's Law holds that "supply creates its own demand" — that producing goods generates enough income to buy those goods. If Say's Law were correct, the economy should have remained near full employment because production capacity hadn't changed. The fact that GDP collapsed despite unchanged productive capacity directly contradicts Say's Law. Factories, workers, and technology still existed in 1933, but production fell dramatically because there wasn't enough demand. This supports the Keynesian claim that aggregate demand, not just supply, determines real output — and that the economy can get stuck far below potential GDP when demand is insufficient.Q10. Suppose Congress cuts federal spending to balance the budget during a recession. Use the Keynesian framework to predict the outcome.
Answer
In the Keynesian framework, cutting government spending during a recession shifts AD to the left at precisely the wrong time. The economy is already in a recessionary gap (equilibrium below potential GDP with high unemployment). Reducing government spending further decreases AD, moving the equilibrium even further below potential GDP. Because of the expenditure multiplier, the GDP decline will be larger than the spending cut itself. Unemployment rises further, and the recession deepens. Keynesians would argue this is exactly the wrong policy — during recessions, the government should increase spending (expansionary fiscal policy) to shift AD right and close the recessionary gap.Q11. Why did Keynes believe that government should manage aggregate demand but NOT control prices and wages in individual markets?
Answer
Keynes separated the macro from the micro. He believed that individual markets for goods and services generally work well at allocating resources among employed workers and active firms. The problem during recessions isn't that markets are misallocating resources — it's that there simply isn't enough total spending to employ all available workers. When 10 million people can work but 1 million are unemployed, individual markets may do a perfectly good job coordinating the 9 million who are employed — the issue is insufficient aggregate demand. The government's role should be limited to ensuring adequate overall demand, not micromanaging prices, wages, or industries, which would introduce new inefficiencies.Q12. An economy has MPC = 0.9. The government is considering two policies to close a $500 billion recessionary gap:
- Option A: Increase government spending by $\Delta G$
- Option B: Cut taxes by $\Delta T$ (assume consumers spend MPC of the tax cut)
(a) What is the expenditure multiplier?
(b) How much government spending ($\Delta G$) is needed to close the gap?
(c) How much must taxes be cut ($\Delta T$) to achieve the same effect? Why is $\Delta T > \Delta G$?
(d) If the government chooses Option A but the economy is actually only $300B below potential, what happens?
Answer
**(a)** Expenditure multiplier: $$\frac{1}{1 - 0.9} = \frac{1}{0.1} = 10$$ **(b)** Government spending needed: $$\Delta G \times 10 = 500 \implies \Delta G = \$50 \text{ billion}$$ **(c)** With a tax cut, only MPC of the cut becomes first-round spending: $$\text{First-round spending} = \Delta T \times 0.9$$ $$\Delta T \times 0.9 \times 10 = 500 \implies \Delta T \times 9 = 500 \implies \Delta T = \$55.6 \text{ billion}$$ $\Delta T > \Delta G$ because with government spending, **100%** of $\Delta G$ enters the spending stream immediately. With a tax cut, only **MPC** (90%) is spent — the rest is saved, never entering the multiplier cascade. **(d)** If the true gap is only $300B but the $50B stimulus creates a $500B boost: - The economy overshoots potential GDP by $200B - This pushes the economy into the neoclassical zone of the SRAS - Result: **demand-pull inflation** rather than output gains - This illustrates the difficulty of calibrating fiscal policy correctlyQ13. Between 1960–1969, the U.S. experienced average unemployment of 4.8% and inflation of 2.3%. Between 1974–1982, average unemployment was 7.5% and inflation was 9.4%.
(a) Plot these two periods conceptually on a Phillips Curve diagram. What happened to the curve?
(b) What caused this shift? Identify the specific events.
(c) Paul Volcker became Fed Chair in 1979 and raised interest rates aggressively. By 1983, unemployment peaked at 10.8% but inflation dropped to 3.2%. Where would this point fall on the Phillips Curve? What does it tell us?
(d) Could a similar Phillips Curve shift happen today? Under what circumstances?
Answer
**(a)** The 1960s data (4.8% unemployment, 2.3% inflation) sits on a Phillips Curve close to the origin. The 1974–82 data (7.5% unemployment, 9.4% inflation) sits **above and to the right** — the Phillips Curve **shifted outward** (a worse trade-off on every dimension). **(b)** Causes: - **1973 OPEC oil embargo:** Oil prices quadrupled, causing cost-push inflation (SRAS shifted left) - **1979 Iranian Revolution:** A second oil shock pushed prices higher - **Vietnam War spending + Great Society programs:** Demand-pull pressures from the late 1960s - **Rising inflation expectations:** Workers demanded higher wages to compensate for expected inflation, creating a wage-price spiral **(c)** The Volcker point (10.8% unemployment, 3.2% inflation) falls **below and to the right** of the 1974–82 curve — indicating the economy moved **down along** a new (lower) Phillips Curve. The aggressive tightening broke inflation expectations, shifting the curve back inward. The cost was severe recession. **(d)** Yes. A major supply shock (e.g., global energy crisis, pandemic-scale supply disruption, or a war disrupting critical supply chains) combined with persistent demand stimulus could shift the Phillips Curve outward again. The 2021–22 inflation episode showed elements of this, though the curve shifted back relatively quickly as supply chains healed.Q14. The Keynesian cross model gives us the equilibrium condition $Y = C + I + G + NX$, where $C = C_0 + MPC \times (Y - T)$.
Given: $C_0 = 200$, $MPC = 0.75$, $I = 300$, $G = 400$, $T = 320$, $NX = -50$.
(a) Solve for equilibrium GDP ($Y^*$).
(b) Calculate the multiplier.
(c) If government spending increases by $100B, find the new equilibrium GDP.
(d) How much would taxes need to be cut (instead of increasing G) to achieve the same $\Delta Y$? Show why the tax multiplier is smaller.
Answer
**(a)** Substitute into $Y = C + I + G + NX$: $$Y = [200 + 0.75(Y - 320)] + 300 + 400 + (-50)$$ $$Y = 200 + 0.75Y - 240 + 300 + 400 - 50$$ $$Y = 610 + 0.75Y$$ $$0.25Y = 610$$ $$Y^* = 2{,}440$$ **(b)** Multiplier $= \frac{1}{1 - MPC} = \frac{1}{0.25} = 4$ **(c)** $\Delta Y = \Delta G \times \text{Multiplier} = 100 \times 4 = 400$ $$Y^{**} = 2{,}440 + 400 = 2{,}840$$ **(d)** The **tax multiplier** is: $$\text{Tax Multiplier} = \frac{-MPC}{1 - MPC} = \frac{-0.75}{0.25} = -3$$ To get $\Delta Y = +400$: $$\Delta T \times (-3) = 400 \implies \Delta T = -133.3$$ Taxes must be cut by **$133.3 billion** (vs. only $100B in additional spending). The tax multiplier is smaller in absolute value (3 vs. 4) because a tax cut first increases disposable income, of which only MPC (75%) is spent — the first-round impact is smaller. With government spending, 100% of $\Delta G$ enters the spending stream directly. This is the **balanced-budget multiplier principle:** $\Delta G$ is more "bang for the buck" than $\Delta T$.7. Glossary
| Term | Definition |
|---|---|
| Real GDP | The amount of goods and services actually produced and sold in an economy, adjusted for inflation |
| Recessionary gap | Equilibrium at a level of output below potential GDP |
| Inflationary gap | Equilibrium at a level of output above potential GDP |
| Disposable income | Income after taxes; the primary determinant of consumption expenditure |
| Sticky wages and prices | Wages and prices that do not respond quickly to changes in demand |
| Coordination argument | The reasoning that workers can’t coordinate simultaneous wage cuts, making wages sticky downward |
| Menu costs | The costs firms face in changing prices (relabeling, reprinting, confusing customers) |
| Macroeconomic externality | When macro-level outcomes differ from micro-level behavior; e.g., individual firms should cut prices but collectively don’t |
| Expenditure multiplier | The concept that a change in autonomous spending causes a more-than-proportionate change in GDP |
| Phillips curve | The short-run trade-off between unemployment and inflation |
| Expansionary fiscal policy | Tax cuts or increased government spending designed to shift AD right and combat recession |
| Contractionary fiscal policy | Tax increases or spending cuts designed to shift AD left and reduce inflationary pressure |
| Stagflation | Simultaneous high unemployment and high inflation, caused by supply shocks |