How Would a Benevolent Ruler Combat a Recession?
11
their demand for equipment to produce more consumer goods or services, so producers of equipment—investment goods— cut production and employment. Thus, in response to the fall in consumption and investment demand, most firms cut back production and employment, so the economy falls into recession. To combat a recession caused by a fall in aggregate demand for goods and services, a policy must be implemented that will increase aggregate demand. To increase aggregate demand for goods and services, the ruler deposits a specific amount of paper notes in the bank account of each household. The deposit is a transfer from the government to the household, not a loan that the household must repay. The ruler calls the transfer to each household a “tax rebate” because it gives back some of the tax that the household paid in the previous year. The tax rebates are called “fiscal stimulus” because they are a government expenditure (“fiscal”) that increases (“stimulates”) consumer demand for goods and services. Households spend a portion of their tax rebates and save the rest, and the portion they spend causes producers of consumer goods and services to increase their production and employment. As managers in firms making consumer goods or services observe the revival of consumer demand, they spend more to increase their equipment, so producers of these investment goods raise their production and employment. But how does the benevolent ruler obtain the paper notes needed to give tax rebates to households? Assume that at the beginning of the year the ruler has no notes on hand. The ruler’s adviser points out that when other governments have faced a similar situation, some of these governments have borrowed from the public by selling government bonds to the public to obtain the paper notes. But the ruler replies that there is no need to sell bonds and thereby incur government debt. Instead, the ruler
