When Expansionary Fiscal Policy is Contractionary: A Neoklassikal Scenario*

Abstract

The paper presents a simple theoretical account of how an increase in government purchases may reduce total employment. It is shown that in a ‘neoklassikal’ model – in which utility maximising consumption choices are combined with a fixed‐coefficient technology – an increase in government purchases will reduce the demand for labour at the given wage rate. The reasoning turns on the link between optimising consumption behaviour and employment in the investment sector. An increase in G will (as a matter of arithmetic) make current consumption scarcer relative to future consumption; and thereby reduce the valuation of future consumption in terms of current consumption. As labour is valued according to its contribution to future consumption (through its contribution to capital formation), it follows that an increase in G will reduce the wage at any given volume of employment.