Sectoral Interactions, Input-Stock Adjustment and Fiscal Policy Responses

Abstract

Efficacy of the fiscal policy is a long standing debate. Mainly, with the resurgence of the monetarists from 1970s, economists became sceptical about the Keynesian prescription of govt. intervention and its beneficial role. Particularly from 1990s there emerged a view, from empirical research, that contractionary fiscal policy may be expansionary and vice versa. Proponents of this view, to support their empirical findings with theory, argued that deficit reduction will increase confidence of consumers and businesses, resulting in increased current spending on consumption and investment. But most of these arguments to contradict the Keynesian results are based on some strong assumptions on expectations. Our paper, which is basically a theoretical study of sectoral interdependence in a macroeconomy, predicts this type of non-Keynesian effects of fiscal policy in a Keynesian framework, without being based on any assumptions on expectations. From our model of industrial interdependence, by simply relaxing the implicit assumption of adequate input stock holdings by the industries, we can show how even in a demand determined market economy with excess demand and excess capacity, multiple equilibria solution can exists, with low level equilibrium trap as a possible solution and how this type of inadequacy of stock of inputs can seize the process of fiscal multiplier and even in the extreme case may result in a contraction of economic activities. We have also found out the levels of the minimum stocks of inputs, the industries must possess to avoid such low level equilibrium trap.