Question

Keynes and early Keynesians maintained that monetary policy would be ineffective in stimulating the economy, especially when the economy is in a deep stagnation such as the Great Depression. The U.S. economy is highly likely to slip into a deep recession because of the coronavirus crisis. Discuss the effectiveness of the Fed’s decision to inject a massive amount of money into the economy to avert any possible recession.

Answer 1

In persuance of Keynes and Keynesian economics, in a recessionary or depression period, economic activities are low and the low price make the fresh investment seems like unprofitable. Given the situation, the rate of interest become so low that money supply doesn't induces fresh investment in the economy as it doesn't affect the liquidity preference. The government is ready to inject high liquidity in the economy after COVID-19 ends, but people might not have enough income to spend following the temporary slowdown in the economic activities during COVID-19. This would pose a serious problem of effective demand in the economy. It doesn't make any sense that just because rate of interest is low and the cost of borrowing is low, investors will invest, because it will only add up to inventory. So only focusing on liquidity would not help the USA economy to get on the previous track. Government should adopt a policy combination of government expenditure and tax cut to boost domestic demand so that there would not be any profit realization crisis for the investors after the economic activities once pick up.