Question

The U.S. economy is mired in the worst economic downturn since the Great Recession of 2008/2009. The decline in U.S. GDP in the first three months of this year was nearly the equal of that during the Great Recession. Real output is expected to fall by six times as much in the second quarter of 2020. The Federal Reserve Board pledged to provide the liquidity needed to prop up the failing economy. The Fed has bought treasury bills and mortgage-backed securities in large lots. And many economists supported the Fed’s actions.

Q: Both Keynesian economists and classical economists who place their emphasis on the supply-side of the economy are far more doubtful that the Fed’s actions would effectively bring an end to the current economic crisis. Explain and illustrate why these Keynesian economists believed that the Fed’s actions by themselves are likely to be ineffective (again using a money market diagram, an investment schedule and an IS/LM diagram). Then explain and illustrate why classical economists who put their emphasis on the supply-side of the economy also expected that the Fed’s action would be ineffective and are already voicing their concerns about the possible return of inflation.

Finally explain and illustrate what these two sets of critics (classical supply-siders and Keynesians) would do differently or in addition to the Fed’s actions.

Answer 1