Question

What are the main differences between

the modern schools of economic thought? Summarize

these in 3-4 paragraphs.

Answer 1

Some of the Modern school of economic thought and the key differences are s follows -

Classical Economics - The core principal of the Classical Theory is that the economy is self regulating. In other words, when the economy is above or below the potential output, there is no external intervention that is needed in order to bring back the economy to potential output levels. Therefore, classical economics is associated with the thought of economic and therefore political freedom. Importantly, the classical theory also holds that wages and prices are always flexible instead of being sticky and therefore markets always clear.

Keynesian Economics - The core difference between classical and Keynesian economic theory is that the former holds that no external intervention is needed to close the recessionary or inflationary gap. However, the Keynesian economist believe that intervention in the form of appropriate "fiscal policy" is critical to close the recession or inflationary gap. Therefore, the basis of Keynesian economics is government intervention in the economy in the form of higher government spending or change in taxation in order to trigger growth or curb inflationary pressure. Further, the key difference between classical and Keynesian economic is that the a Keynesian believes that "sticky" wages and prices prevent the efficient clearing of wages and prices. On the other hand, classical economist believe that wages and prices are always flexible. An extension of traditional Keynesian economics is the "New Keynesian Economics." The key difference is that the new Keynesian economist do believe that the household sector and the private sector do operate on rational expectations. However, it holds on to the view that wages and prices are sticky.

The Monetarist View - This is another modern school of thought by Milton Friedman. While classical theory has basis on free markets and Keynesian school believes in government intervention (fiscal policy), the Monetarist View holds that economic performance is largely dependent on changes in money supply. Therefore, the core focus of a monetarist is towards the monetary policy instead of the fiscal policy. To elaborate, when the economy is in recession, the recommendation of the monetarist would be to expand money supply in order to revive economic growth. This is opposed to Keynesian view of expanding government spending. Further, the monetarist also holds to the view that money supply needs to be curbed relatively swiftly once the economy is back to potential output. If the money supply is not curbed, all excess money supply will translate into higher prices.

Conclusion: In summary, the classical theory is focused on "free markets" with no intervention. The Keynesian theory is focused on government intervention (fiscal policy) to revive the economy from recession or curb inflation. The Monetarist view, on the other hand, is primarily focused on monetary policy (changes in money supply) as the single most important factor that determines economic growth. Further, the classical theory holds that wages and prices are flexible and adjust according to economic activity. On the other hand, the Keynesian theory holds that wages and prices are sticky and therefore external intervention is critical.