Question

Compare and contrast the assumptions and policy recommendations for two of the schools of thought (Keynesian/ New Keynesians, Monetarism, New Classical, RBCT, ABCT) that we’ve discussed in class. In your opinion, which of these schools of thought are most useful for explaining short-term fluctuations in growth? Why?

Answer 1

Comparision of assumptions of two schools of thought:

* Classical economics emphasises the fact that free markets lead to an efficient outcome and are self-regulating.

*In macroeconomics, classical economics assumes the long run aggregate supply curve is inelastic,therefore any deviation from full employment will only be temporary.

*The classical model stresses the importance of limiting government intervention and striving to keep markets free of potential barriers for their efficient operation.

* Keynesians argue that the economy can be below full capacity for a considerable time due to imperfect markets.

* Keynesians place a greater role for expansionary fiscal policy or government intervention to over come recession.

Difference in policy recommendations

1. Government spending

* The classical model recommends little need for the government to intervene in managing economy.

* The keynesian model makes a case for greater levels of government intervention, especially in a recession .

2. Fiscal policy

* Classical economics places little emphasis on use of fiscal policy to manage aggregate demand.

* Keynesian economics suggests government's need to use fiscal policy,especially in recession.

3. Government borrowing

* A classical view will stress the importance of reducing government borrowing and balancing the budget .

* Keynesian view suggests that government borrowing may be necessary to increase over all aggregate demand.

4. Supply side policies

* Classical view suggest the most important thing is enabling the free market to operate. this may include reducing the power of trade unions.

* Keynesian do not reject supply side policies. they just say they may not always be enough.

Most economist believe that classical theory does not describe and is not that much useful short run fluctuations. Even the classical economist themselves, such as David Hume,realized that classical economic theory did not hold in short run.