Question

The Classical School of economic thinking is quite different from the Keynesian School. The adherents believe in different roles for government and have different ideas about what drives an economy and even what an economy is and how it functions. Explain the two approaches for the following scenarios (be sure to think of monetary policy, fiscal policy, effects on the components of GDP, and incentives people may face):

The economy is in a recession.

The Federal Reserve Board has decided to lower interest rates below what many consider to be the proper or natural rate.

Some policy makers are advocating an inflationary policy to address unemployment.

Senator R has proposed a law exempting credit card purchases and interest on credit debt from taxes to stimulate consumption.

Answer 1

a)

When the economy is in recession, it is necessary to expand the economy to buck up the level of economic activities in order to speed up the economy.

Established school of musings has its pledge that genuine hole could be expanded through expanding supply side components it implies Real GDP is controlled by supply side factors the level of speculation, the level of capital and the profitability of work e.t.c. In this way different instruments and arrangements of money related approaches would help much than financial ones. Consequently government would have little part here. This will help speculation and henceforth supply sides will increment to build gross domestic product.

On other hand as Keynesian suggests that gdp is more of demand side determinants, recession can be handled through strong government intervention in terms of fiscal policies like increasing spending etc. This will increase AD to increase GDP.

b)

Classical view suggests that the money market equilibrates through an adjustment in the interest rate. Thus lowering interest rate would increase demand of money and decrease supply of money to reach a new level of equilibrium of money.

On other hand Keynes demonstrated that savers and speculators are separate gatherings which don't really associate: budgetary middle people (banks) are in the middle. Lower financing costs may not expand utilization especially in light of the fact that the wage impact of lower loan fees mean individuals have less wage.

C)

Classical School believes that unemployment is caused by supply side factors real wage unemployment, frictional unemployment and structural factors. Thus it downplays the role of demand deficient unemployment. Beside it also suggests that there is no trade off between inflation and unemployment because in long run once wages adjust, unemployment will return to the natural rate, and there will be higher inflation. Thus there will be no use of employing such inflationary policy to address unemployment.

On other hand Keynesian believes in Phillips curve theory that there exist tradeoff between inflation and unemployment. Thus trading off some inflation with less unemployment through proper policies would be of good.