Question

Select one of the following schools of economic thought: Keynesian, Chicago, and Austrian. Identify three keys points or beliefs that are held by that particular school. What are the macroeconomic policy implications of those beliefs? Explain your answer. Which school of economic thought do you find to be most convincing? Why?

Answer 1

1)Keynesian school of economic thought:
- The central theme of this school of thought is that government intervention can stabilize the economy. He argued that during recessions free market cannot automatically provide full employment through self balancing.

Keynesian economists justify government intervention through public policies that aim to achieve full employment and price stability.

three keys points:
- The most important driving force in an economy is the "aggregate demand"- which is measured as the sum of spending by households, businesses, and the government. Aggregate demand is influenced both public and private sector decisions. Private sector decisions can sometimes lead to adverse macroeconomic outcomes like recession, which calls for intervention by the government eg.fiscal stimulus package.
- Prices and wages respond slowly to changes in supply and demand, resulting in periodic shortages and surpluses, especially of labor. i.e. if prices of goods fall in the market it will not result in immediate reduction of wages and vise a versa. It is only if the low prices persist for a long period that the firms will reduce output and the number of workers or their wages to reduce loses.
- Keynesians believe that,Changes in aggregate demand, whether anticipated or unanticipated, have their greatest short-run effect on real output and employment, not on prices. Because prices are somewhat rigid, fluctuations in any component of spending (consumption, investment, or government expenditures) causes output to change.

Macroeconomic policy implications: During a recession demand in the market decreases due to cut in spending. This leads to less investment spending by businesses, due to fall in demand. which in turn leads to job cuts and increase in unemployment again causing fall in demand by customers and the cycle goes on. This puts the responsibility of increasing output and generating employment opportunities in the market on the government by investing in the economy. Thus new investments will increase employment which in turn will increase demand for goods in the market. Thus, state intervention is necessary to moderate the booms and busts in economic activity.

2) Chicago school of economic thought: Chicago School is a neoclassical economic school of thought that originated at the University of Chicago in the 1940s. The main tenets of the Chicago School are that free markets best allocate resources in an economy and that minimal or no government intervention is best for the economy.The theories developed were based on intense mathematical modeling to test hypotheses.

Keys points are:
- They believe that markets allocate resources more efficiently than the government.
- And that monopolies are created by government's attempt to regulate an economy.
- Governments should focus on maintaining a steady and low rate of growth of money supply instead of managing aggregate demand in the economy.

Friedman's quantity theory of money states that general price levels in the economy are determined by the amount of money in circulation. And economic growth can be better controlled by managing general price levels, where individuals and groups make economic allocation decisions in a rational way.
Thus, reduction or elimination of regulations on business is beneficial for the economy.They believed that if markets behave efficiently, then there would be no major imbalances in the market (like the great depression of 1930's).

The Chicago belief in free markets and absence of government regulations has influenced world bodies such as the World bank and IMF.
Milton Friedman from this school challenged the dominance of Keynesian economics in the postwar period.

3) Austrian school of economic thought: The Austrian school of economics was founded in 1871 with the publication of Carl Menger’s Principles of Economics. In his book, Menger argued that economic analysis is universally applicable and that the appropriate unit of analysis is man and his choices.

Key beliefs:

- The Austrian school holds that prices are determined by subjective factors like an individual's preference to buy or not to buy a particular good. Choices are made by an individual.
- They believe that any increase in money supplywhich is not supported by an increase in the production of goods and services leads to an increase in prices. But prices of some goods may increase faster than the others.
- Acoording to them the business cycles are caused by distortion in interest rates due to the government's attempt to control money. As misallocation of capital takes place if the interest rates are kept artificially low or high by the intervention of the government and as a result the economy goes through recession.

     The Austrians have also forcefully demonstrated the superiority of the free market and the hazards from all forms of socialist planning and government intervention

I find Keynisian school of economics most convincing.

During the Great Depression of the 1930s when the existing free market economic theory was unable either to explain the causes of the severe worldwide economic collapse, John Maynard Keynes put forward his theory of government intervention through public policies to achieve full employment and price stability. He advocated deficit spending by the government on labor-intensive infrastructure projects to stimulate employment and stabilize wages during economic downturns. And this is what the governments applied to kick start the economy and come out of the great depression.

The global financial crisis of 2007–08 also showed that the free market policy is not self adjusting and can lead to recession. Again the U.S government had to intervene in the market by reducing interest rates and issuing fiscal pakages to revive the economy. Similarly, overall in the present times it has been accepted by many economists and governments that a mix of free market and government intervention is good economic policy.