In: Economics
To understand the concept, we need to look at both these economic cycles which an economy usually would face. During a recession, the aggregate demand for goods and services is low. This in turn leads to lower production capacity as producers do not want to produce more goods and services. The end result of this is that producers then resort to firing people from their staff and limit its capacity and the earnings of people also begin to fall rapidly. The money in circulation within the economy is low and it deters the capacity to grow for the country.
On the contrary an inflation cycle is characterized by a rise in flow of money in the country, wherein people have excess cash in their hands and the aggregate or total demand for goods and services is very high, which suppliers are unable to sustain. The end result of this is that the prices of goods and services is too high and the poor sections of the society may not be in a position to afford goods for itself.
The following are two critical policies which the government can follow during a recession or an inflation cycle and whether these are Keynesian or classical in their approach has also been explained: -
1) Borrowing and Increased or Decreased Spending: -
The Keynesian economics primarily focuses on government interventions as a primary tool to tackle the menace of an inflation or recession. It says that whenever an economic cycle is deep in existence in the country, free market economics is not sufficient to be able to correct the situation.
It advocates, that during a recession phase, the government can increase its borrowings and thereby increase its spending so as to correct the economy. This expenditure would result in contracts being handed out to private players who would then increase infrastructure capability on one hand, and on the other would have sufficient money to expand operations and hire more people.
The exact opposite approach takes place during an inflation cycle, when the government reduces its expenditure in the economy and thereby reduces the impact of inflation by ensuring that some part of the money in circulation is retained by the government instead of spending and this helps in correcting inflationary pressure in the economy.
2) Revision in Taxes: -
This approach is followed by classical economists who believe that free market economics is sufficient to balance a recession or an inflation and there should be no direct government intervention in the economy what so ever.
They advocate that during a recession cycle, the government can reduce taxes and allow for free markets to take over and decide the price of goods and services. They focus towards the supply side of economics which can be increased or decreased as per a recession or an inflation cycle respectively.
As taxes in the economy are reduced, producers increase their production capacity they say which neutralizes the effects of a recession on the country. Similarly, during an inflation cycle, tax rates may be increased so as to enable the country to reduce production and supply and help the economy return back to its normal state.
Conclusion: -
Thus, we can conclude by saying that while Keynesian economists focus on ensuring that an economy can return to its normal state by government intervention of spending increase or decrease, classical economists on the other hand focus towards ensuring that an economy can revive by tax corrections or other market-based economics only.
Please feel free to ask your doubts in the comments section if any.