Question

9. John Maynard Keynes famously criticized the classical macroeconomic model by saying “In the long run, we are all dead.” While Keynes was probably exaggerating his views, he believed he was making an important point.

a. (8 points) is Keynes main criticism of the classical model? (Hint: this criticism also applies to policy-makers relying on the long-run model of the relation between the price level and real output.)

b. (8 points) Why do some economists today oppose “Keynesian” policies in the sense that they oppose using active monetary and fiscal policy to increase aggregate demand in the short run?

Answer 1

a)

Following are criticism of classical model:

• Full employment is not general condition and economy is subject to economic shocks.
• Supply does not creates its own demand.
• Economic system without government interference can not work efficiently. Government intervention is required to restore full employment in economy.
• Investment and saving are done by different groups so these are affected by the different factors of productions.
• Equilibrium can be set up even before the full employment level.
• Increase in demand can cause rise in real output level, while classical does not think so.

b)

Some economists such as monetarist and new classical do not accept Keynesian theory of government intervention in economic activities.

They consider that government actions do not produce any favorable impacts in economy. New classical economists such Lucas say that rational expectation make monetary and fiscal policies quite ineffective in addressing economic shocks. Hence, government should not go for active monetary and fiscal policies. Active monetary and fiscal policies will cause only instability and distortions in economy,