Question

1) A decline in the interest rate is likely to have no effect on GDP? Agree or disagree? Why?

2) Households tend to increase their spending during a recession because they realize that more spending will cause firms to hire more workers and the problem of unemployment will be solved.” Do you agree or disagree? Explain.

Answer 1

1)

There can not be straightforward answer to this question. it depends on economic conditions in economy. Fall in interest rate motivates private investment. Since interest rate is a kind of cost for firm or investors. When interest rate falls, there is incentive to make more investment in economic activities. Although fall in interest rate reduces the cost of borrowing fund, but if economy is passing through recession, private investor might not increase their investment for fear of losing money.

2)

This is not fully correct statement. People are not free money illusion. They might think that their incomes have decreased due to recession, they even might reduce their spending. Further, If they are rational enough, they might increase their spending, but all can be so much rational.

Thus keynese contends that government intervention is must to restore output and employment. such market system does not work so efficiently to restore equilibrium in short run.