Question

Attempt to briefly explain the great recession according to each of the following four business cycle theories:

1. New Keynesian

2. Real Business Cycle Theory

3. Monetarist

4. Austrian School

Use each of the four model perspectives to answer the question: how did this all happen? In your view, was an appropriate Fiscal and Monetary Policy Response followed?

Answer 1

Following are explanations for recession:

• New Keynesian: They believe that over short run, wages and prices are rigid, so fall in aggregate demand cause recession. Output and unemployment fall during recession. Government intervention is required to correct it.
• Real Business cycle theory: Theory of real business stresses on real factors for causing recession. Technological and supply shocks create recession in economy thereby leading to fall in output and employment.
• Monetarists: Monetarists suggest that fall in money supply causes fall in demand , there is fall in output and employment. So excessive fall in money supply must be held responsible for recession.
• Australia School: Excessive lending or lending interest rate which is below the risk factor leads to failure of business, and put economy in recession.

Typcially, Expansionary fiscal and monetary policies are followed to correct recession. It was suggested by the keynesian and such policies have been used increasingly across the world. Fiscal policy is more effective relative to monetary policy to de-stressing aggregate demand.