Question

1) If the economy is in a recession and the president invites three economists—A Keynesian, a monetarist, and a new classical—to offer explanation and policy options, what would each say in two sentences or less?

-Keynesian:

-Monetarist:

-NeoClassical:

2) Between the crises of 1930s and 2008, what are (mention two for each):

a)       the similarities?

b)       the differences?

3) If you were an influential economist, to prevent deep recessions in the future, what policies/thoughts would you offer?  

Answer 1

1. Keynesian

Keynesian macroeconomics argues that the solution to a recession is expansionary fiscal policy that shifts the aggregate demand curve to the right.Expansionary fiscal policy consists of tax cuts or increases in government spending designed to stimulate aggregate demand and move the economy out of recession.

Monetarist

According to Monetarist government should seek out balanced budget during recession.Monetarism emphasises the importance of controlling the money supply to control inflation. Monetarists are generally critical of expansionary fiscal policy arguing that it will cause just inflation or crowding out and therefore not helpful.Monetarism is an economic theory that focuses on the macroeconomic effects of the supply of money and central banking. Formulated by Milton Friedman, it argues that excessive expansion of the money supply is inherently inflationary, and that monetary authorities should focus solely on maintaining price stability.

Neo Classical

Neoclassical economists believe that the economy will rebound out of a recession or eventually contract during an expansion because prices and wage rates are flexible and will adjust either upward or downward to restore the economy to its potential GDP. Thus, the key policy question for neoclassicals is how to promote growth of potential GDP.

2.Similarities:

Huge economic slumps accompanied both. Also, the diagnoses and prescriptions were the same. Both catastrophes were laid at the feet of market failure. To correct for the alleged market failure associated with the Great Depression, Roosevelt came up with the New Deal. In short, the prescription was a massive increase in the scope and scale of the government’s reach and involvement in the economy. This type of intrusive response has also followed the Great Recession, ushering in a plethora of government regulations, particularly those that affect banks and financial institutions. In both cases problems existed in financial markets.The financial sectors also played prominent roles in both periods. The economy and the stock markets reacted to both the increase and the decrease in economic activity during the late 1920s and the 1990s. Stock market values declined during both depression and recession.

Difference

A recession is a widespread economic decline that lasts for several months. A depression is a more severe downturn that lasts for years.In a recession, gross domestic product contracts for at least two quarters. In a typical recession, GDP growth will slow for several quarters before it turns negative.The devastation of a depression is so great that the effects of the Great Depression lasted for decades after it ended.

3. Policies to avoid Recession

Expansionary monetary policy

Cutting interest rates should help to boost aggregate demand. Amongst other things, lower interest rates reduce mortgage interest payments, giving consumers more disposable income. Lower interest rates also encourage firms and consumers to spend rather than save. (effect of lower interest rates)

Expansionary fiscal policy

Expansionary fiscal policy involves increasing government spending and/or cutting taxes. This injection into the circular flow is financed by government borrowing. If the government cut income tax or VAT, it increases disposable income and therefore increases spending.

Quantitative Easing

Quantitative easing involves the Central Bank electronically creating money and using this money to buy long-dated securities. This increases bank reserves and should help encourage bank lending. Also, it reduces interest rates on bonds which should help encourage spending and investment.

Helicopter money.

Helicopter money is a policy to increase the money supply and give money directly to consumers. This is effective in a period of deflation – where consumers are reluctant to spend and banks are reluctant to lend money.

Ensure financial stability

In a credit crunch, government intervention to guarantee bank deposits and major financial institutions can maintain credibility in the banking system.