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Why would Keynesian economists be pessimistic about the ability of monetary policy to stimulate output in...

Why would Keynesian economists be pessimistic about the ability of monetary policy to stimulate output in a situation such as the Great Depression.  In such a depression situation what type of policy would be effective? Explain.

Also, carefully explain the similarities of the conditions at the present time and point out some of the tools that FED has unleashed to preserve the efficacy of monetary policy.

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Answer #1

a) At the time of deprssion the market is in a liquidity trap i.e. the demand for liquiity is so high that people in the market will keep as much money as the Fed will release but the interest rate will not rise. here, the SRAS curve is also horizontal till full employment. Sp, to deal with this situation the government have to take active expansionary policy and reduce the taxes and increase the expenditure.

b) Fed has reduced the interest rate close to zero and flushed the market with fresh money and liquidity. this will increase the investment and reduce the saving forcing people to consume more.

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