Question

Explain the Financial Crisis solution using one of the following schools of thought. Austrian, Monetarism, Keynesian or Chicago.

Answer 1

Keynesian School of Thought:

Financial crisis in the economy leads to fall in the level of National Output in the economy and also reduces the growth rate of GDP in the economy. It reduces investor sentiment and reduces the level of aggregate demand in the economy creating recessionary gap in the economy. To eliminate the situation of recessionary gap in the economy, the government intervention is needed as prices are wages are sticky and will not change automatically to move the economy to full employment level. Thus, government intervention in the form of expansionary fiscal policy which involves increase in government expenditure and reduction in the tax rate is needed to move the economy to full employment level. This is because it will increase the level of aggregate demand in the economy and help in eliminating recessionary gap in the economy.