Question

The economy of Albernia is facing a recessionary gap, and the leader of that nation calls together five of its best economists representing the classical, Keynesian, monetarist, real business cycle, and Great Moderation consensus views of the macroeconomy. Explain what policies each economist would recommend and why.

Short answer

Answer: 1. Classical Economist: Allow the market to self-adjust through changing prices and wages without government intervention. 2. Keynesian Economist: Implement fiscal policies like increased government spending or tax cuts to stimulate aggregate demand and reduce unemployment. 3. Monetarist Economist: Implement expansionary monetary policy through lowering interest rates or increasing the money supply to stimulate borrowing and spending. 4. Real Business Cycle Economist: Focus on policies to improve worker productivity, such as investment in education and technology, without intervening directly in the economy. 5. Great Moderation Consensus Economist: Employ a combination of both fiscal and monetary policies to balance short-term interventions with long-term stable economic growth.

Step-by-step solution

Introduction to the different economic schools of thought

To prepare for discussing the different policies that each economist would recommend, it's important to briefly understand the main principles underlying each of the schools of thought: - Classical: Assumes a self-regulating economy, where markets always reach equilibrium without intervention. - Keynesian: Believes that government intervention can be beneficial to manage aggregate demand and ensure economic stability. - Monetarist: Focuses on the control of the money supply to maintain price stability and minimize inflation. - Real Business Cycle: Emphasizes the importance of technological changes and external shocks in determining economic fluctuations. - Great Moderation Consensus: Views effective central bank policy and regulation as key to maintaining macroeconomic stability.

Explaining the Classical Economist's Policy Recommendation

A classical economist would argue that the recessionary gap is temporary and the economy will eventually return to full employment on its own. They would recommend against government intervention and would advocate for allowing the market to self-adjust through changing prices and wages. They believe in the long run, these market forces would automatically eliminate any unemployment by bringing the economy back to full employment.

Explaining the Keynesian Economist's Policy Recommendation

A Keynesian economist would recommend government intervention to stimulate aggregate demand to close the recessionary gap and increase output. They might suggest fiscal policies like increased government spending on projects or infrastructure, or tax cuts to encourage consumer spending and investment. By directly influencing demand, a Keynesian economist aims to kick-start the economy and reduce unemployment.

Explaining the Monetarist Economist's Policy Recommendation

A monetarist economist would focus on the money supply to address the recessionary gap. They might recommend the central bank to implement expansionary monetary policy, which could involve lowering interest rates to stimulate borrowing and investment, or increasing the money supply through quantitative easing. This would reduce the cost of borrowing and promote spending, which in turn, could stimulate economic growth.

Explaining the Real Business Cycle Economist's Policy Recommendation

A real business cycle economist would argue that the recessionary gap is a result of external shocks or technological changes, and would not advocate for significant policy changes to address it. They believe that the economy will naturally adjust to the altered circumstances, so any government intervention would likely be counterproductive. Instead, they might recommend policies to improve worker productivity, such as investment in education and technology.

Explaining the Great Moderation Consensus Economist's Policy Recommendation

A Great Moderation consensus economist would likely focus on the role of central banks in maintaining macroeconomic stability. They might recommend using a combination of both fiscal and monetary policies to control inflation and stimulate economic growth. This could involve adjustments to interest rates, government spending, or taxes, depending on the specific circumstances in Albernia. The key would be balancing short-term policy interventions while maintaining a long-term focus on stable economic growth. By understanding the principles behind each economic school of thought, we can see how each would respond to Albernia's recessionary gap with distinct policy recommendations.