Question

If the economy is suffering through a rampant inflationary period, would a Keynesian economist advocate for stabilization policy that involves higher taxes and higher interest rates? Explain your answer.

Short answer

The increase and decrease of cyclic unemployment are explained by changes in aggregate demand. As a result, it is critical to stabilising the economy by raising the tax and interest rates. This will reduce aggregate demand, lowering aggregate demand and shifting the AD curve to the left.

Step-by-step solution

Concept introduction

Keynesian economists advocate for policies that will help to stabilise the economy.

Explanation of solution

Keynes believed in putting policies in place to improve the economy. Because the economy is facing high inflation, the policy to be pursued is to raise tax rates and interest rates. It also believed in achieving a state of equilibrium in the short term. Furthermore, Keynes believes that demand should be changed rather than supply. Any shift in demand will result in a shift in output and pricing. The AD curve is formed as a result of business cycle fluctuations and wage and price rigidity. The rise and decrease of cyclic unemployment are explained by changes in aggregate demand. As a result, it is critical to stabilising the economy by raising tax rates and interest rates. This will result in a drop in aggregate demand, lowering aggregate demand and shifting the AD curve to the left.