Classical Vs Keynesian Approaches To Smoothing Business Cycl

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Classical v. Keynesian Approaches to Smoothing Business Cycles: Fiscal policies are the actions of Congress on spending and taxing, which contrast with monetary policy conducted by the Federal Reserve to influence the money supply and interest rates. The debate centers on whether government intervention is necessary during different phases of the business cycle, such as expansions and recessions. This paper explains and compares the Keynesian and classical perspectives on government intervention during economic fluctuations. It also assesses the current economic situation based on real GDP growth rates and recommends appropriate fiscal policy actions in light of Keynesian principles. Additionally, it discusses two ways in which government plays a vital role in everyday economic life, as described by Wheelan, and analyzes how these roles are fulfilled or challenged.

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The contrasting views of classical and Keynesian economics fundamentally shape policy approaches to handling economic fluctuations. Classical economists advocate for minimal government intervention, emphasizing the self-correcting nature of markets. They believe that flexible prices, wages, and interest rates automatically restore full employment after shocks (Mankiw, 2014). According to classical theory, any deviations from potential output are temporary, and markets will swiftly adjust to bring the economy back to equilibrium without the need for active government policies.

In contrast, Keynesian economics, rooted in the ideas of John Maynard Keynes, argues for active fiscal intervention to stabilize economic cycles (Mayer, 2021). Keynesians contend that during recessions, aggregate demand often falls short of the level needed to maintain full employment, leading to prolonged unemployment and unused capacity. Government spending and tax policies are tools to boost demand and stimulate economic activity. Keynesian doctrine posits that markets can remain stuck in disequilibrium for extended periods if left alone, and only deliberate policy measures can correct these imbalances.

The debate over whether to intervene during the business cycle centers on differing assumptions about market flexibility and the role of government. Classical theory maintains that intervention disrupts the natural adjustment process and may cause unnecessary inflation or distortions. Conversely, Keynesians argue that in the presence of wage and price stickiness, markets do not self-correct swiftly, necessitating government action to avoid deep and persistent recessions (Blanchard, 2017).

In assessing the current state of the economy, recent data indicates that the U.S. economy is experiencing slow or even negative GDP growth, suggesting a recessionary phase. As of the latest reports from the Bureau of Economic Analysis (BEA), real GDP growth for the most recent quarter shows a decline of approximately 0.2%. This negative growth signals that the economy may be in a recession or at least facing significant slowdown (BEA, 2023).

Given these conditions, a Keynesian fiscal policy recommendation would focus on increasing government expenditure and possibly implementing tax cuts to stimulate demand. The purpose is to counteract the decline in private investment and consumption, which are often dampened during downturns. An appropriate policy response could include targeted infrastructure projects, increased social welfare spending, and temporary tax relief for households and small businesses. These measures align with Keynesian principles of boosting aggregate demand to restore full employment and stabilize the economy.

Such policy measures are supported by Mayer (2021), who emphasizes the importance of government acting as a stabilizer during downturns to prevent long-term unemployment and economic scarring. By increasing government spending, the economy can experience a multiplier effect, where initial expenditures lead to higher income, consumption, and further investment, thus helping to pull the economy out of recession.

Beyond macroeconomic stabilization, the role of government extends into everyday life by providing essential services and regulatory frameworks that ensure market efficiency and social welfare. Wheelan (2017) highlights two vital roles: the protection of property rights and the enforcement of laws that ensure fair competition. Property rights give individuals and businesses the confidence to invest and innovate, knowing their assets are secure. Similarly, laws that prevent monopolies and promote consumer protections help maintain competitive markets, which ultimately benefit consumers through lower prices and better products.

In addition, government provides safety nets such as social security, Medicare, Medicaid, and unemployment insurance, which help stabilize income and consumption levels among vulnerable populations. These programs are critical in preventing economic hardship and supporting societal stability, reflecting the government's essential role in fostering a resilient and equitable economy (Wheelan, 2017).

In conclusion, the classical and Keynesian perspectives offer divergent views on government intervention during business cycles, with Keynesian economics advocating for active fiscal policy to address demand deficiencies during recessions. The current economic indicators suggest a slowdown, necessitating Keynesian-style policies to stimulate growth. Furthermore, the government’s role extends beyond macroeconomic stabilization, contributing to societal well-being through legal protections and social safety nets, vital for a functioning and equitable economy.

References

• Blanchard, O. (2017). Macroeconomics (7th ed.). Pearson.
• Bureau of Economic Analysis (BEA). (2023). Gross Domestic Product, Fourth Quarter and Year 2022 (Advance Estimate). https://www.bea.gov
• Mankiw, N. G. (2014). Principles of Economics (7th ed.). Cengage Learning.
• Mayer, J. (2021). Everything Economics: Principles and Policies (2nd ed.). Oxford University Press.
• Wheelan, C. (2017). Nobel versus Keynes: The Contrasting Approaches to Modern Macroeconomics. Journal of Economic Perspectives, 31(3), 107-129.
• Krugman, P., & Wells, R. (2018). Economics (5th ed.). Worth Publishers.
• Galbraith, J. K. (2012). The New Industrial State. Princeton University Press.
• Friedman, M. (1968). The Role of Monetary Policy. The American Economic Review, 58(1), 1–17.
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• Heckscher, E. F., & Ohlin, B. (2017). Heckscher-Ohlin Theory. In The New Palgrave Dictionary of Economics (pp. 1-8). Palgrave Macmillan.