The United States has leaned towards two economic theories when it comes to the economy and how it should be run. Classical and Keynesian theory. Both of these theories have great intentions to strengthen our economy and keep our nation moving forward. In today’s economy both are incorporated and there is a time for classical and a time for Keynesian. There is a fine line for which might be better than the other at the moment. Before the 1930’s classical theory came.
After the 1930’s recession, Keynesian theory introduced by John Keyns. Classical theory which can be best described by Alex Smith as “A change in supply will eventually be matched by a change in demand. So that the economy is always moving towards equilibrium”. Alex Smith believed in the “Invisible Hand”, which means the government will not interfere with the people choose to buy and sell freely with each other. He believed that the market would reach equilibrium automatically this way.
Classical theory was the original term used by early economists. The goal was to balance the budget and to limit government intervention.
Classical economics will assume that the long-run aggregate supply curve will be inelastic. This means that any movement from full employment will only be temporary. Keynesian theory is total spending in the economy and the effects on inflation and output. Keynesian has three main principals when it comes to the economy. The first one is that (Blinder)’A Keynesian believes that aggregate demand is influenced by a host of economic decisions – both public and private – and sometimes behaves erratically.
’ Almost all Keynesian’s believe that monetary policy and fiscal policy are reasons for affecting aggregate demand. The decisions made by the public (government) include spending and tax policies.
The second principle is (Blinder)’changes in aggregate demand, whether anticipated or unanticipated, have their greatest short-run effect on real output and employment not on prices’. This idea shows inflation rising only a small bit when unemployment falls. It is believed that the short run won’t necessarily be inferred from what must happen in the long run. Keynesians live in the short run and are not worried about the long run. The third principle is (Blinder) “Keynesians believe that prices, and especially wages, respond slowly to changes in supply and demand, resulting in periodic shortages and surpluses, especially of labor”. There a large difference between Keynesian and Classical Theory. Keynesians will lean towards a demand orientation, while Classical is more oriented towards supply. People who consider themselves classical economists will argue that supply creates its own demand. They also will say there needs to be little government intervention (Invisible Hand). The market forces equate supply and demand and there are no market inefficiencies.
People are rational. Aggregate supply is vertical. There is no surplus in the market. Keynesians will say that demand creates its own supply and there is no need for the government to remove the market inefficiencies. There is a multiplier effect if you increase demand. It will create income. Aggregate supply is horizontal in the short run and vertical in the long run. There will be a surplus in the economy and government intervention is needed to boost growth through fiscal and monetary policies. Classical economist’s theory cautions state against its participation in economic activities and believes that the free market system delivers the efficient result. Full employment is a general condition. Conversely, Keynesian theory does not subscribe to classical theory and argues that full employment is not a general condition. The government should make active participation in economic activities to restore equilibrium. The United States economy was hit by the economic crisis in 2008-2009, the private economic system could not mend the things that had gone unintended ways. The federal government announced huge packages to restore equilibrium.
Gradually unemployment was reduced from the peak of ten percent. Now the government has achieved unemployment target of four percent or its consideration of full employment. The government is following more of Keynesian theory. Monetary and fiscal policy go hand in hand and are implemented simultaneously today as well as in the future to produce required effects on the economic client. An example would be that the United States adopts an expansionary fiscal policy by lowering taxes and increasing government spending to bring a higher GDP growth. Nonetheless, this policy leads to inflation as well and therefore the United States FED adopts a contractionary monetary policy by raising nominal interest rates and so reducing inflation and unemployment and keeping GDP growth in control. There is a time and place for everything. It is hard for some people to see what might be the best option for the US for how to help the current market.
The Economy is always moving and changing constantly and sticking with one theory because you don’t like that any other theory contradicts yours is wrong. People need to open their minds to all options to make the best decision for the current economy.
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