Which of the following policy recommendations are consistent with the Classical,

Question

Which of the following policy recommendations are consistent with the Classical, Keynesian, Monetarist, Supply-Side, and/or Great Moderation Consensus views of the macroeconomy and stabilization policy? Explain carefully!

a. Since the long-run growth rate GDP is 2% per year, the money supply should grow at 2% per year.

b. Decrease government spending in order to decrease inflationary pressure.

c. Increase the money supply side in order to alleviate a recessionary gap.

d. Always maintain a balance budget.

e. Decrease the budget deficit as a percentage of GDP when facing a recessionary gap.

Explanation / Answer

a. Since the long-run growth rate GDP is 2% per year, the money supply should grow at 2% per year. ( Monetarist): The key driver behind this belief is the impact of inflation. They showed that expansion of money beyond the growth of output always causes inflation. The Economy's growth or health and the belief that by controlling the supply of money , inflation can be controlled.

b. Decrease government spending in order to decrease inflationary pressure.( Supply-de Economics). Supply-side economics show that the Aggregate Demand and Aggregate Supply curves produce the macro-economic stability in the economy. Therefore, during inflationary periods, government spending can increase AS, thereby curbing inflationary pressures.

c. Increase the money supply side in order to alleviate a recessionary gap. ( Keynesian). This policy is based on the Keynesian principle of creating Demand when recessionary fall takes place. This was successfully tried by the Roosevelt Administration to revive the economy during the 1940s. It was called “pump-priming”, by pumping money to increase demand.

d. Always maintain a balance budget. (Classical ): The classical view in effect shows that in the long-run Aggregate Supply is inelastic. Therefore merely increasing government expenditure through deficit-financing only creates inflation. The best method is to keep the budgets always balanced.

e. Decrease the budget deficit as a percentage of GDP when facing a recessionary gap.(Great Moderation consensus) The period of great Moderation emphasized the importance of stability through structural reforms rather than policy manipulations.

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