Difference Between Keynesian Economic Thought and Others

6 months ago

Atiqur Rahman

8 minutes

⇒ 1. Keynesians believe that unemployment is both high on average and too variable.

They think that times of recession or depression are economic disorders and not as effective as market responses to unappealing occasions. This does not imply that Keynesians will resort to government spending, taxes and money supply every now and then in order to keep the economy at full employment. This method of fine-tuning will not work because as there is a pause between the time that an alteration in policy is required and the time the government identifies this.

Then, there is also a lag when the government identifies that an amendment in policy is required and when it takes action. The last lag occurs between the time that policy is changed and when changes affect the economy. This, too, can take many months, yet many Keynesian economists still believe that a modest goal of stabilization is coarse-tuning, implying that an economist need not have complete quantitative knowledge of intervals to frame monetary policy when the unemployment rate is very high.

⇒ 2. Some Keynesians are more anxious about tackling unemployment than about inflation.

They believe that the costs of low inflation are small. However, there are many anti-inflation Keynesians. Keynesians usually support more aggressive expansionist policies than non-Keynesians. Keynesians support aggressive government policies to stabilize the economy created on value judgment on the belief that macroeconomic fluctuations significantly reduce economic well-being and that the government is well-informed and clever enough to improve on a free market.

⇒ 3. New classical think that predicted variations in the money supply do not affect real output.

They believe in the concept that markets, even the labour market, adjust speedily to eradicate efficiencies and surplus and that business cycles may turn out to be efficient. In the 1990s, the new classical schools also came to accept the view that prices are sticky and that the labour market does not adjust as quickly as they previously thought.

⇒ 4. Many Keynesians are sceptical about the idea that people use all available information to form their expectations about economic policy.

Keynesians follow a stabilization policy, taking into account that the prices are sticky under rational expectation models. But Rational expectations do not consider rigid prices; rational expectation models with sticky prices are thoroughly Keynesian by definition.

⇒ 5. There exists a “natural rate” of unemployment in the long run.

Before 1970, Keynesians thought that the long-run level of unemployment was determined by government policy and that the government could accomplish a short unemployment rate by accommodating a high but stable rate of inflation. In the later stages of the 1960s, Milton Friedman, a monetarist, and Columbia’s Edmund Phelps, a Keynesian, overruled the idea of long-run trade-offs on theoretical proofs.

They claimed that to keep unemployment below the “natural rate”, the only way the government could do this was with macroeconomic policies that would continuously drive inflation higher and higher. In the long run, they claimed, the unemployment rate could not be below the natural rate.

Soon thereafter, Keynesians like Robert Gordon presented empirical evidence for Friedman’s and Phelps’s views. Since 1972, Keynesians have integrated the “natural rate” of unemployment into their thinking.

⇒ 6. The new classical theory emphasizes the capability of a market economy to heal recessions by lowering wages and prices.

In the mid-1970s, the New classical economists accredited economic slumps to people’s misunderstandings about what was happening to relative prices (such as real wages). Problems would rise, they claimed, if people did not know the current price level or inflation rate. However, such misunderstandings should be brief and cannot be high in societies in which price indexes are printed monthly, and the monthly inflation rate is less than 1 percent.

Therefore, economic downturns, according to the early new classical view, should be mild and brief. Yet, during the 1980s, most of the world’s industrial economies endured deep and long recessions. Keynesian economics undoubtedly forecasts periods of tenacious involuntary unemployment, though it may not be theoretically profound.

⇒ 7. According to new classical theories of the 1970s and 1980s, a decrease in the growth of the money supply, if perceived correctly, should have only small effects on real output.

Yet, when the Federal Reserve and the Bank of England proclaimed that monetary policy would be squeezed to cure inflation and then implemented on their promises, acute recessions followed in each country. New Classical might propagate that the contraction was unexpected because people did not follow what the monetary authorities said. The Archaic Keynesian theory says that any monetary constraint is contractionary because firms and individuals have fixed-price contracts and not inflation-adjusted contracts, which seems more reliable with certain events.

⇒ 8. Harvard’s Robert Barro originated the idea of debt neutrality.

Barro propagates that inflation, unemployment, real GNP, and real national savings should not be affected by whether the government finances its spending with high taxes and low deficits or with low taxes and high deficits. Because individuals are rational, so they will correctly observe that low taxes and high deficits today must mean higher future taxes for them and their inheritors. They will cut consumption and increase their saving by one dollar for each dollar increase in future tax liabilities. Thus, an increase in private savings should counterbalance any increase in the government’s deficit.

Keynesian analysis, by contrast, sees a rise in deficit, with government spending held constant, as an increase in aggregate demand. With the massive U.S. tax cuts between 1981 and 1984, it was observed that private saving rates did not rise; real interest rates soared. With the fiscal offset by monetary contraction, real GNP growth was not affected (Alan S. Blinder, 1987). Again, all this appears more reliable with Keynesian than with the new classical theory.

⇒ 9. Finally, the European depression of the 1980s was the vilest since the depression of the 1930s.

Governments, controlled by the British and German central banks decided to fight inflation with restrictive monetary and fiscal policies conforming to the Keynesian framework. The anti-inflation campaign was supported by the European monetary system, which, in effect, spread the stern German monetary policy all over Europe. The new classical school has no comparable explanation.

New Classical and traditional economists, in general, propagate that European governments affect more deeply in labour markets with high unemployment benefits, for example -limits on firing workers. But at the same time, these interferences existed in the early 1970s, when unemployment was extremely low.

Difference Between Keynesian Economic Thought and Others

⇒ 1. Keynesians believe that unemployment is both high on average and too variable.

⇒ 2. Some Keynesians are more anxious about tackling unemployment than about inflation.

⇒ 3. New classical think that predicted variations in the money supply do not affect real output.

⇒ 4. Many Keynesians are sceptical about the idea that people use all available information to form their expectations about economic policy.

⇒ 5. There exists a “natural rate” of unemployment in the long run.

⇒ 6. The new classical theory emphasizes the capability of a market economy to heal recessions by lowering wages and prices.

⇒ 7. According to new classical theories of the 1970s and 1980s, a decrease in the growth of the money supply, if perceived correctly, should have only small effects on real output.

⇒ 8. Harvard’s Robert Barro originated the idea of debt neutrality.

⇒ 9. Finally, the European depression of the 1980s was the vilest since the depression of the 1930s.

Read More in: Theory of Public Finance

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⇒ 1. Keynesians believe that unemployment is both high on average and too variable.

⇒ 2. Some Keynesians are more anxious about tackling unemployment than about inflation.

⇒ 3. New classical think that predicted variations in the money supply do not affect real output.

⇒ 4. Many Keynesians are sceptical about the idea that people use all available information to form their expectations about economic policy.

⇒ 5. There exists a “natural rate” of unemployment in the long run.

⇒ 6. The new classical theory emphasizes the capability of a market economy to heal recessions by lowering wages and prices.

⇒ 7. According to new classical theories of the 1970s and 1980s, a decrease in the growth of the money supply, if perceived correctly, should have only small effects on real output.

⇒ 8. Harvard’s Robert Barro originated the idea of debt neutrality.

⇒ 9. Finally, the European depression of the 1980s was the vilest since the depression of the 1930s.

Read More in: Theory of Public Finance

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