Keynesian Vs. Classical Economics
Keynesian – John Maynard Keynes
1. Economy will not self correct (during a
recession
A. People will save too much – paradox
of thrift.
B. Sticky Prices and Wages.
C. People are motivated by “animal
spirits”.
2. We need to stimulate the economy
A. Expansionary monetary policy does
not always work (liquidity trap).
B. We need expansionary fiscal policy
during recessions (purposely run a
budget deficit: lower taxes and higher
government spending).
C. This additional spending creates a
multiplier effect.
Classical – F.A. Hayek
1. Economy will correct itself (during a
recession)
A. When people save more → interest
rates decrease → people have the
incentive to save less and buy and
invest more.
B. Prices and wages will decrease →
causes people to buy more and
businesses to expand production.
C. People are motivated by economic
calculation.
2. It is not necessary to stimulate the
economy since it self-corrects
A. The liquidity trap is an unlikely
scenario since people respond to
changes in prices and interest rates.
B. Political incentives make it difficult
to run deficits only during recessions.
Government will continuously run
budget deficits.
C. The multiplier effect does not occur
when production is redistributed, only
when it is created.
3. For Keynesian economics to work, it
must be timed correctly. However, it is
subject to timing problems:
A. Recognition lag
B. Administrative lag
C. Impact lag