Question 1 A.During our last recession, many employers opted to freeze wages, lo

Question

Question 1

A.During our last recession, many employers opted to freeze wages, lower wages, and decrease their current labor force; therefore, does this align with Keynesian Theory? Is Keynesian Theory only applicable in the short-run as opposed to the long run? Please explain.

B.In 2013-2014, the nation was struggling with a persistent high level of unemployment, low rates of economic growth, and high federal budget deficits. Explain how solutions to these economic problems conflict with one another. If you were economic dictator, how would you proceed against this set of problems?

Explanation / Answer

A)

In recession, in accordance with the Keynesian theory, firms face deficient demand and so they lay of workers. During the transition process from the beginning to the end of the recession employers are still in the process of laying off workers. Their anticipation of continuance of recession forces them to focus on cost cutting. So they continue to fire workers which tends to raise the unemployment rate.

They stop doing so when recession ends. And with it, their anxiety about future ends as well. Thus the unemployment rate reach its peak usually after the recession

Keynesian himself suggested that in the long run we all are dead which implies long run is a time period that arrives after a long duration so his theories are more suitable in the short-run.

B)

The recession of 2008-09 was shock to the economy that resulted from sub-prime crises. The government enacted the American Recovery and Reinvestment Act as an immediate economic stimulus package worth $787 billion (in total $830 billion) on February 2009. The purpose was to end the 2008 recession quickly by stimulating consumer spending and creating or saving around 2 million jobs. It instilled the confidence in the economic agents that was needed to boost economic growth.

However, stimulus failed in its very aim of saving jobs and increasing consumption spending. The failure of the stimulus was a blow to the theory that economies can be brought into action by an injection of government spending. People realized that every dollar injected by the government through spending would eventually be taken out in the form of taxes.

There was the same dilemma in fiscal policy operation in 2013-14. If goverment reduces its spending to reduce budget deficit, it will depress aggregate demand AD so that the growth rate will fall further and unemployment will rise beyond 10%. If it goes with fiscal expansion, there will be mounting fiscal deficits with already a 110% debt -GDP ratio which cannot be reduced except by seigniorage.

Excessive budget deficit implies huge government spending and an extremely lower level of revenue. Countries that run excessive budget deficits often have high debt-GDP ratio which is why they need discipline in their fiscal policies

An expansionary fiscal policy leaves a definite and effective crowding out in short run thereby reducing private investment. More than that, increased government spending must be financed through. If it is met with heavy public debt, then this increased spending will leave another detrimental effect apart from crowding out.

An economy with high debt-GDP ratio is unlikely to run long. Higher debt-GDP ratio reduces its credibility and global reputation. It raises questions on its ability to repay its debt in future.

It may even happen that the economy is likely to borrow further to pay interest on its previously acquired debts. Using another method, government with high debt-GDP ratio can raise funds by raising taxes or reducing its spending which ultimately leaves heavy burden on the general public. It has thus been rightly said that heavy public debt can bring on insolvency.

Recommended policy is yet, a fiscal expansion but with budgetary discipline. Budgetary policies will initiate fiscal discipline, set limit for the budget or fiscal deficit, impose restrictions on debt acquisitions and prohibit monetization of budget deficit. In this way budgetary policies will not allow the government to run excessive budget deficit in any circumstances

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