The Keynesian ideas were developed in 1930s at the time of Great Depression when orthodox economists had failed to explain the rising effects of unemployment and downturn of the economy. Earlier economists had argued that economy should be left to operate on itself without any external interventions from the government. Keynesian advocates for government interventions. In the case of unemployment, he suggests that the government should intervene by increasing its spending and decreasing level of taxation, which are fiscal policy tools. Through these interventions, there will be increase in aggregate demand and output which, in the long run reinstate the economy to full employment.
Another suggestion by the Keynes could be use of monetary policy which can be effectively carried out by the Central Bank of the country. The Central Bank has the mandate to manage the currency of the state, control supply of money as well as the prevailing interest rates in the market. Unemployment occurs when there is low supply of money in the economy. To induce money supply, using monetary policy, the central bank will have to purchase bonds and treasury bills from the public through using such tools as open market operations according to Keynesian suggestions. This causes increased money supply and in the long run will cause rise in aggregate demand through increased investment expenditures. This encourages production as well as rising interest rates that will work to restore equilibrium full employment in the economy.
Furthermore the Central bank can affect the market conduct by lowering levels of interest rates that commercial banks use to lend money. Low interest rates drives up desire to borrow more and encourage the public to secure loans at low interests. The money acquired will be used to increase consumption and facilitate aggregate demand for investment goods and services as well. Therefore through multiplier process the economy equilibrium employment will be restored to normal level.
On the issue of unemployment in the economy, classical economists will argue that the economy is always self-regulating. It is capable to regain to its natural level of real output as long as all the resources in economy are fully employed. Cyclical movements realized in the economy are corrected through the mechanisms of self-adjustment. Say’s law for instances states postulates that the economy is capable of generating enough income to meet the level of real output it has generated. Unemployment comes as a result of recessions where there is excess workforce than what is demanded in the market and can be corrected through flexible adjustments that take place in the labor market. The labor market is assumed to be equilibrium always. In the case of excess labor force, classical argue that wages paid to will be reduced in order to accommodate the existing workforce. The unemployed workforce only exists voluntarily, simply because they cannot accept the wage rate being offered on the market.
Sowell, Thomas. On classical economics. New Haven Conn: Yale University Press, 2006. Print.
Brien, D. The classical economists revisited. Princeton, NJ: Princeton University Press, 2004. Print.
The argument is posed by the Classical school. The main advocates include Milton Friedman, John Stuatmill, etc. They argue that so long as the economy is at full employment there should always be minimal government intervention. Milton Friedman cites an example of the Great Contraction, which he argues was caused by financial shocks. Its existence and duration prevailed due to misleading policies that aimed at contraction of money supply by the Fed. The economists also argue against intervention of the government in the currency markets.
Supply of money always automatically adjusts itself but banks should participate in the money market just to control the terms for instance interest rates over which loans are made. The economists argue that inflation occurs because banks allow excessive supply of money in the market.
Mankiw, N. Principles of macroeconomics. Mason, OH: South-Western Cengage Learning, 2009. Print.
The testing policy requires all manufacturing companies of food and drugs products to employ appropriate methods for testing and substantiating the safety of their products. This includes both the content and the final products. This policy is cost pushing, because the companies will have to incur more costs on labor and raw materials for testing. The costs are transferred to consumers in form of high prices thus facilitating cost push kind of inflation on the market. Regulating hot dog content regulation is also in the same case of contributing to inflation as it involves additional costs to manufacturer that are carried along the product chain to customers in price form.
Coleman, William. The causes, costs and compensations of inflation an investigation of three problems in monetary theory. Cheltenham, UK Northampton, MA: Edward Elgar Pub, 2007. Print.
The U.S current state of economy is in downturns or recessionary periods in which it is characterized by rising levels of unemployment and bankruptcy as shown by large borrowing from upcoming economies, such as China through treasury bills. There is fall in GDP, business profits, household income, investment spending as well as inflation etc.
Economic News Release. Employment Situation,2013.http://www.bls.gov/news.release/empsit.toc.htm,23rd Feb.2013.
The possible application policies can be explained in the following:
Monetary policies (advocated by the Classical Theorists)
The policy carried out in this case will be expansionary, whereby the Federal Reserve Bank can carry out three approaches to recover U.S economy. The first approach will be adjusting its Fed reserve rates it has imposed on commercial banks. This will enable the commercial banks that have excess reserve to lend more to the public. Increasing the circulation of money in the public will stimulate demand and thus aggregating the economy to full employment.
The other action can be conducting open market operation which will involve purchasing of treasury notes or other bonds from its member bank. This will increase money supply in these banks to have enough to lend to the public.
The third approach can be lowering discount rates charged to commercial banks borrowing. This will lead to reduced interest rates thus encourage public borrowing hence creating demand in the economy.
Expansionary Fiscal Policy (Keynesian theorists)
The policy is carried out by executive bodies and the man tools include government expenditures and taxes. The U.S government can increase its expenditures through facilitating government projects such as construction, purchase of public goods in order to increase money supply in economy. This will encourage increase in aggregate demand, and thus bring the economy to full employment. In addition, it should lower rate of taxation to retain money circulation to the public.
Tucker, Irvin. Macroeconomics for today. Mason, OH: South-Western Cengage Learning, 2011. Print.
Sardoni, Claudio. Unemployment, recession and effective demand the contributions of Marx, Keynes and Kalecki. Cheltenham England: Edward Elgar, 2011. Print.