Question

Most observers recognize that the financial crisis began when the collapse in housing prices led to a series of defaults on mortgage-backed securities. The earliest signs appeared in 2004/2005, and the crisis continued through 2012. The Financial Crisis caused a drop in housing prices and negatively shocked AD resulting in unemployment. During the same period, Congress recognized that economic growth had stalled, and looked to take action. This culminated in the Economic Stimulus Package of 2008. This congressional action is an example of the Keynesian Perspective.

Answer the following based upon your own opinions:

What are some benefits of the Keynesian Perspective?

What are some of the drawbacks of the Keynesian Perspective?

Answer 1

First let us describes the Economic Stimulus Package of 2008 which came through American Recovery and Reinvestment Act (ARRA). The package was aimed to overcome the recession within a certain period. Major components under the packages included:

1. Reduction in Tax
2. Increase spending in unemployment benefits
3. Created new jobs in federal contract, grants and loan

During the recession, demand was low compared to the supply in the economy due to low purchasing power of the citizen.

Keynesian economics says about increase in aggregate demand to fight against the economic recession.

Keynes’s economic model is known as IS-LM model. They are two curves, look like as follows:

Y, Y₂

Benefits:

As the spending (government + individual) increases, aggregate demand increases and economy would be in revival path. Higher multiplication effect of government and personal spending have higher effect on aggregate demand.

Decrease in tax also induce to spend more by increasing disposable income.

Again with excess supply, Price falls, this means real money supply (M/p) in the market increases à fall in rate of interest (r) à increase in investment à increase in aggregate demand

Drawbacks:

Keynesian economics encourages government spending or tax cut which encourages government to borrow more.

Shift of IS curve along with LM curve increase rate of interest (r) which partially offset the expansionary effect

Again with excess supply, Price falls, this means real money supply (M/p) in the market increases à leading to inflation