Which of the following Statements Would a Keynesian Economist Most Likely Agree with
First of all, I didn`t say anything about the school of rational expectations. Like Keynes himself, many Keynesians doubt this school`s view that people use all available information to formulate their expectations for economic policy. Other Keynesians accept this view. But when it comes to the big issues I`ve dealt with, it doesn`t depend on whether expectations are rational or not. Rational expectations, for example, do not exclude rigid prices; Rational waiting models with sticky prices are, by my definition, End-to-End Keynesian. However, I should note that some new classics consider that rational expectations are much more fundamental in the debate. 5. Many, but not all, Keynesians advocate activist stabilization policies to reduce the amplitude of the business cycle, which they see as one of the most important economic problems. Here, however, even some conservative Keynesians are parting ways, doubting either the effectiveness of the stabilization policy or the wisdom of the attempt. An offshoot of the new classical theory formulated by Harvard`s Robert Barro is the idea of debt neutrality (see national debt and deficits). Barro argues that inflation, unemployment, real GNP and real national savings should not be affected by the fact that the government finances its spending with high taxes and low deficits, or with low taxes and high deficits. Because people are rational, he argues, they will rightly realize that low taxes and high deficits today must mean higher future taxes for them and their heirs.
They will reduce consumption and increase their savings by a dollar, Barro said, if every dollar increases future tax obligations. Thus, an increase in private saving should compensate for any increase in the public deficit. In contrast, naïve Keynesian analysis sees an increased deficit with public spending kept constant as an increase in aggregate demand. If, as in the United States in the early 1980s, the stimulation of demand is cancelled out by a contractionary monetary policy, real interest rates are likely to rise sharply. From a Keynesian perspective, there is no reason to expect an increase in the private savings rate. 3. Keynesians believe that prices, and wages in particular, are slow to respond to changes in supply and demand, leading to periodic shortages and surpluses, especially of labor. Even Milton Friedman acknowledged that “among every institutional arrangement imaginable, and certainly among those now prevalent in the United States, there is only a limited degree of flexibility in prices and wages.” 1 In everyday language, this would certainly be called a Keynesian position. The second omission is the assumption that there is a “natural rate” of long-term unemployment. Before 1970, Keynesians believed that long-term unemployment levels depended on government policies and that the government could achieve low unemployment by accepting a high but stable inflation rate.
In the late 1960s, Milton Friedman, a monetarist, and Edmund Phelps of Columbia, a Keynesian, rejected the idea of such a long-term compromise for theoretical reasons. They argued that the only way to keep unemployment below what they called the “natural rate” was through macroeconomic policies that would continually drive inflation up and down. In the long run, they argued, the unemployment rate could not be lower than the natural rate. Soon after, Keynesians such as Robert Gordon of Northwestern presented empirical evidence from the perspective of Friedman and Phelps. Since about 1972, Keynesians have incorporated the “natural rate” of unemployment into their thinking. Thus, the natural rate hypothesis played virtually no role in the intellectual fermentation of the period from 1975 to 1985. According to early classical theorists of the 1970s and 1980s, a properly perceived decline in money supply growth is expected to have little, if any, impact on real output. But when the Federal Reserve and the Bank of England announced that monetary policy would be tightened to fight inflation and that they would keep their promises, severe recessions followed in all countries. The new classics might claim that the tightening was unexpected (because people didn`t believe what the monetary authorities said). Maybe it was in part. But it is certain that the approximate contours of the restrictive policy were anticipated, or at least correctly perceived, as they unfolded.
The old-fashioned Keynesian theory, which asserts that any monetary constraint is contractionary because firms and individuals are tied to fixed-price contracts, not inflation-adjusted contracts, seems more compatible with real events. Monetary policy can only have a real impact on output and employment if certain prices are rigid – for example, if nominal wages (wages in dollars, not in real purchasing power) do not adjust immediately. Otherwise, an injection of fresh money would change all prices by the same percentage. .