Controlling macroeconomic issues;
THE FOLLOWING NOTES ARE THE BASIC CONCEPTS IN THE MAINSTREAM (CAPITALISTIC, NEO-CLASSICAL) ECONOMICS.
- Economy is controlled by 2 policies
- Fiscal (by Government):Taxes and Expenditures
- Monetary (by Central Bank): Money supply and Interest rate
- Government spending and Taxes are the main weapon to control the level of economic activities (by Keynesian school)
- To increase the level of economic activity
- Increase Government expenditure
- Decrease taxes
- In the equilibrium
- Government Expenditure + Investment Expenditure = Taxes + Savings
- Any variation of this will cause inflation or unemployment.
Trade-off in Keynesian Model
- There is a trade-off between unemployment and inflation.
- Stagflation: In late 60s an 70s, US experienced high inflation and high unemployment due to the high government expenditure, oil shock, and heavy international competition.
- Keynesian model can only solve half of the problem (inflation or unemployment, not both)
- Fixes: Monetarists suggests that the severe short-term recession with the high interest rates can fix the stagflation,
- Investment behavior depends on interest rates.
- Higher interest rates discourage investment
- Low interest rates encourage investment
- The central back (such as Federal Reserves in US) can influence investment by changing interest rates