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In analyzing the Classical-Keynesian debates,
let's begin with this key point.
This debate is primarily a dispute over how the macroeconomy
adjusts during a recession and finds its way back to full employment.
On the one hand, the classical economists believe that
a price adjustment mechanism would cure the economy.
Specifically, they believe that in the event of unemployment,
prices, wages and interest rates would all fall.
This would in turn increase consumption, production,
and investment and quickly return the economy back to its full employment equilibrium.
In contrast, the Keynesian school argued that
before the price adjustment mechanism had time to work,
it would be overpowered by a more deadly income adjustment mechanism.
To the Keynesians, when an economy sinks into a recession, people's incomes fall.
This fall in income causes them to both spend less and save less,
while businesses respond by investing and producing less.
This reduction in consumption, savings,
investment and output, in turn,
drives the economy deeper into recession rather than back to full employment.
You could see now why this debate is so important.
One school of economics, the classical approach,
believes that the best cure for a recession is to leave the free market alone.
This approach is also known as laissez faire.
And laissez faire economists are those who believe that
most government policies will probably make things worse not better.
So the best policy is relatively little government.
On the other hand,
the Keynesian school believes that in the absence of government intervention,
as income and savings and investment fall,
a recession may only get worse.
Keynesians, therefore,
prescribe large scale government expenditures to prime the economic pump.
And Keynesians are typically activists who believe the government can create and
implement fiscal and monetary policies that will positively affect the economy.
In fact, this debate is as important today as it was over 100 years ago.
And this is because many of the macroeconomic policies,
now favored by ideological conservatives,
have their roots in classical economics,
while those on the more liberal side of
the ideological spectrum are generally much more supportive of the Keynesian approach.
And how any nation's government moves forward
to address that nation's macroeconomic problems problems with
the light laissez faire hand or
a heavy interventionist hand will have a tremendous impact on the business environment.
So let's dig even deeper into this debate in our next module.
Dr. Peter NavarroProfessor
