The modern world economy is characterized by political governance that is backed up by economic policies. Economic approach is aimed at achieving long run macroeconomic stability that is attaining a stable low unemployment rates…
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John Maynard Keynes set a good underpinning for government economic decision that has since then be improved by the post-Keynesian economists, through both support and critic of Keynes ideas. It’s on the basis of these foundations that the government sets policies aimed at attaining long run macro-economic policies. Keynesians approach towards stability In establishing a long term s macroeconomic stability, it deems necessary to first understand what causes instability in the economy. Both monetarist and Keynesian economist agree that the world at times suffers from macroeconomic instability as shown by great recessions and booms. However the two economic thoughts differ on the cause and thus advocate for different approaches towards stability. Keynes study was based on aggregate demand and argued that the changes in the components of demand altered the equilibrium (Beetsma 2004). To the Keynesian economists aggregate demand is identical to output levels that can be measured in terms of the Gross Domestic product (GDP). The components of demand are, consumption, investment, export surplus and government expenditure modeled as (GDP =C + I+ X + G= AD). Keynesian economics agreed that these demand components always fluctuate and thus the GDP can never be stable. This formed the main critic of self-adjusting mechanism as brought about the classical economists, with Keynesian economists arguing that investment was influenced by marginal efficiency of capital in addition to interest rates. Thus some savings are not invested as some individuals hoard cash balances if they speculate a rise in capital returns. Another cause of instability as observed by the Keynesian economists are fluctuations of the supply side, where output levels can be altered by artificial supply restrictions, wars, changes in cost of production all which reduce the output levels. All the alterations of the equilibrium call for correction measures, with which Keynesian economist suggest the opposite adjustment of either the government expenditure or consumption component. They thus advocate for discretionary fiscal policy where government expenditure is adjusted or alteration of taxes to reduce or increase overall consumption levels. The Keynesian economists argue that money velocity is unstable and unpredictable in nature and thus disregard monetary policies effectiveness in adjusting in equalizing aggregate demand changes. Moreover, due to frequently changing components of demand; Keynesian economists contempt annual budget adjustments and advocate for discretionary fiscal policies that instantly combat recessions and inflation despite causing surplus or deficit budget. In times of economic recession, when supply is more than demand hence causing reduction in commodity prices, demand has to be created. This is achieved by either reducing taxes or increasing government expenditure. Taxes are seen to reduce disposable income, readily available for consumption. A reduction in taxes increases disposable income and hence increases aggregate consumption. Government consumption on the other hand creates demand for the excess supply. In times of inflation the opposite is applied, that is increased taxes to reduce disposa
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