Keynesian and Classical Models of Unemployment - Assignment Example

On the other hand, Keynesian economists view the labor market in the short-run assuming fluctuations in the economy; the Keynesian aggregate supply curve is horizontal where wages are "sticky" and not everyone in the labor force finds jobs. Thus, Keynesian unemployment is demand-driven and caused by variables exogenous to the labor market, such as economic recessions and decreases in output that alters aggregate demand causing disequilibrium. Keynesian economists who give importance to exogenous demand-driven causes of unemployment will, therefore, prescribe expansionary fiscal policies to stimulate aggregate demand such as increasing government expenditures and inducing consumption to restore equilibrium and lower short-run unemployment.

Supply-siders focus on managing aggregate supply to stabilize short-run fluctuations and increase output in the long-run. They begin with the implications that without structural policies to shift the aggregate supply curve outward, fiscal policies focusing on demand-effects cannot increase aggregate output in the long-run because of crowding-out effects; while at the same time causing inflation because despite the shift in the aggregate demand curve, the crowding-effect causes excess demand, thereby increasing prices.

However, since structural policies are difficult to implement, supply-siders emphasize the supply-side effects of fiscal policies assuming that aside from demand-effects, fiscal policies have strong supply-side effects, which can shift both the short-run and long-run aggregate supply curves to the right, offsetting inflationary pressures while increasing aggregate output. Hence, supply-siders would advocate fiscal policies that reduce taxes affecting the labor force, such as an income tax cut because of its ability to stimulate aggregate supply by providing laborers greater incentives to work thereby increasing overall productivity.

Furthermore, the shift in aggregate supply offsets inflationary pressures in the long-run, such that if the supply curve shifts far enough, the aggregate output can increase without increasing prices.Question 3:In reaction to Keynesian prescriptions that governments must take an active policy role in stabilizing the economy, Monetarists take a more passive stance regarding economic policy, advising that the Fed must simply allow money supply to grow at a constant rate, and make adjustments only if the rate which the full employment economy grows deviate from nominal targets.

Hence, Monetarists prefer rules-based policy regimes as opposed to discretionary ones, where the margin for error is larger. The rationale for Monetarist prescriptions lies in the assumption that the economy is inherently stable, wherein disruptions within the economy are caused by wrong economic policies. Monetarists argue that the economy is better-off if policymakers, with their limited abilities, refrain from fine-tuning the economy. They emphasize the time lags present in implementing economic policy.