Classical vs Keynesian Perspectives on Equilibrium Can the economy get stuck Keynesian view Yes Unemployment equilibrium the economy has reached a point of macroeconomic equilibrium somewhere below full potential output which results in sustained unemployment Ping pong ball down carpet stairs the ping pong ball needs help The economy has lots of equilibrium points with high unemployment there will always be structural and frictional unemployment Classical View No Faith in the invisible hand Be patient Laisse Faire Market will fix itself Moving a ball in a pool will eventually end up in the same spot Determinants of Planned Investment income interest rates expectations Planned investments amount businesses plan to spend no matter what Interest rates when interest rates go up planned investments go down When interest rates go down planned investments go up Future expectations If a business believes that demand will increase they will invest in more inventory Paradox of thrift The paradox states that an increase in autonomous saving leads to a decrease in aggregate demand and thus a decrease in gross output which will in turn lower total saving Classical Theory of Deficits and critique Government borrowing comes at the expense of private borrowing Could increase inflation if more money is printed to finance debt Deficits require borrowing by selling bonds If federal reserve prints money to buy wtreasury bonds this is called monetizing the deficit Risk of Crowding out Gov t borrowing increases the total amount of borrowing which increases the interest rate and decreases planned investment Is crowding out an issue Keynesians emphasize business expectations in the determination of planned investment more than interest rates Gov t should borrow and spend to create jobs and jump start the economy Exploding debt and historically low interest rates Debt Deficits Contexts US tax payers are responsible for debt banks will be looking at the GDP as security on how we are going to pay the debt back Social security holds alot of this debt We are 28 trillion in debt 22 is publicly held and the rest is held outside the US US corporations that are situated outside of the US hold a significant amount of debt We are doing better than other countries in terms of debt Debt as a percentage of GDP is small How does History support the argument that debt isn t bad Higher debt after WW2 and then a boom came with prosperity