Question

• Describe the Neoclassical model of aggregate demand and aggregate supply.
• Describe the policy implications of the Neoclassical perspective.
• Describe the interrelationship between the Neoclassical and Keynesian economic models.

In 2009, American Recovery and Reinvestment Act provided for roughly $800 billion in government spending (most of it) and tax cuts (less) to jumpstart the economy. Do you think this was the correct approach? Cite three reasons why or why not. Would your opinion change if you were in the auto industry at the time?

Answer 1

Neoclassical Model of Aggregate demand and Aggregate Supply

With a vertical AS curve, shifts in aggregate demand do not alter the level of output but do lead to changes in the price level. Because output is unchanged between the equilibrium E0, E1, E2, all unemployment in this economy will be due to the natural rate of unemployment

ASn AD AD 135 130 125 120 15 110 105 100 95 AD P. Eo Po E2 0 100 200 300 400 500 600 700 800 Real GDP (a) The long-run AS curve

If the natural rate of unemployment is 5%, then the Phillips curve will be vertical. That is, regardless of changes in the price level, the unemployment rate. In Neoclassical economics there is no long term trade off between unemployment and inflation

8 7 6 5 4 2 0 Unemployment Rate (b) The vertical Phillips curve

Policy Implications of the neoclassical perspective :

As Neoclassical believes that economy is self correcting and there is no need of Government intervention. Government “fine tuning” of the economy either through fiscal or monetary policy is unwise and ineffective. But the perspective of Neoclassical have some implications in their Policy. As follows :

Recognition lag: the time it takes to determine that a recession has occurred

Legislative lag: the time to get a bill passed

Implementation lag: The time to get the projects started

Impact lag: the delay between the time a policy is enacted and the time that policy has its impact on the economy

Interrelationship between Neoclassical and Keynesian Economic Models.

The Keynesian view consider that changes related to Aggregate Demand because of business cycle fluctuations. The Keynesian are not very convinced with the self correcting economy can easily return to full employment and believe in to advocate policy makers actively attempt to reverse recessionary and inflationary periods. The neoclassical perspective places more emphasis on aggregate supply. The level of potential GDP is determined by long term productivity growth and that the economy typically will return to full employment after a change in aggregate demand. Skeptical of the effectiveness and timeliness of Keynesian policy, neoclassical economists are more likely to advocate a hands-off, or fairly limited, role for active stabilization policy. While Keynesian would tend to advocate an acceptable trade off between inflation and unemployment when counteracting a recession, neoclassical economists argue that no such trade off exists; any short-term gains in lower unemployment will eventually vanish and the result of active policy will only be inflation

ARRA 2009

ARRA had three spending categories. It cut taxes by $288 billion. It spent $224 billion in extended unemployment benefits, education, and health care. It created jobs by allocating $275 billion in federal contracts, grants, and loans. Congress designed the Act to spend $720 billion, or 91.5 percent, in its first three fiscal years. It allocated $185 billion in FY 2009, $400 billion in FY 2010 and $135 billion in FY 2011.

The Obama administration did better than planned. By the end of FY 2009, it spent $179 billion according to a 2015 report by the Congressional Budget Office. Of that, $68 billion went toward tax relief and credits. Another was spent on $34 billion in health services and $21 billion on education. It also spent $28 billion in unemployment compensation and $13 billion in extra Social Security and veterans' checks.

The ARRA succeeded in improving the GDP, as it was projected 1.4% to 3.8%. Actually it worked better and stimulated the growth rate to 4.4%

The Stimulus for Small Business helped create jobs, increased lending from the Small Business Administration and community banks, and reduced capital gains taxes for small business investors.

The public works construction was probably the most well-publicized. Signs were posted wherever stimulus money was used to construct roads or public buildings. It was estimated to retain or add 3 million jobs, many of which were sorely needed in the construction industry.