Classical Macroeconomic Theory

Why did Classical economists expect some business leaders to invest even during the worst recession or depression?

Because they thought that most business leaders were very entrepreneurial and could see beyond the recession

To Classical economists, which type of fiscal policy financing produces "crowding out?"

Borrowing

According to Classical economists, were flexible wages good or bad for the economy? Why?

Good because flexible prices were better than reducing employment during a recession

Arthur Laffer (i.e., of the Laffer Curve) argued that a tax cut in the early 1980s would cause the amount of tax revenue collected by the government

Increase

People often wonder what will happen to the economy if consumers reduce their spending. Will we go into a recession as a result? Classical economists argued that the decrease in consumer spending would amount to a(n) __________ in consumer savings. This would reduce real interest rates and thereby cause _____________________ to increase to make up for the reduced consumers spending.

Increase; Investment

How does crowding out affect real interest rates?

It increases real interest rate

In the early 1800's economists were at odds (they disagreed) over whether a recession was likely to turn into a permanent depression. The most notable economists on the pro-side (that is, we go into a recession and never come out) was ______________ On the other side was ____________________________________

Jean Baptise Say; Malthus

Classical economists looked at the nature of the business cycle, the self-correcting mechanisms in the economy, and the effectiveness (or ineffectiveness) of fiscal and monetary policies and concluded the best economic policy for government to pursue was ________________. This economic policy fit in well with their political beliefs that good government should be __________ government.

Laissez-faire; small

According to Classical economists, which type of fiscal policy financing produces inflation?

Monetizing debt

If the money supply increases and there is no money illusion, what will happen to nominal interest rates?

Nominal interest rates increase

Based on Say's Law, Classical economists argued that a recession would not turn into a permanent depression as long as

People continued to have an interest in working

If the nominal interest rate is 8% and inflation is running at 6%, what is the real interest rate?

Real = nominal - inflation = 8% - 6% = 2%

If the money supply increases and there is no money illusion, what will happen to real wages?

Real wages will decrease

How is Say's Law usually presented as a 'one-liner?'

Supply creates its own demand

Which major macroeconomic event did the Laffer Curve have an impact on?

The Reagan tax cut

Arthur Laffer (i.e., of the Laffer Curve) sought to show a connection between the tax rate and

The amount of tax revenue collected

What did Classical economists have to say about how common money illusion was among the general public?

They say that money illusion is widespread, but people learn quickly

What was the point in Classical economists constantly reminding everyone that the business cycle was indeed a true cycle?

They wanted to make sure that people understood that the recession would correct itself even if government did nothing to correct it

Identify the three different basic ways that an "expansionary fiscal policy" might be financed.

a. Taxes and the dangers of incentives b. True borrowing and crowding out c. Monetizing debt and inflation

According to Classical economists, can any expansionary fiscal policies permanently increase the level of real GDP?

a. The level of real GDP: no b. The level of employment: yes

What effect will crowding out have on the economy (i.e., real GDP)?

it will have no or little effect on real GDP