Describe how the neoclassical school of thought would respond to the following s
ID: 1127018 • Letter: D
Question
Describe how the neoclassical school of thought would respond to the following scenario:
The economy has experienced a sudden collapse of asset prices, with the stock, real estate, and commodity market experiencing declines of over 50 percent relative to last year. Data show a loss of nearly 1 million jobs since last month, which brings to year-to-date loss of jobs to nearly 5 million. And, bank lending has slowed sharply, and initial data on investment suggests a sharp decline in new projects. The central bank reports that that bank balance sheets have deteriorated significantly, and it is contemplating emergency monetary actions. The country's Prime Minister claims to be "on top of the situation," but polls suggest her popularity is falling fast as confidence in the government's economic leadership diminishes. This appears to be the start of a serious recession, with the rate of decline in production rivaling the rapid declines in 2008 and 2009.
Describe clearly, or use diagrams, or other specified models to describe how they would handle the situation.
Explanation / Answer
Neo Classical school of thought believe in automatic adjustment of the economy. They will not advice the government to follow expansionary fiscal or monetary policy. They believe that economy always remain at full employment level as wages and prices in the economy are flexible. Thus, the economy will self adjust as decline in prices will increase the real wages of workers which will lead to increase in real income of the workers which increases consumption of workers and thus demand increases which in turn increases national output of the economy and the economy will return to its potential level. Thus, neo classical believe in self adjustment of the economy and no government intervention.