Describe how the capitalist school of thought would respond to the following sce
ID: 1127024 • Letter: D
Question
Describe how the capitalist 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
In order to overcome this situation, the capitalist school of thought would persuade the government to increase the level of money supplied in the economy. The increase in the amount of money supply in the economy will reduce the level of interest rates in the economy which is also the cost of investment. Reduction in the cost of investment will increase the level of investment in the economy. Since the popularity of the government is falling, expansionary fiscal policy in the form of increasing government expenditure and reducing tax rate is needed to increase aggregate demand and also increase government popularity.
Thus, the current situation involves use of both expansionary monetary and expansionary fiscal policy to increase overall aggregate demand of the economy.