|Table 1. Comparing the Keynesian and Neoclassical Models|
|Focus||Focus on the short run||Focus on the long run|
|What determines GDP?||Aggregate demand (AD)||Aggregate supply (AS)|
|Is aggregate demand stable?||Keynesians believe that AD is unstable (private sector spending varies a lot); thus fiscal and monetary policy are necessary to offset the resulting business cycles.||Neoclassicals believe that AD is relatively stable.|
|How responsive are wages and prices to changes in demand?||Keynesians believe wages and prices adjust slowly in response to changes in demand.||Neoclassicals believe wages & prices adjust quickly in response to changes in demand.|
|Intervening in the economy||Keynesians encourage stimulating the economy during recessionary times and slowing the economy down during booms, using a combination of fiscal and monetary policy.||Neoclassicals advocate a hands-off, or fairly limited, role for active stabilization policy.|
|Policy implications in the short run||Keynesians believe fiscal and monetary policy should be used actively in the short run to manage aggregate demand.||Neoclassicals believe that the economy is self-correcting, and fine-tuning the economy through monetary and fiscal policies in the short run makes problems worse and not better.|
|Policy implications in the long run
||Keynesians believe fiscal and monetary policy in the long run should be devoted to increasing potential GDP. Tax cuts on business investment can help, as well as investing into public infrastructure.||Neoclassicals believe fiscal policy (primarily in the form of tax cuts) should be devoted to increasing physical and human capital (i.e. AS).|
At short time scales, I think, something sort of ‘Keynesian’ is a good approximation, and surely better than anything straight ‘neoclassical.’ At very long time scales, the interesting questions are best studied in a neoclassical framework, and attention to the Keynesian side of things would be a minor distraction. At the five-to-ten-year time scale, we have to piece things together as best we can, and look for a hybrid model that will do the job.
The Great Recession ended in June 2009 after 18 months, according to the National Bureau of Economic Research (NBER). The NBER examines a variety of measures of economic activity to gauge the economy's overall health. These measures include real income, wholesale and retail sales, employment, and industrial production. In the years since the official end of this historic economic downturn, it has become clear that the Great Recession was two-pronged, hitting the U.S. economy with the collapse of the housing market and the failure of the financial system's credit institutions, further contaminating global economies. While the stock market rapidly lost trillions of dollars of value, consumer spending dried up, and companies began cutting jobs, economic policymakers were struggling with how to best combat and prevent a national, and even global economic collapse. The Congress passed the American Recovery and Reinvestment Act in early 2009 which provided some $800 billion worth of fiscal stimulus through tax cuts and government spending increases.Were the policies implemented to stabilize the economy and financial markets during the Great Recession effective? Many economists from both the Keynesian and neoclassical schools have found that they were, although to varying degrees. Alan Blinder of Princeton University and Mark Zandi for Moody’s Analytics found that, without fiscal policy, GDP decline would have been significantly more than its 3.3% in 2008 followed by its 0.1% decline in 2009. They also estimated that there would have been 8.5 million more job losses had the government not intervened in the market with the TARP to support the financial industry and key automakers General Motors and Chrysler. Federal Reserve Bank economists Carlos Carvalho, Stefano Eusip, and Christian Grisse found in their study, Policy Initiatives in the Global Recession: What Did Forecasters Expect? that once policies were implemented, forecasters adapted their expectations to these policies. They were more likely to anticipate increases in investment due to lower interest rates brought on by monetary policy and increased economic growth resulting from fiscal policy.