The Theory Of Government Spending And Fiscal Policy

The ISLM model uses many of the same ideas that Keynes did to show change in output in equilibrium. Using ISLM, both monetary and fiscal policy can be effective, depending on the slopes of both IS and LM curves. As the General Theory suggests, government spending and fiscal policy can be very effective when the IS schedule is steep and the LM curve is flat. When this happens, there is a low interest elasticity of investment, which leads to less crowding out because investment is not very sensitive to changes in interest rates. Monetarist school of thought preserves Keynes idea that there is a natural rate of unemployment in the long run. In the short run they both believe that unemployment rate can go below the natural rate.†¦show more content†¦Economist Hyman Minsky created the financial instability hypothesis in response to the efficient market hypothesis that Keynes created in the 1970s. Keynes develop developed a basic theory of investment, crediting investment with being the â€Å"driving variable that operates through a multiplier to establish total income† (Wray, 2015, p. 4) Minsky looks to Keynes investment theory of the business cycle and as an extension, adds his financial theory of investment that allowed him to analyze the capital economy that exists today. Minsky thought that investment finance plays a large role in the economy and that it cannot be overlooked. He believes that government intervention is absolutely essential, as can be seen throughout history. Before Big Gove rnment and Big Banks, recessions in the economy were severe, frequent, and lengthy. Upon their introduction recession have become milder and less frequent. Central banks act as a lender of last resort. Policies were introduced to act as stabilizers and kept the economy from ever getting back to the point where it was during the great depression. (Rezende, 2015) In his financial instability hypothesis, Minsky argues that when the economy appears to be stable, expectations go up and there is increased optimism, which eventually leads to instability. Essentially, stability in the economy leads to instability. This occurs because with this increase in optimism, people’s behaviors change and create financial bubbles, whichShow MoreRelatedInsight From Theory And History1638 Words   |  7 Pages1 Insights from Theory and History When referring to the subject of International Political Economy the main focus of study in this field looks at analyzing and finding reasons for the problems that arise or are affected from the interaction of international political decision, international economics, international trade, as well as different social systems and societal groups. 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