Chapter 10: Problem 17

According to Keynes, can the private sector always remove the economy from a recessionary gap? Explain your answer.

Short Answer

Expert verified

No, according to Keynes, the private sector cannot always remove the economy from a recessionary gap. In times of recession, the private sector often reduces spending, which may not be enough to maintain full employment. Therefore, Keynes argued for government intervention to stimulate demand and pull the economy out of the recessionary gap.

Step by step solution

Understanding Keynesian Economics

Keynesian economics is a theory that says the government should increase demand to boost growth. Keynesians believe consumer demand is the primary driving force in an economy, and as such, advocates for active policy responses from the public sector, and monetary policy actions by the central bank, to stabilize output over the business cycle.

Exploring Recessionary Gap

A recessionary gap, or contractionary gap, occurs when a country's real GDP is lower than its GDP at full employment. The gap is the amount by which the actual output in an economy falls short of its potential output. It is an economic situation characterized by slack economic activity, high unemployment, and lower-than-potential output.

Keynes' View on Private Sector's Capability

According to Keynes, in times of recession, the private sector often fails to produce enough demand to maintain the level of full employment. He argued that during recessions, the private sector could become too fearful or cautious, leading to reduced spending and investment. Without sufficient demand, firms lay off workers which reduces consumers' disposable income and further reduces demand. This vicious cycle of reducing demand can lead to recession or depression.

Role of Government According to Keynes

In such scenarios, Keynes believed the government can step in by increasing public spending or decreasing taxes to stimulate demand. This could, in turn, pull the economy out of the recessionary gap by encouraging increased consumer spending and business investment. Thus, in Keynes' point of view, merely relying on the private sector may not be always sufficient to remove the economy from a recessionary gap. The state's intervention is crucial to ensure economic stability.

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