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IAI Actuarial Core Principles · Business Economics · Main economic schools and their key features

Which feature of classical economics is most relevant when a classical economist argues that a government should not try to stimulate a recessionary economy through additional spending?

A classical economist would argue that flexible wages, prices and interest rates push the economy back to full employment on their own, so stimulus is unnecessary and government borrowing may crowd out private investment. Sticky prices, animal spirits and multipliers are Keynesian arguments.

  1. AMarkets self-correct towards full employment, so intervention is unnecessary and may crowd out private activityCorrect
  2. BAggregate demand determines output in the short run and long run
  3. CWages and prices are sticky, making recessions prolonged
  4. DAnimal spirits drive investment and cause persistent slumps
  5. The multiplier is greater than one for every rupee spent

Explanation

Classical thought holds that flexible prices, wages and interest rates restore full employment, so discretionary policy is unneeded and extra government borrowing can crowd out private investment. Options B to E describe Keynesian ideas.

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