Answer to Question #197275 in Macroeconomics for sahil kumar

Question

from lucas point of view, what are the limitation of the Keynesian model? What improvement does he suggest?

Answer 1

Notable limitations of the Keynesian model is that public investments can be &rd-quo;crowded-out & rd-quo; by fiscal policy. Considering the case of an exogenous decrease in aggregate demand Keynesian economic model advocates using government spending to return production to trend levels. It can increase the interest rate through an increased demand for real balances. With increased output/income levels, demand for money and goods increases. The higher interest rate decreases business investment due to increased costs for borrowing, and a higher opportunity cost in using money. The end result is that government expenditure can return output to trend levels, but at the cost of private investment.