Economists tend to fall into two distinct camps where government intervention in the economy is concerned. "Keynesian" economists favor active policymaking based on the Phillips Curve and NAIRU theories. These theories purport a possible trade-off between unemployment and inflation and suggest that appropriate policy can be enacted to guide us back to a soft landing when business cycles create havoc within the economy. Economists who align more with the "Classical" school would have a "leave it alone" (Laissez Faire) attitude and would oppose active policymaking. "Rational Expectations Theory" (a "new classical approach") suggests that people figure out what will happen based on past policy changes, therefore rendering active intervention ineffective. Which theory is better? Why?

Expert Answers

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It is important to note that there is no correct answer to this question.  The answer is solely a matter of opinion.  We can never prove which macroeconomic theory is more accurate.

We cannot prove which theory is more accurate because there are too many variables that act upon the economy at any given time.  We cannot hold those variables constant and experiment with different economic policies.  For example, we cannot say “okay, quantitative easing has not really helped the economy.  Now let’s try to end quantitative easing.  That will tell us which policy is better.”  We cannot do this because so many things are different now than they were when the Fed first started quantitative easing.  Among other things, the economic situation in Europe is much different than it was before.  If we put an end to quantitative easing and the economy improves, we will not know if it was the policy change that mattered or if it was something else.

We also cannot prove which theory is better because we cannot run experiments.  Back in 2008, the US government declined to rescue Lehman Brothers.  It failed and the economy crashed.  We cannot go back to 2008 (or recreate that situation) and see what would have happened if we had bailed out Lehman Brothers.  In short, we simply cannot know which theory is better.

My own view is that government intervention is a good idea.  However, that is mainly a statement of faith, not a statement that can be backed up by hard data. 

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