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2. The theory: two opposed models
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All the macroeconomic relations have a quantitative dimension that must be closely followed and recorded in order to manage or intervene in them. The potential policy responses available represented by the myriad economic theories present discrepancies, as will be shown.
The neoclassical model
The neoclassical model assumes that, at a given moment, there is a productive capacity (which we will call total or aggregate supply) determined by the number of factories, machines, equipment, etc. (physical capital) and workers (human capital). Further, it assumes that prices are always flexible. This flexibility is what would allow supply and demand to always return the economy to equilibrium at full employment.
When there is an oversupply of a resource that results in its surplus, its price would drop (the wages would drop) and then its demand would increase, thus automatically correcting the existing unemployment.
The main idea of this so-called liberal model is that to achieve equilibrium with full employment it will be enough to make prices completely flexible and allow markets to function freely. Exogenous interventions of any kind would be useless to correct imbalances, since imbalances are supposed to resolve on their own as a function of the freedom of markets and flexibility of price.
According to this model, iInterventions will only lead to economic inefficiencies by causing either price increases (inflation) or displacement of individual spending. The latter might happen as rational private agents, who realize the State’s increasing deficit, foresee that taxes will be higher in the future and therefore would rather save than consume.
The Keynesian model
The starting hypotheses of the Keynesian model present a different vision of the operation of the economy and reach very different conclusions. The main difference is that for Keynes, prices are rather rigid, that is, that they would not respond to changes in demand. And he thought that this rigidity especially affected wages because workers are usually not willing to accept lower wages than they receive at any given time.
If we are standing on a level of production that does not have the capacity for full employment, it means that the demand of employment is lower than the supply. The capacity to achieve full employment could be propelled by increasing the aggregate demand which would result in the creation of more employment opportunities.
Therefore, according to this model, the State’s interventions aimed at increasing aggregate demand would be very useful and necessary in order to increase production when the economy is below full employment. Only when the economy has reached its full employment level could any further intervention increasing the demand cause an increase in prices.
