2. In 2008, problems in the financial sector led to a drying up of credit around the country: home-buyers were unable to get mortgages, students were unable to get student loans, car-buyers were unable to get car loans, and so on.
Explain how the drying up of credit can lead to compounding effects throughout the economy and result in an economic slump.
When people can’t get credit to finance their purchases, they will be unable to spend money. This will weaken the economy, and as others see the economy weaken, they will also cut back on their spending in order to save for future bad times. As a result, the credit shortfall will spark a compounding effect through the economy as people cut back their spending, making the economy worse, leading to more cutbacks in spending, and so on.
If you believe the economy is self-regulating, what would you advocate that policy makers do?
If you believe the economy is self-regulating, then you would advocate doing nothing in response to the slump.
If you believe in Keynesian economics, what would you advocate that policy makers do?
If you believe in Keynesian economics, you would advocate that policy makers undertake monetary and fiscal policies to stimulate spending in the economy.
Solutions appear at back of book.