The Great Depression

Transcription

1 I HAVE called this book the General Theory of Employment, Interest and Money, placing the emphasis on the prefix general. The object of such a title is to contrast the character of my arguments and conclusions with those of the classical [1] theory of the subject, upon which I was brought up and which dominates the economic thought, both practical and theoretical, of the governing and academic classes of this generation, as it has for a hundred years past. I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience The classical economists was a name invented by Marx to cover Ricardo and James Mill and their predecessors, that is to say for the founders of the theory which culminated in the Ricardian economics. I have become accustomed, perhaps perpetrating a solecism, to include in the classical school the followers of Ricardo, those, that is to say, who adopted and perfected the theory of the Ricardian economics, including (for example) J. S. Mill, Marshall, Edgeworth and Prof. Pigou.

2 The Great Depression The United States Contraction ~85,000 Business Failures ~5,000 Bank Failures ~New York Stock Exchange declines from $87 billion to $19 billion. ~12 million workers lose their jobs. ~Farm income fell by half. ~Manufacturing output fell by nearly 50 percent.. ~Real Income declined by an index of 100 to a low of 68 (1931) Chapter 15-3

3 The Relationship between John Maynard Keynes and the Three Principal Ideological Aspects of Neoclassical Economics Keynes Accepts: ~Marginal Productivity Theory of Distribution The allocation of resources is efficient and just. ~The Invisible Hand Capitalism is rational and efficient. Keynes Rejects: ~Automatic Self Adjusting Markets Keynes argues that capitalism may function at less than full thus necessitating government intervention as a stabilizing force. employment Chapter 15-4

4 Keynes Departure from Neoclassical Economics Keynes provides two rationales for denying the neoclassical automaticity argument: 1. Income, more so than the interest rate, is a more important factor in influencing the quantity of saving. ~Consumption and saving are dependent on income. 2. The Interest Rate is derived from the interaction of the supply and demand for money. ~By making independent the derivation of the interest rate from the interaction of savings and investment, Keynes introduces the possibility that at an equilibrium interest rate savings and investment are unequal. Chapter 15-5

5 The Significance of Keynes Theory of Interest Rate Determination The Rate of Interest is Not a return to saving or waiting, but rather a payment for parting with liquidity. The Demand for Money = Liquidity Preference depends on three motives: i. Transactions Motive Cash for current exchanges. ii. Precautionary Motive Cash for security; a percentage of total resources. iii. Speculative Motive Cash used to secure a profit on future market activity. The Speculative Motive Introduces Expectations. ~If interest rates are low, then the price of bonds will be high. A speculator may expect interest rates to rise and bond prices to fall. A wise speculator will choose to hold cash in the present, waiting for interest rates to rise and bond prices to fall. ~Alternatively, If interest rates are high, then the price of bonds will be low. A speculator may expect interest rates to fall and bond prices to rise. A wise speculator will choose to part with cash and buy bonds in the present, thus speculating that interest rates will fall and bond prices will rise. Chapter 15-6

6 The Implications of Keynes Theory of Interest Rate Determination The rate of interest may be too high to generate an equilibrium between savings and investment. A high, disequilibrium, interest rate will generate: ~ Savings > Investment ~ Aggregate Supply < Aggregate Demand The Result: Business Inventories Production Employment Income The Outcome, Absent Government Intervention: Investment Expenditures Income More than Proportionate Saving The Process Continues Until: Income Saving until it is = Investment at Less than Full Employment Chapter 15-7

7 A Role for Government Stabilization Policies Monetary Policy: Fiscal Policy: ~ Reducing the Interest Rate Investment Saving Saving = Investment Aggregate Demand = Aggregate Supply ~Income inequality makes monetary policy ineffective. Wealthy citizens save at higher rates than less wealthy citizens. As income becomes concentrated with the wealthy, savings rises. ~There is no rate of interest low enough for Saving = Investment, instead people prefer to hold and horde cash. resulting in a depression. Chapter 15-8

8 Keynes and Depression Economics In response to a circumstance in which saving exceeded investment, the government has the power, and obligation, to borrow and spend available unused liquidity. Government spending would increase injections into the expenditure stream such that the economy may return to full-employment equilibrium. Where should government direct its expenditures? ~Keynes preferred public works: schools, hospitals, parks, and other public conveniences. ~Public expenditures should not add to capital stock so as to not exacerbate the excess capacity circumstance. Chapter 15-9

9 The Economic Impact of World War II Between 1939 and 1944 the Wartime Economy enacts Keynes Fiscal Policy: ~Manufacturing, mining, and construction output double. ~ Manufacturing, mining, and construction productive capacity increases by 50% ~The American economy produced, 296,000 Planes 5,400 Cargo Ships 6,500 Naval Vessels 64,500 Landing Craft 86,000 Tanks 2,500,000 Trucks Chapter 15-10

10 Capitalism s Volatility Continues: Post World War II Keynesian economics resolve the Great Depression. However, instability in capitalism takes a new form. Post World War II - Plague of recurring Recessions. ~ , 11 month recession. ~ , 13 month recession. ~ , 9 month recession. ~ , 9 month recession. ~ , nearly 2 year recession. ~ , Stagflation: Stagnant growth, high inflation. (Persistent unemployment 6 10%, Inflation 5 11%) ~ , Severe recession, unemployment rate > 10% ~ , 8 month recession. ~Late , Approximately 12 month recession. ~ , Great Recession, worst since the Great Depression. Chapter 15-11

11 Unintended Consequences of Keynesian Economics Keynesian prosperity has been purchased at a heavy cost. 1. The Permanent Wartime Economy. ~Since World War II, increased government spending and stimulus has been disproportionately directed toward military, rather than socially beneficial outcomes. 2. The Debt Economy ~The necessary increases in government and consumer spending required to stabilize capitalism have also greatly increase indebtedness. The explosion of debt makes the economy vulnerable to a debt-default crises. Chapter 15-12

12 Contradictions in Keynes Arguments, Part I Keynes Acceptance of Marginal Productivity. ~Identical to neoclassical marginal productivity theory, Keynes proposes reducing real wages to reduce unemployment. i. Reduce nominal wages relative to constant prices (unlikely). ii. Increase prices relative to constant nominal wages (more likely). Keynes Acceptance of Marginal Productivity Theory and Rejection of the Automaticity of the Market is Logically Inconsistent!!! ~Marginal productivity theory is predicated on the premise that markets efficiently allocate resources. If markets do not, however, always automatically self correct, then markets can be inefficient. ~If markets are inefficient, then the distribution of income may be unjust and marginal productivity theory cannot explain the wage rate. Chapter 15-13

13 Contradictions in Keynes Arguments, Part II Keynes Posits that Income Inequality may be a factor in economic crisis. ~If the marginal productivity theory argument holds, then the distribution of income reflects an efficient allocation of income. ~If the allocation of income is determined efficiently, then income inequality cannot be a source of market failure. Keynes argument for government intervention violates the tenets of utilitarian philosophy. ~Keynes suggests reducing income inequality, however this requires government redistribution. ~Correcting macroeconomic crises requires government intervention in the way of additional expenditures. *Government action will cause reductions in utility for some that will not necessarily raise utility for others!!! Chapter 15-14