Macroeconomics

1. Macroeconomics Lecture 8 The Great Depression

2. Outline Business cycle shocks in the IS-LM model. The IS-LM model in action: the Great Depression.

3. Demand shocks and the business cycle

6. Summary: real and nominal demand shocks C: r I:

9. Overview of Events in the US

10. The Start of the Recession By 1928, the US economy was already moving towards a recession when the FED tightened monetary policy to reduce capital outflows: M falls, i increases, and Y falls. Investment boom (residential) in the late 20s. Stock market boom (speculative bubble). The rise in the interest rate might have contributed to the subsequent stock market crash.

11. The nominal Interest in the US, 1928-39.

13. The role of the stock market crash

14. Decomposition of the change in GNP in US, 1930-33.

15. The banking crisis Deflation increased the real value of debt and many defaulted on loans. Uncertainty about the solvency of banks caused bank runs, which were not prevented by loans from the FED. This generated (endogenously) a reduction in the nominal stock of money. Investment funds dried up.

16. Stabilizing effects of deflation

17. Destabilizing effects of deflation

18. The role of economic policy Both the FED and the government may have played an important role by what they did not do. The FED was inactive and did little to expand money supply or prevent the banking crisis. After 1933, it expanded money supply, though. The government was concerned about balancing the budget, and actually ran a very tight fiscal policy in 1933.

19. Total government full-employment surplus out of full-employment output.

21. What could have been done? Keynes suggested an expansionary fiscal policy. Monetary policy seemed to have been important for the actual recovery, despite the potential liquidity trap. Regulation and control of banks.

23. What is next? Different representations of the supply side of the economy (i.e., the labour market). The role of expectations.

24. The liquidity trap