Economics 113: Great Depression

1. Economics 113: Great Depression October 8, 2007

2. Keynesian Economics I • Y = C + I + G + X • Y= C + A • C = c0Y • DY = DA/(1-c0) • 1929 real GDP: $865 billion • 1932 real GDP: $643 billion • Private investment I goes from $91 to $17 billion

3. Keynesian Economics II • The world was enormously enriched by the constructions of the quinquennium from 1925 to 1929; its wealth increased in these five years by as much as in any other ten or twenty years of its history.... A few more quinquennia of equal activity might, indeed, have brought us near to the economic Eldorado.... Some austere and puritanical souls regard it both as an inevitable and a desirable nemesis on so much overexpansion…. It would, they feel, be a victory for the mammon of unrighteousness if so much prosperity was not subsequently balanced by universal bankruptcy. We need, they say, what they politely call a 'prolonged liquidation' to put us right. The liquidation, they tell us, is not yet complete. But in time it will be. And when sufficient time has elapsed for the completion of the liquidation, all will be well with us again…

4. Keynesian Economics III • Krugman: In the spring of 2005 a panel of “conservative scholars and policy leaders” was asked to identify the most dangerous books of the 19th and 20th centuries. You can get a sense of the panel’s leanings by the fact that both Charles Darwin and Betty Friedan ranked high on the list. But The General Theory of Employment, Interest, and Money did very well, too. In fact, John Maynard Keynes beat out V.I. Lenin and Frantz Fanon. Keynes, who declared in the book’s oft-quoted conclusion that “soon or late, it is ideas, not vested interests, which are dangerous for good or evil,” [384] would probably have been pleased. • [M]acroeconomic theorists before Keynes… believed that the crucial thing was to explain the economy’s dynamics, to explain why booms are followed by busts, rather than to explain how mass unemployment is possible in the first place. ... Although Keynes speculated about the causes of the business cycle ..., those speculations were peripheral to his argument. Instead, Keynes saw it as his job to explain why the economy sometimes operates far below full employment. That is, The General Theory for the most part offers a static model, not a dynamic model – a picture of an economy stuck in depression, not a story about how it got there...

5. Monetarist Economics I • PY = MV • M = mB • 1929 PY: $104 billion • 1932 PY: $59 billion • 1929 M: $47 billion • 1932 M: $36 billion. • 1929 B: $5.9 billion • 1932 B: $6.4 billion

6. Monetarist Economics II • Milton Friedman: [T]he failure of the Federal Reserve System to follow the course of action for which it was set up…. [T]he Federal Reserve followed a policy which led to… widespread bank failures… a reduction in the quantity of money…. [F]or every $100 of money in 1929, by 1933 there was only $67… • The Federal Reserve allowed the quantity of money to decline by a third. While, at all times, it had the possibilities and the power of preventing that from happening…

7. Other Theories • Hayekian theories • Gold-exchange standard • Overinvestment in construction • Structural theories? • Overconsumption theories?

8. Issues… • For Keynesians: what caused the collapse in investment? • For Keynesians: why did not the government compensate via fiscal policy? • For monetarists: why did the money multiplier collapse? • For monetarists: why did the Federal Reserve allow the money multiplier to collapse?