Keynes theory and the Great Depression - Essay Example

Keynes Theory and the Great Depression Number: Due: Question A The Great Depression Explanation Some early economists such as Irving and Keynes are believed to have overseen the rise of the Great Depression through the analysis of financial markets (Barry, 1985). It is clear that most of the events in the great depression were in line with some other events in the financial markets such as the stock market collapse, waves of bankruptcy, and bank failure, and then freezing in the money stock. However, the way in which the financial factors contributed to the rise of the Great Depression has brought about different arguments from the economists. The failure of the financial markets and the economic activity provide a clear understanding of the Great Depression and the financial shocks during the 1930s were so severe and therefore it was impossible for the policy-makers to prevent the Great Depression (Bernanke, and Harold 1991). The Great Depression is believed to have come as a result of the changes in the money supply. The important events that happened in the years between 1929 to 1940 would allow different economists to come up with different theories to explain the Great Depression. Events in the wake of the great depression included the changes in the nominal GNP and the monetary stock, price changes, and the changes in the size of the various elements of the money stock. Few economists such as Friedman and Schwartz were more interested in explaining the original downturn in 1929 that later changed into the Great Depression but however other events such as the stock market crash and the recession period might be contributing factors in the onset of the Great Depression (Bordo, 1998). The decrease in the number of people that would go banking in the early 1930, greatly reduced the money multiplier and the money stock. With regard to this problem, the Federal Reserve was unable to handle the situation through the use of open market operations and giving of loans to banks to facilitate supply of money created a severe situation in the economic activity. Critics argue that this failure policy by the Federal Reserves was as a result of leadership failure. Nevertheless, the recovery of the monetary system between the years 1933-1936 was followed by an economic fall and monetary policy decline in 1937 which the economists believe was as a result of the increase of the required reserve ratio in an attempt to handle the banking system problem (Brown, 1956). Several studies have been put forward in explanation of the link between the financial market history and the onset of the Depression. The Depression moreover is believed to have arisen as a result of the reduction of the excess reserves that were believed to have been an unnecessary surplus and the need to control the monetary policy. Cameron (1993) argues that the increased reserves were a demonstration of the high liquidity that was preferred by banks in the wake of the Depression in the financial system. There have been issues with the proper link between financial and real markets, although economists believe that the prices, and the IS-LM paradigm is the required framework that explains the relationship between the two. However, the need for the interest rate to use in the measure of the monetary policy in the early stages of the Depression and how the adjustment process in selling of goods, bond, and the money markets. Several other studies, on the cause of the Great Depression point out on the IS-LM paradigm, the financial markets that were viewed with regard to changes in the money stock, or how the stock market price affects the wealth of individuals, and hence the consumption and demand of the citizens. Various other research indicates that the demand for money was stable in the 1930s and therefore would not have been the cause of the economic recession and concluded that money supply-shocks had vital effects on the output of an individual (Campa, 1990). In addition, some economists question the role the money-supply changes in the decline of the banking exercise that led to the decrease in the amount of money supply in the decline of the economy. However, in the IS-LM model, the stock money is required to contract in the early stages of the Great Depression but this was not the case and thus the money supply had no role to do with the economic decline in the 1930s (Cecchetti, 1932). The international monetary forces that saw the rise of different prices in different countries, might have caused the early price and output reductions as explained in the price-specie-flow mechanism. B). Fall of the Convention From the above convention it is clear it fell apart because the instability of a country might be as a result of both the speculation and due to human nature. Thus the activities of human beings depend on the optimism rather than any mathematical expectations. The actions of the human beings in the future can never depend on mathematical formulas since there is no basis for making such calculations. Even though Keynes believes that the economic changes in a country can only be as a result of shifts in the moods of the consumers and the investors, it can bring questions by critics as it is not clear on the causes of mood change in the economic fluctuations can never be through the expectations in terms of profit accrued out of the activities. Moreover, the convention does not work since it relies upon the existing state of affairs to continue indefinitely. But however, there might be reasons to expect some changes. This is because the real outcome of an investment over a long period of time rarely depends on the initial expectation of an asset. It might be clear that the probabilities of expecting a positive or negative change is equally likely and therefore assumptions based arithmetic probabilities and the state of ignorance result to “absurdities”. Keynes assumes that the existing state of market evaluation is correct in terms of the prevailing knowledge among the economists and can only be altered under the influence of the yield of the investment which cannot actually be true since the knowledge of an economist does not depend on the calculated mathematical expectation. Critics cite out that there are certain factors that might affect the market valuation which are not relevant to the expected yield (Chandler 1930). Therefore this convention can only work if the human beings can only depend on the maintenance of the convention in terms of “considerable measure of continuity and stability” in day to day human affairs (Cowles 1939). Nevertheless if the market investment was well organized and thus the consumers depend on the maintenance of the convention would serve as an encouragement to the investors that there is a limited number of risks they can run into and this could be in terms his own judgement in the future. Thus with regard to this an investor is able to judge his investment and change his ideas or move to another investment before a crisis happens (Diaz, and Carlos 1984). Therefore the convention cannot work because of a gradual rise in the capital investment in a community that is owned by people who do not manage nor have knowledge of the market changes with the business in question. Moreover, in recent times there has been changes in the profits of investments that do not have any significant impact on the market. Nevertheless, there are no basis of the convention to hold it steady as the evaluation of the convention is established due to the results knowledge of the market consumers that are prone to changes mostly because of the change of the market opinion on some factors which do not make any difference in the prospective investment yield (John, 1920). C). Is the Great Depression Likely Again? The level of spending by the consumers is affected by stability of a country. But since the spending of a consumer is part of my earning in a circular economy and the citizens depend on each other in the investment, this is likely to affect the economy as a whole. The other party that does not now sell is likely to act in a way that affects the consumer too. This implies that there is a cycle in this case, people save money and does not spend at difficult times, which makes things worse for others in the economies that need the money. Keynes believes that in this situation, the central Bank need to come up to assist which is an unlikely scenario for the US has for the moment become the world hegemony and if a given country does not give in to her demands they go into war that further implies that the economy would be at its worst. In this regard the recession would only be controlled if people (consumers) are given enough security that brings confidence for investment. In the near future, people are likely to be saving money and not spending it. This is because of fear of security. Recent years have seen wars in Afghanistan, Iraq, and other parts of the Middle East and there is growing concern over the world peacefully. Saving and not using money bring about the problem of, “liquidity trap” (Chandler, 1930). This is the case where people hoard money and are not willing to spend no matter the government interference to encourage the circular flow of income. Keynes believes that the government should encourage people to spend. Is it however likely? Most of the developing states are governed by hungry and corrupt leaders that do not take responsibility for any actions to restore the economy. They are after taking the top seats and do not have ideas on what should be done to increase the living standards of the people and most of the countries have poor economies at the moment that is likely to get worse with time. People might try to hoard money because they have lost trust with the economy, this can further be accelerated by certain events such as a stock crash. It might be due to a natural disaster, such as drought, earthquake, or hurricane. This is more evident in the present world and more tragic events are likely to happen. The Haiti tragedy is a practical example where the cause of the earthquake tragedy is due to the irresponsibility of the government as it had been foreseen before and thus the government never took any steps to take precautions and safety measures in its event. Moreover, hoarding of money might also be as a result of loss of jobs, or a weak sector of the economy. It might also be as a result of inequality of the resource allocation whereby the rich might be producing more goods but no one is able to buy because of lack of money. These things are common in most of the developing countries. These factors make the economy to not to be consistently more often going through a period of “recession” and “recoveries”. The Federal Reserve might also not release money often to the economy making people to hold on to what they already have. This is a critical problem as the Great Depression too started in the same manner. However, “healing” of any depression is never easy and some critics argue that the Great Depression was only handled because of US involvement and thus it had to spend in order to defend itself. Conclusion Keynes theory states that demand is vital in any economy, especially at the time of “downturn” (John, 1920). Nevertheless, he asserted that the government actions would be important in promoting demand at the macro level, so as to handle the problem of unemployment and deflation. However, he believes that in most cases it is not a guarantee for the output in a given country to move towards a full employment level. He continued to assert that if this was possible it would contradict with the classical theory and other schools such as those of supply-side economics or the Australian school which use the assumption that that the output tends to move towards equilibrium in a poor economy. References Allan, W. (1935). “The Keynes Theory and its Implications”. 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(1999). “Economic Recovery from the Argentine Great Depression: Institutions, Expectations, and the Change of Macroeconomic Regime.” Journal of Economic History 59, 567-599. Read More