Keynesian Liquidity Preference Framework - Essay Example

Apart from this optimistic approach there will be some negative characteristics of high money supply like, it will hike the inflation rate up to an optimal level (Fontana 31). Let's say the treasury printed so much in Federal Reserve Bank (FED) which made every American a millionaire, after the retirement of everyone, there would be no more workers or servants left to do the biddings which urges the industries to attract people by raising their wages. This of course is the essence of inflation; so persistency in spending the money would be required to overcome the circumstances which may arise due to higher money supply and we can say that it's a best cure of recession.

A recession will change in depression if a "Liquidity Gap" occurs in it. A liquidity gap is when people hoard money and refuse to spend, no matter how much the government tries to expand the money supply. There are ample reasons why people hesitate to invest the money; it can be a consumer loss of confidence on the economy probably due to stock market crash or the law and order situation in the country, natural disaster like earthquake or hurricane are also the major cause which abate the spending of the money in the country, although saving is a good thing but it is not viable if spending and investment are not on an adequate level.

You know "Wars are good for economy" (it must astonish you) almost all the economist agree that World War II cured the great depression because the U.S finally began massive spending on defense. Social Programs are much more preferable over the ways to avoid depression. The success of Keynesian economics can be evaluated by having a glance over the recession periods. In U.S, before the World War II, eight recessions worsened into depression which happened in (1807, 1837, 1882, 1893, 1920, 1933 and 1937) and since world war II there have been nine recessions under Keynesian policies happened in (1945-46, 1949, 1954, 1956, 1960-61, 1970, 1973-75, 1980-83, 1990-92) and not a single recession turned into a depression.

Richard Nixon who was the 37th president of the United States (1969-1974) once declared that "We are Keynesians now" shows the importance of Keynesian Liquidity Preference Theory.As mentioned earlier savings is a must for the economy. According to Keynes saving is equal to investment; means every dollar which is saved is ultimately utilized as an investment in the economy (Keynes 150). Now the concept of money supply and price level effect comes into place; if the economy reaches on an optimal level then people become less interested to invest and under this influence price level increases because the income level also increases.

In liquidity preference framework, Keynes (211) states that the money demand can be equated with the term Marginal Efficiency Unit (MEU). Keynes further apprises that nothing will induce the people to invest money if they are on a consensus that the economy is on its peak point from where the prices of the commodities begin to rise and result in increasing the inflation rate up to a vulnerable position (Handa, 511). The industry which badly gets hurt from this jeopardous situation is the banking industry because