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Economics 113: Great
Depression
October 8, 2007
Keynesian Economics I
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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
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…
Keynesian Economics III
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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...
Monetarist Economics I
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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
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…
Other Theories
• Hayekian theories
– Gold-exchange standard
– Overinvestment in construction
• Structural theories?
• Overconsumption theories?
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?