To comprehend the Great Depression is the pinnacle of macroeconomics Essay Example

significantly imbalanced during this time period and rectifying it required either reducing government spending or increasing taxes. These actions caused further reduction in aggregate demand (as depicted in the top graph), which led to decreased expenditure (moving from A to B in the bottom graph). This negative multiplier effect worsened consumer confidence even more. According to Keynes, pursuing a balanced budget strategy during times of low consumer confidence was not suitable for governments.

In his 1936 book, The General Theory of Employment, Interest, and Money, Keynes provided a remedy for unemployment. He proposed that the Treasury should fill discarded coal mines with banknotes enclosed in old bottles at appropriate depths. Subsequently, the mines would be filled with municipal waste up to surface level and private enterprise would be responsible for unearthing the notes using laissez-faire principles. This approach would eradicate unemployment.

According to John Maynard Keynes in his book The General Theory on page 129, although it would be preferable to construct buildings and other infrastructure, if political and practical obstacles prevent this, any form of spending during the Great Depression could help stimulate the economy. The government simply needed to spend money on anything at that time.

Keynes observed that the government did not comprehend the negative repercussions of a balanced budget on the economy, lamenting that "In the long run, we're all dead" if action was not taken to encourage spending and discourage hoarding. Without such intervention, the population's survival in the long run was uncertain. A potential cause of a severe recession is illustrated by a normal economy with high employment levels and expendable income; in such cases, individuals tend to have a

high propensity to consume.

The multiplier effect in the economy results in a circular flow of money. My spending turns into your earnings, and your spending turns into my earnings. However, on October 24, 1929 (known as Black Thursday) the stock market experienced a significant drop. By mid November of 1929, the New York Stock Exchange had fallen 40 percent causing a decrease in consumer confidence within the American economy and all over the world. This resulted in low consumer confidence, with worried consumers trying to survive economic adversity by saving. As a result, their marginal propensity to save was high.

The act of me hoarding money affects your earnings negatively, as my spending is a part of it. In response to your own financial struggles, you may also start hoarding money, which further exacerbates the situation. This vicious cycle was observed during the Great Depression wherein the accumulation of money in difficult times made living more challenging. To counter this, Keynes advocated government intervention in the form of increased spending - referred to as "priming the pump" of the economy. (Kangas)

S. (1997) presents a graph that demonstrates the Multiplier Effect, which occurs when Government spending initially increases (top graph), leading to a greater-than-proportional rise in expenditure (bottom graph point A to B), also known as "priming the pump." However, it is important to consider why consumers tend to save money at first and address this issue in order to prevent future economic downturns. This is an essential step towards avoiding potential financial emergencies.

It is worth noting that the Hoover Government's goal of achieving a balanced budget led to a mistake where they tightened the money

supply, causing people to hold onto their money as it decreased. I believe that the stock market crash was a highly visible event that caused a significant decrease in consumer confidence from 1929 onward. If the economy had been operating efficiently and effectively at the time of the crash, its impact may have been lessened, and the shock to confidence and loss in spending by those affected could have worn off over time.

Despite its fragility, the business in 1929 was not stable enough and was vulnerable to shocks such as the one delivered by Wall Street, according to Galbraith (1954, p. 187). As a result, the already delicate economy meshed with the stock market crash during the 1930s leading to decreased consumer confidence and increased money hoarding.

The Economy from 1929 onwards: Point A (1929) represents the economy at full employment. However, due to the low consumer confidence that arose from the stock market crash, aggregate demand fell. This caused consumers to hoard money, resulting in decreased consumption. Additionally, government spending was cut in an attempt to achieve a balanced budget. Animal spirits also led to investment decreases. This decrease in aggregate demand is demonstrated from Point A (1929) to B (1932). If labor were to comply with taking a pay cut, the economy could return to full employment at Point C (1937-8). Furthermore, investment on capital items during the 1930s fell from a top of forty billion dollars almost overnight, leaving the American and eventually global economy in a cycle of negative investment.

Even though four billion dollars were being invested, which was considerable during the Great Depression, it was insufficient to account for

the depreciation that was occurring. As a result, negative investment was prevalent, primarily due to the pessimistic animal spirits of investors. The trend of pessimism commenced on 'Black Thursday', the day of the stock market crash, and persisted throughout most of the 1930s. It is noteworthy that animal spirits have significant influence on investment decisions.

Furthermore, after October 1929, investors were less willing to spend significant amounts of funds on investments due to the significant reduction in their expected investment returns. This decline in estimated investment returns is evident in the ISLM model's investment function. Additionally, bankrupt banks view demand deposits as liabilities. These deposits are readily withdrawable by customers and thus must be promptly fulfilled by the bank. Banks employ these deposits to procure assets and earn revenue, while also paying interest to customers.

During the 1930s bank runs, banks were required to repay deposits to customers. To meet this obligation, they sold assets like bonds, shares and long-term loans. However, since everyone was selling but no one was buying, asset prices decreased drastically. This left banks unable to satisfy demand deposits. Consequently, during the Great Depression around 10,000 banks failed - which is equivalent to about 40 percent of the total number of banks in 1929 (Kangas.S. 1997). The failure of so many banks led to a shortage of real money within the economy as bank loans were a significant source of investment funds. As a result, investment ceased during the 1930s.

The ISLM model illustrated below provides a further explanation on how the shortage of funds leads to a decrease in investment, and subsequently affects the interest rate. In terms of economic history, the Great

Depression was resolved by World War II. Keynesians hold the perspective that the infusion of a large amount of money into defense spending was the solution. Hence, it can be concluded that the notion of "wars are good for the economy" originated from this period. Unknowingly, during this era, the Hoover Government resorted to Keynesian spending, affirming that wars provide economic benefits. However, the preferable scenario would be to channel resources towards social programs instead of wars.

It is important to acknowledge the success of Keynesian economics in the post World-War II era, as evidenced by the occurrence of nine recessions between 1945 and 1992 (1945-46, 1949, 1954, 1956, 1960-61, 1970, 1973-75, 1980-83, 1990-92) and the prevention of any depressions during that time (Kangas .S. 1997). The effectiveness of Keynesian economics played a significant role in this achievement. Furthermore, today's policymakers do not prioritize achieving a balanced budget and instead focus on controlling consumer confidence to regulate aggregate demand. With a greater understanding of Keynesian economics, modern governments are equipped to handle economic hardships.

In contrast to the 1930s, current governments have learned from past mistakes and understand which decisions will positively impact the economy. An illustration of successful governmental action is the Howard government's introduction of the first homeowners grant. This grant resulted in Australia prospering while America was experiencing a minor recession, due to money being spent on new housing developments and creating a multiplier effect in our economy.

There is debate regarding the likelihood of another Great Depression. Supporters of Keynesian economics argue that government intervention using monetary or fiscal policy can create a multiplier effect, reducing the possibility of such an event. However, some

people disagree and point to Japan's current situation as evidence that government spending may not always lead to the desired result. Despite decreased interest rates and increased money supply in Japan, its economy continues to be sluggish. This is concerning considering their reputation for high savings rates (Mankiw, 2000, p.
Econstats, 03).

As per (p 450), a cultural trait is hindering the efficacy of Keynesian economics in Japan. Though interest rates are low, savings' returns are unsatisfactory. Nevertheless, Japanese consumers prioritize saving over investing due to their heightened risk aversion and resilience during tough economic times, unlike consumers from Australia or America. Therefore, the typical Japanese consumer prefers to save rather than invest large borrowed sums.