• Figure 19-2 shows large budget deficits
• Attempts to balance the budget through increased taxes contractionary policies at an inopportune time
[Insert Table 19-2 here]
• The essential facts about the Depression are shown in Table 19-1
• During the Great Depression:
• The stock market fell by 85%
• GNP fell by 30%
• The unemployment rate rose from 3 to 25%
19-1
The Great Depression: The Facts
• The Great Depression shaped many institutions in the economy, including the Federal Reserve and modern macroeconomics
• Classical economics of the time had no well-developed theory that could explain the persistent and excessive unemployment NOR any policy recommendations to solve the problem
foreign currency to provide an anchor for prices and expectations • Frequently there are unsuccessful attempts at stabilization before
the final success
• Relationship is very rough, with large gaps between the growth lines that persist for years
Changes in output growth or velocity, or both, affect inflation
• They emphasized the role of monetary policy in determining the behavior of output and prices
• Friedman attacked view that monetary policy was impotent during the 1930s
Great Depression • Suggestions for policy measures that could prevent future
depressions Vigorous use of countercyclical fiscal policy was preferred
method for reducing cyclical fluctuations.
• He argued that the Depression was evidence of the importance of monetary factors
Failure of the Fed to prevent bank failures and decline Байду номын сангаасf money stock was largely responsible for the severity of the depression
• Often a coordinated attack on hyperinflation: heterodox approach to stabilization
• Monetary, fiscal, and exchange rate policies combined with income policies
Keynesian revolution
19-6
The Keynesian Explanation
• Essence of the Keynesian explanation of the Great Depression is contained in the simple aggregate demand model
• His theory explained ➢ What had happened ➢ What could have been done to prevent the Great Depression ➢ What could be done to prevent future depressions
• The Great Depression and the inadequacy of prevailing economic theories was the setting for John Maynard Keynes and his great work The General Theory of Employment, Interest, and Money
Conclusion: Inflation is a monetary phenomenon,
at least in the long run
[Insert Figure 19-1 here]
19-11
Hyperinflation
• Hyperinflation: very high rates of inflation around 1,000 percent per annum
19-10
Money and Inflation in Ordinary Business Cycles
• Figure 19-1 shows annual M2 growth and the inflation rate of the GDP deflator for the U.S.
• Inflation rate and money growth generally move together
Monetary view came close to being accepted as the orthodox explanation of the Depression
19-9
Money and Inflation in Ordinary Business Cycles
• In examining the links between money growth and inflation, convenient to use the quantity theory of money:
• Dislocation of the economy becomes too great, and the government finds a way of reforming its budget process
• Often a new money is introduced and the tax system is reformed • Often exchange rate of a new currency is pegged to that of a
• The private economy was inherently unstable • Active stabilization policy needed to maintain a strong economy
• Keynesian model offered:
• An explanation of what had happened • Suggestions for policy measures that could have prevented the
19-8
The Monetarist Challenge
• Keynesian emphasis on fiscal policy and its downplaying of the role of money was challenged by Milton Friedman and his coworkers in the 1950s.
• Net investment was negative
• CPI fell nearly 25%
[Insert Table 19-1 here]
19-4
The Great Depression: The Facts
• What was economic policy during this period?
MVPY (1)
or in growth rate form:
mvy (2)
Putting inflation on the left-hand side, we have:
myv (3)
Equation (3) can be used to account for the sources of inflation. Monetarists claim that inflation is predominantly a monetary phenomenon, and velocity and output changes are small.
19-5
The Great Depression: The Issues and Ideas
• What macroeconomic theories can explain the Great Depression?
• How could it have been avoided? Can it happen again?