By Hillsdale College Online Courses October 19, 2015
Gary Wolfram discusses Keynesian economics and the factors that pulled the national economy out of the Great Depression.
The following video is a clip from Hillsdale’s Online Course: “Economics 101: The Principles of Free Market Economics,” featuring Gary Wolfram, the William E. Simon Professor of Economics and Public Policy.
Transcript:
Gary Wolfram:
You probably heard some economist or historian claim that World War II somehow got us out of the Great Depression. The basis of this claim lies in what has come to be known as Keynesian economics. In 1936, British economist John Maynard Keynes wrote The General Theory of Employment, Interest, and Money to explain why the Great Depression had such a long period of time where labor markets did not seem to come into equilibrium, where the demand for labor and the supply of labor are equal. For years, lots of people were looking for jobs but couldn’t find them. Keynes argued that the problem was a lack of demand for goods and services, resulting in a lack of demand for labor. The way to solve this problem, according to Keynes, was to increase government spending.
The simple Keynesian model states that government spending adds to total demand, which adds more to production and more workers being hired. For example, towards the end of the Great Depression, the U.S. government spent lots of money building all sorts of tanks and planes and ships and armaments to fight World War II. We then sent them all over the world where many of them were blown up fighting our enemies. But ask yourself, would it make any difference if our enemies blew up our weapons of war or if we took them out to the middle of the Mojave Desert and blew them up ourselves? Evidently, as long as the government kept spending money building new weapons, our economy would grow.
Looking at this example, we might begin to question whether Keynes's theory fits with how the real world works. A source of confusion, even for professional economists, comes from the way we measure our gross domestic product or aggregate economic activity. Those statistics include not only consumer spending and factories, machines, and producer spending but also government spending, no matter what the government spends that money on. So for example, if the government hired you and paid you fifteen dollars to dig a hole and fill it up again, the data would show fifteen dollars of government spending and fifteen dollars of economic output. The same economic principle was seen, for example, in building a $15 million fighter jet and blowing it up. Neither really creates a better economy or more prosperity.
If you know anyone who lived through World War II, ask them what it was really like. Ask them about the ration coupons they needed to buy even basic products. Ask if they could buy goods and services they normally bought. If we had taken all the military men and women living in tents while serving in Europe and the Pacific and instead moved them to Central Park, would anyone have said, "Oh my gosh our economy is doing so much better?" Yet both would fit the Keynesian theory of how governments could grow their economies.
What really moved us out of the Depression was a combination of factors that would boost our economy today just as well. They include the increase in international trade, fewer government regulations on the economic system, and lowered corporate and personal income tax rates that were implemented after the war.
If you'd like to learn more about Keynesian economics, you can listen to Lecture 7 of Econ 101.
FAQs
The Great Depression inspired Keynes to think differently about the nature of the economy. From these theories, he established real-world applications that could have implications for a society in economic crisis. Keynes rejected the idea that the economy would return to a natural state of equilibrium.
How did Keynesian economics affect the Great Depression? ›
Because Keynesian economists believe that recessionary and inflationary gaps can persist for long periods, they urge the use of fiscal and monetary policy to shift the aggregate demand curve and to close these gaps. Aggregate demand fell sharply in the first four years of the Great Depression.
What did Keynes believe in times of a recession or a depression? ›
Keynesian economics argues that demand drives supply. To create jobs and boost consumer buying power during a recession, Keynes held that governments should increase spending, even if it means going into debt.
How would a Keynesian economist respond to a recession or depression? ›
For example, Keynesian economists would advocate deficit spending on labor-intensive infrastructure projects to stimulate employment and stabilize wages during economic downturns. They would raise taxes to cool the economy and prevent inflation when there is abundant demand-side growth.
What did Keynes believe was the best method for ending the Great Depression? ›
Keynes believed that the best method for ending the Great Depression was to reduce government spending and raise taxes, thereby reducing the federal budget deficit.
What are the economic theories of the Great Depression? ›
The two classical competing theories of the Great Depression are the Keynesian (demand-driven) and the monetarist explanation. There are also various heterodox theories that downplay or reject the explanations of the Keynesians and monetarists.
What was Keynesian economics and what was its relationship to the 1937 recession? ›
Keynesian economists stated that the recession of 1937 was a result of a premature effort to curb government spending and balance the budget. Roosevelt had been cautious not to run large deficits. In 1937 he actually achieved a balanced budget. Therefore, he did not fully utilize deficit spending.
What is the biggest problem with Keynesian economics? ›
Another criticism of Keynesian theory is that it leans toward a centrally planned economy. If the government is expected to spend funds to thwart depressions, it is implied that the government knows what is best for the economy as a whole. This eliminates the effects of market forces on decision-making.
What triggered the Great Depression? ›
Among the suggested causes of the Great Depression are: the stock market crash of 1929; the collapse of world trade due to the Smoot-Hawley Tariff; government policies; bank failures and panics; and the collapse of the money supply.
How did Keynesian economics help the 2008 recession? ›
In the United States, there was a return by the government of George W. Bush to a moderate form of Keynesian policy, with interest rates lowered to ease unemployment and head off recession, along with a form of fiscal intervention with emergency tax cuts to boost spending.
Short Answer. The correct answer reflects John Maynard Keynes's belief that the primary problem during recessions is inadequate aggregate demand (b).
How did Keynes propose to end the Great Depression quizlet? ›
john maynard keynes believed that to end the great depression, government should _____. John Maynard Keynes asserted that instability prompted businesses and individuals to cut back on spending and invest. The government must intervene and spend money to restore the economy.
How did Keynesian economics solve the Great Depression? ›
Active fiscal policy. Keynes argued that the solution to the Great Depression was to stimulate the country ("incentive to invest") through some combination of two approaches: A reduction in interest rates (monetary policy), and. Government investment in infrastructure (fiscal policy).
What are the two main ideas of Keynesian economics? ›
Keynesian economics is based on two main ideas. First, aggregate demand is more likely than aggregate supply to be the primary cause of a short-run economic event like a recession. Second, wages and prices can be sticky, and so, in an economic downturn, unemployment can result.
What in Keynesian perspective could help an economy to come out of a recession? ›
Keynesians believe that the solution to a recession is expansionary fiscal policy, such as tax cuts to stimulate consumption and investment, or direct increases in government spending, either of which would shift the aggregate demand curve to the right.
What ended the Great Depression? ›
Despite all the President's efforts and the courage of the American people, the Depression hung on until 1941, when America's involvement in the Second World War resulted in the drafting of young men into military service, and the creation of millions of jobs in defense and war industries.
Which policy was proved wrong by the Great Depression? ›
Answer and Explanation: There were two great mistakes is witnessed at the time of great depression on the policy front. 1. A contractionary monetary and fiscal policy that falls overall economic output lead to the downward slope of demand in the economy.
Why did the classical economists fail to explain the Great Depression? ›
Economists failed to forecast the Great Depression, perhaps because they had lacked reason to theorize enough about business cycles. Since theory is a public good, the market produces too little of it.
Which economist solved the Great Depression? ›
Keynes's basic idea was simple: to keep people fully employed, governments have to run deficits when the economy is slowing, as the private sector would not invest enough to keep production at the normal level and bring the economy out of recession.
Who made money during the Great Depression? ›
Business titans such as William Boeing and Walter Chrysler actually grew their fortunes during the Great Depression.
Keynesian economics advocates using active government policy to manage aggregate demand to address or prevent economic recessions. The thrust of Keynesian economics is that government intervention can support and strengthen the economy. John Maynard Keynes developed his theories in response to the Great Depression.
Why did Keynesian economics fail? ›
Failure to consider the potentially adverse effect of government spending on the preexisting level of aggregate demand was and remains a disabling flaw in Keynesian theory—then and now. If the theory's underlying logic is flawed, it can be expected that policies and programs based on it will fail.
What are the criticism of Keynesian theory? ›
Critics argue that Keynesian policies can lead to government inefficiency, excessive government intervention, and potentially inflation. There are also debates about the effectiveness of Keynesian policies in the long run.
What is the opposite of Keynesian economics? ›
Monetarism focuses on controlling the money supply to control the economy. Keynesianism focuses on government spending to control the economy. Monetarists believe in fighting inflation by adjusting the amount of money in circulation.
How did the Keynesian perspective address the economic market failure of the Great Depression quizlet? ›
How did the Keynesian perspective address the economic market failure of the Great Depression? The Keynesian perspective addressed the Great Depression by advocating for increased government expenditures and lower taxes to stimulate demand and pull the economy out of the depression.
Did Keynesian fiscal policy help end the Great Recession? ›
Keynesian fiscal policy, through measures such as TARP and various stimulus programs during the Great Recession, helped to mitigate economic decline and stabilize the markets, leading to a more prosperous recovery.
What is the Keynesian view of inflation? ›
The Keynesian theory implied that during a recession inflationary pressures are low, but when the level of output is at or even pushing beyond potential gross domestic product, or GDP, the economy is at greater risk for inflation.
What was the dominant economic view in America prior to the onset of the Great Depression in 1929? ›
Question: The dominant economic view in America prior to the onset of the Great Depression in 1929 wasq,laissez-faire capitalism.
