by Meg Sullivan • UCLA Newsroom Two UCLA economists say they have figured out why the Great Depression dragged on for almost 15 years, and they blame a suspect previously thought to be beyond reproach: President Franklin D. Roosevelt. The chart suggests that the recessionary gap remained very large throughout the 1930s. In a period of low economic activity output is low, workers are unemployed, and factories remain idle. Keynesian economics does not believe that price adjustments are possible easily and so the self-correcting market mechanism based on flexible prices also obviously doesn’t. We have learned of the volatility of the investment component of aggregate demand; it was very much in evidence in the first years of the Great Depression. As the capital stock approached its desired level, firms did not need as much new capital, and they cut back investment. The United States did not carry out such a policy until world war prompted increased federal spending for defense. 2. Keynesian economists argue that sticky prices and wages would make it difficult for the economy to adjust to its potential output. In this analysis, and in subsequent applications in this chapter of the model of aggregate demand and aggregate supply to macroeconomic events, we are ignoring shifts in the long-run aggregate supply curve in order to simplify the diagram. And second, you find out how much they knew. His most important work, The General Theory of Employment, Interest and Money, advocated a remedy for recession based on a government-sponsored policy of full employment. President Franklin Roosevelt thought that falling wages and prices were in large part to blame for the Depression; programs initiated by his administration in 1933 sought to block further reductions in wages and prices. government intervention is not necessary to promote full employment. Higher tax rates tended to reduce consumption and aggregate demand. 3 (Part 1) (May/June 2008): 133–48. Keynesian economists argue that sticky prices and wages would make it difficult for the economy to adjust to its potential output. (Kates 2017: ix) This is the entire preface to the third edition: Figure 17.2 “Aggregate Demand and Short-Run Aggregate Supply: 1929–1933” shows the shift in aggregate demand between 1929, when the economy was operating just above its potential output, and 1933. One similarity between the Great Recession and the Great Depression is that, in both episodes: there were significant problems in financial markets. For Keynesian economists, the Great Depression provided impressive confirmation of Keynes’s ideas. Keynes’s 1936 book, The General Theory of Employment, Interest and Money, was to transform the way many economists thought about macroeconomic problems. But never had the U.S. economy fallen so far and for so long a period. Figure 17.1 The Depression and the Recessionary Gap. This act, which more than 1,000 economists opposed in a formal petition, contributed to the collapse of world trade and to the recession. Which of following best explains why this happened? Keynesian economics asserts that changes in aggregate demand can create gaps between the actual and potential levels of output, and that such gaps can be prolonged. The federal government, for example, doubled income tax rates in 1932. John Maynard Keynes, English economist, journalist, and financier, best known for his economic theories on the causes of prolonged unemployment. The Keynesian economists actually explain the determinants of saving, consumption, investment, and production differently than the Classical. Classical economists believe that any fall in Real GDP will be temporary and will end when labour markets adjust to the new price level. Economists of the classical school saw the massive slump that occurred in much of the world in the late 1920s and early 1930s as a short-run aberration. Total government tax revenues as a percentage of GDP shot up from 10.8% in 1929 to 16.6% in 1933. It thus stressed the forces that determine the position of the long-run aggregate supply curve as the determinants of income. Henry Thornton’s 1802 book, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, argued that a reduction in the money supply could, because of wage stickiness, produce a short-run slump in output: A half-century earlier, David Hume had noted that an increase in the quantity of money would boost output in the short run, again because of the stickiness of prices. Disadvantages: No one wants to follow keynesian policies because they are hard. You could take Henry Thornton’s 1802 book as a textbook in any money course today.”. prices are flexible and adjust quickly during economic downturns. But, with state and local governments continuing to cut purchases and raise taxes, the net effect of government at all levels on the economy did not increase aggregate demand during the Roosevelt administration until the onset of world war (Brown, 1956). problems with AD and AS, important part of the great recession is that there was a shock to, is the primary regulatory response to the financial turmoil that contributed to the great recession, most significant factor was a large and persistent decline in aggregate demand, encompasses government acts to influence the macroeconomy. Because goods and services are produced that can not be sold for prices that cover their costs up 19. 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