John Maynard Keynes: Depression DestroyerA Look at the Contributions of the 20thCentury‟s Most Influential Economist Presented by: Jeff Keele, Ph.D.
Economics in the 1930sGreat DepressionDust BowlNew Deal PoliciesKeynesian Economics John Maynard Keynes 1936
The Context:Business Cycles and Depressions Business Cycles Recurring booms and busts in economic performance All economies face them Deep, long “busts” are called Depressions
Depression Cycles In AmericaU.S. Depressions 1819 1836 1857 1873 1893 1921 (brief) 1929 GREAT DEPRESSION None Since … WHY???
Causes of the GREAT DEPRESSIONBoom of the “Roaring Twenties” Coolidge era policies favor business and wealthy Concentration of Wealth increases Gap between rich and poor expands National economy overly dependant on conspicuous consumption
Causes of the GREAT DEPRESSIONSpeculative run in the Stock Market Margin trading Leveraged purchases stocks bought with borrowed money Rampant, undisciplined speculation Stock prices unrealistically high
Poor BusinessPractices Huge land speculation wave in Florida Resort developments multiply Shares hawked to cash-flush banks, corporations, and wealthy individuals
Florida Land BubbleMany bought on credit, most for speculation.Land prices quadrupledHuge paper profits for speculatorsTHEN…Slowing economy led to a sell-off Falling prices created a credit crisis Credit crisis created a panic and collapse of the whole Florida land market. Large investors lost enormous paper assets
Slowing Economy +Florida Land Bubble Collapse = Stock Market CrisisStock market crash destroys paper wealth Stock values plummet Stock no longer covers collateral requirements Margin calls issuedDepositors try to withdraw cash to covermargin calls on their stock
Stock Market Crisis Banking crisisBanks unable to pay depositors Panic Runs on banks Large-scale bank failures Deposits uninsured Depositors lose
Depression Cycles DownwardNewly wealthy now find themselves newlypoorConsumer spending plummets – especiallyfor consumer luxuriesNew orders dry up for producersProducers lay off workersWorking classes lose income and decreasespending
Depression Cycles DownwardCongress passes Smoot-Hawley Tariff Act Shuts off imports in an attempt to protect domestic producers Foreign nations respond by shutting off American imports Efficiency and wealth gained from world trade evaporates
Government Response President Herbert Hoover and US Government…?? Wait for the market to correct itself “Pump priming?” well, maybe, but didn‟t DO it.Dominant economic paradigm: Laissez Faire Government will just mess it up worse. Let it fix itself.
ClassicalEconomic Theory Adam Smith and the Invisible Hand Competition and profit motive are core Economies tend toward efficient equilibrium when left alone Governments should not meddle
Classical Economic Theory David Ricardo Systematized Smith‟s workRicardian Equivalence: Government spending can not stimulate economic performance Stimulation will be exactly counterbalanced: By offsetting taxes – if paid for by tax increases By offsetting savings – if paid for by government debt
Enter: John Maynard KeynesBy 1930: Already the most influential British economist Prep School at Eton Gifted in math, classics and history BA 1905, MA in 1909 at Kings College, Cambridge Math first Economics – motivated by interest in politics
Keynes‟ BioLectureship at CambridgeWWI: Worked for the Adviser to the Chancellor of the Exchequer and Treasury Financial representative for the Treasury to the 1919 Paris Peace Conference
Keynes‟ BioRepresentative of FinanceDepartment at the VersaillesPeace Conference in 1919 Argued against reparations They would crush Germany & cause more conflictPublished:The Economic Consequences of the Peace in 1919A Tract on Monetary Reform in 1923Treatise on Money in 1930
Keynes Bio Published his magnum opus, The General Theory of Employment, Interest and Money, in 1936Classical EconomicsChallenged core paradigm of Markets may not always tend toward an equilibrium at full employment Government has a role in stimulating economic performance – by stimulating demand
Keynes‟ ThesisDepression could becomea long-term equilibriumoutcome Financial shocks and gloomy expectations could permanently suppress aggregate expenditures (demand) Large-scale unemployment - both human and capital - could result
Keynes‟ ThesisSolution: Stimulate AggregateExpendituresOnly the government is capable ofsufficiently massive stimulationGovernments should SPEND their wayout of a depressionCounter-cyclical Fiscal Policy: Cut taxes and increase spending in recession/depression Increase taxes and cut spending in times of inflationary expansion
Keynes‟ Open Letter to President Roosevelt New York Times: December 31, 1933“Broadly speaking, therefore, an increase of output canoccur only by the operation of one or other of three factors.”…•Individuals are induced to spend more (but they don’t have it)•Business are induced to spend more by increasing theircapital and employment (but they have excess capacity and don’thave existing orders to justify expansion)or•Government must “create additional current incomesthrough the expenditure of borrowed or printed money.”
Keynes‟ Open Letter to President Roosevelt… “Thus, as the prime mover in the first stage of thetechnique of recovery, I lay overwhelming emphasis on theincrease of national purchasing power resultingfrom governmental expenditure which is financedby loans and is not merely a transfer through taxationfrom existing incomes.”
Keynes‟ Open Letter to President Roosevelt… "The setback American recovery experienced this pastautumn was the predictable consequence of the failure ofyour administration to organize any material increase innew loan expenditures during your first six months of office.The position six months hence will depend entirely onwhether you have been laying the foundations for largerexpenditures in the future."
New DealProgramsResettlement Administration Relocate families to new, planned communitiesFarm Security Administration Rural rehabilitationRural Electrification Administration Charged to bring electricity to farms, etc.Tennessee Valley Authority Flood control, electrification, fertilizers in Tennessee Valley
New Deal & Keynesian Theory Keynes‟ model Provided: Scientific justification for New Deal Theoretical guide for New Deal expansion Confidence that short-term deficits were OKFresno Auditorium Oakland-Alameda Bridge Imperial Canal, CA
More Keynes-compliant Policies of the 30‟sUnemployment benefitsSocial Security InsuranceProgressive income taxesAll of theses are “automatic stabilizers”
More 1930sSafeguards againstEconomicDepression Federal Reserve Building,1937 FED: Federal Reserve Board strengthened Regulates banking practices and money supply Guards against bank failures and maintains a stable money supply FDIC: Federal Deposit Insurance Corporation Created to guarantee depositors money if banks fail Works to maintain confidence and avoid financial panics
More 1930s Safeguards against Economic DepressionSEC: Securities and ExchangeCommission strengthened to guardagainst stock market collapse Tighter accounting and reporting practices imposed on publicly traded corporations Limits placed on margin trading Strengthened controls on insider trading
More 1930sSafeguards againstEconomic Depression Strengthened Labor laws Protect workers rights Improve distribution of income Avoid some of the income inequality that made the „20s boom so volatile Maintain laborer income to maintain private sector demand
Keynesian model‟s successesLess volatile business cyclesNo major depression sinceimplementationGreater economic security for workingclassesPolitical stability in advanced worldeconomies where Keynesian policiesare practiced
Keynesian model‟s weaknessesInflationary tendency Government stimulation may cause inflation Keynes discounted this possibility for times of deep recession/depressionDeficit spending Tax cuts and increased services are easy to sell to voters in recessions Tax increases and reduced services are a hard political sell for elected officials even in inflationary expansions
Keynesian model‟s weaknessesGovernment deficits compete with privateinvestment for investment money Crowding out effect May reduce net private investmentGrowing government sector Inconsistent with Lockean view of minimalist government Government may become more intrusive
ContemporaryMacroeconomicTheory and Practice Dr. Ben Bernake, FED Keynesian Base: Chairman Automatic stabilizers well entrenched to mellow out wide swings in the business cycle Monetarist Anti-inflation Program: Greenspan and now Bernake guarding against inflation through cautious Monetary policy
Contemporary Dr. Milton Macroeconomic Friedman Theory and PracticeSupply Side theory focusing on tax incentivesfor investment -- a la Milton Friedman Reduced tax burden -- to be balanced partially by promised economic growth and partially by reduced government spending Claimed as model for Reagan and G.W. Bush administrations, but not really implemented Both cut taxes but failed to balance with reduced spending – leading to large deficits that counteract the expected benefits
Keynes Is Still Key Despite important later developments in theory and practice … Monetarist theories Supply Side and Neo-Classical theories Contemporary Macroeconomic theory and contemporary policy are firmly grounded in Keynes‟ ideas from the 1930s.