Keynesianism: Rise & Close of The Great Depression

Abstract

The Great Depression left a legacy on the role of the government in economics; it was a dark period in United States and global history that people have strived to avoid reoccurring. It was a severe economic downturn that had both national and global implications; it consisted of a period of widespread unemployment and poverty as well as the collapse of international trade and by some is considered to have led to the outbreak of World War II. It has become a fascinating subject for both historians and economists alike and both have questioned if we can analyze the causes for both the beginning and end of the depression and make parallels to the economy today in order to prevent a future economic catastrophe from occurring again. One of the largest reasons for this fascination, as Robert Samuelson points out in the article “Revisiting the Great Depression”, is that “there is no precise definition of a depression […] recoveries from run-of-the-mill recessions occur fairly rapidly in response to automatic market correctives and standard government policies. […] A depression occurs when these mechanisms don’t work, or don’t work quickly. The pivotal question becomes: Why?”.[1] This pivotal question brought up by Samuelson is how the economic theory of Keynesianism came about, it was an effort from British economist John Maynard Keynes to understand what caused the Great Depression in order to find a solution to end it.

The Great Depression

The Great Depression notably began with the stock market crash on October 29, 1929 a shock to the American people who had been living with misguided optimism and overconfidence since the stock market boom had begun in 1925.[2] October crash was followed by a significant decrease in output, not just in the United States but in countries all over the world, and an acute decrease in prices.[3] Over the course of twenty-one days after the stock market crash, the Dow Jones dropped from 327 to 199, an almost 40% decrease.[4] Prices for farm products, and certain agricultural crops such as wheat and corn had a significant 54% price decrease between 1929 and 1933 and building materials during this time frame experienced a 25% price decrease.[5]

Additionally, the years between 1929 and 1934 saw an increase in United States treasury borrowing as well a decrease in consumer credit and short-term individual borrowing. Additionally, long-term debt such as mortgages experienced difficulties as well and by 1933 it was estimated that one-third to one-half of the $40 billion in outstanding mortgages in the United States were due to mortgage foreclosures causing the Federal Housing Agency to refinance $5 billion in mortgages.[6]

Keynesianism Theory

Throughout the duration of the depression and the years that have followed, economists and historians have both tried to understand what exactly caused such a catastrophic global economic crisis. In 1931, John Maynard Keynes wrote that “in the middle of the greatest economic catastrophe…of the modern world…there is a possibility that when this crisis is looked back upon by the economic historian of the future it will be seen to mark one of the major turning points.”[7] It was out of this belief that he developed a macroeconomic theory that attempted to explain the depression and develop a solution for it.

Keynes can largely be considered the founder of modern macroeconomics; with his theory he not only criticized but replaced the classic macroeconomic theory.[8] At the center of Keynes’ theory was his idea of effective demand which ignored Say’s Law, a commonly accepted theory of classic macroeconomists. Say’s Law is the classical view that supply creates its own demand, under this view production creates income and income then drives demand; effective demand is Keynes’ view that demand is what determines output and income and that demand can be deficient.[9] It was the idea of effective demand that contributed to Keynes’ proposed solution to the problem of the depression which was essentially government intervention with the purpose of creating demand to increase spending and stimulate the economy. Keynes proposed that the Federal Reserve cut rates, and recommended things such as public investment, protective tariffs and reduced interest rates. Keynes’ also suggested the idea of public works to fight increasing unemployment but only as a last resort.[10]

Conclusion

The impacts of the Great Depression were far reaching, it impacted multiple manufacturing countries as well as the people in them. Economic impacts were felt by people across multiple industries and societies had to adjust to a new state of poverty that vastly contrasted the luxurious and lavish lifestyles of the decade before. Many economic theories developed throughout the years of the depression and have continued to develop in the many years since them, and while confidence in the Keynesianism theory has wavered in recent years and been replaced by a new classicism[11], his theory is still largely one of the most impactful to be developed. Keynesianism largely challenged and replaced classic economics and influenced economic policy with his push for government intervention.

References

Bernstein, Michael A., “The Great Depression as Historical Problem,” OAH Magazine of History 16, no. 1 (Fall 2001): 3-10, https://www.jstor.org/stable/25163480.

Crafts, Nicholas and Peter Fearon, “Lessons from the 1930s Great Depression,” Oxford Review of Economic Policy 26, no. 3 (Autumn 2010): 285-317, https://www.jstor.org/stable/43664566.

Geisst, Charles R., “Chapter Five: The Great Depression,” in Loan Sharks: The Birth of Predatory Lending, Washington D.C.: Brookings Institution Press (2017), pg. 204-231. https://www.jstor.org/stable/10.7864/j.ctt1hfr25r.8.

Irwin, Douglas A., “Who Anticipated the Great Depression? Gustav Cassel versus Keynes and Hayek on the Interwar Gold Standard,” Journal of Money, Credit and Banking 46, no. 1 (February 2014): 199-227, https://www.jstor.org/stable/42920077.

Palley, Thomas, “The General Theory at 80: Reflections on the history and enduring relevance of Keynes’ economics,” Investigacion Economica 76, no. 301 (July-September 2017): 87-101, https://www.jstor.org/stable/26205119.

Samuelson, Robert J., “Revisiting the Great Depression,” The Wilson Quarterly 36, no. 1 (Winter 2012): 36-43. https://www.jstor.org/stable/41484425

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[1] Robert J. Samuelson, “Revisiting the Great Depression,” The Wilson Quarterly 36, no. 1 (Winter 2012): 36. https://www.jstor.org/stable/41484425

[2] Charles R. Geisst, “Chapter Five: The Great Depression,” in Loan Sharks: The Birth of Predatory Lending, Washington D.C.: Brookings Institution Press (2017), pg. 204-231. https://www.jstor.org/stable/10.7864/j.ctt1hfr25r.8.

[3] Douglas A. Irwin, “Who Anticipated the Great Depression? Gustav Cassel versus Keynes and Hayek on the Interwar Gold Standard,” Journal of Money, Credit and Banking 46, no. 1 (February 2014): 199, https://www.jstor.org/stable/42920077.

[4] Robert J. Samuelson, “Revisiting the Great Depression,” The Wilson Quarterly 36, no. 1 (Winter 2012): 38. https://www.jstor.org/stable/41484425

[5] Robert J. Samuelson, “Revisiting the Great Depression,” The Wilson Quarterly 36, no. 1 (Winter 2012): 39. https://www.jstor.org/stable/41484425

[6] Charles R. Geisst, “Chapter Five: The Great Depression,” in Loan Sharks: The Birth of Predatory Lending, Washington D.C.: Brookings Institution Press (2017), pg. 212. https://www.jstor.org/stable/10.7864/j.ctt1hfr25r.8.

[7] Nicholas Crafts and Peter Fearon, “Lessons from the 1930s Great Depression,” Oxford Review of Economic Policy 26, no. 3 (Autumn 2010): 285, https://www.jstor.org/stable/43664566.

[8] Thomas Palley, “The General Theory at 80: Reflections on the history and enduring relevance of Keynes’ economics,” Investigacion Economica 76, no. 301 (July-September 2017): 87-101, https://www.jstor.org/stable/26205119.

[9] Thomas Palley, “The General Theory at 80: Reflections on the history and enduring relevance of Keynes’ economics,” Investigacion Economica 76, no. 301 (July-September 2017): 93-94, https://www.jstor.org/stable/26205119.

[10] Douglas A. Irwin, “Who Anticipated the Great Depression? Gustav Cassel versus Keynes and Hayek on the Interwar Gold Standard,” Journal of Money, Credit and Banking 46, no. 1 (February 2014): 217, https://www.jstor.org/stable/42920077.

[11] Michael A. Bernstein, “The Great Depression as Historical Problem,” OAH Magazine of History 16, no. 1 (Fall 2001): 3-10, https://www.jstor.org/stable/25163480.