Question

One important breakthrough in economic understanding as a result of the work of Keynes was that total private demand may not be sufficient to maintain full employment output. After watching the short film on Keynes and the Great Depression discuss how this new understanding of the economy contributed to the nations ability to pull itself out of the Great Depression. Can you draw any parallels to the slow down we are currently in?

Answer 1

If a recession occurs, the Neoclassical and Austrian schools argue in general that no government intervention is needed. Unemployment and excess supply of goods will be solved by allowing market prices to decrease (including wages) until all markets clear: Supply equals demand and factors of production are fully employed.

Keynes disagreed with both Neoclassical and Austrian views. He observed that a generalized price and wage reduction ,solely brought about through market forces, necessary to bring markets back to equilibrium during a recession, would be hard to attain. For example, workers may not want to see their nominal compensation decrease because nobody likes a pay cut.

Keynes believed there could be circumstances in which lower interest rates would not reignite growth because business confidence was too low. As a consequence, Keynes advocated government intervention in the form of fiscal policy.

He argued that when crises occur, the government should intervene to keep capital and labor employed by deliberately running a larger fiscal deficit. This intervention would limit the damages of major recessions.

This greatly helped in the great depression. ALos this helped in the financial crisis in 2008/2009. In the current pandemic situation also govenremnt has taken many steps based on Keynes theory and provided lot of fiscal stimulus to businesses and households in the form of cash susidy, high unemployment benefits , liquidity etc., to bring the confidence back. The interest rates are almost 0.