Question

5.  Classical Economics

What is a “bank run”? ______________________________________________________

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2. What role does consumer psychology play in bank runs? _______________________

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3. What happened to the quantity of money in the aftermath of the Great Depression?

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4. Why do runs on banks reduce the quantity of money?  _________________________

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5. According to John Maynard Keynes, what should the government do if private spending is insufficient to maintain full employment? __________________________

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6. What does Friedman believe to be a fundamental weakness in the leadership system of the Federal Reserve (during the discussion with Von Hoffman about Keynes and Strong)? __________________________________________________________________

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7. Why does Friedman believe that the US government has taken such an active role in the economy in the post-World War II era? ____________________________________ ____________________________________________________________________________________________________________________________________________________

Answer 1

(a)Bank run :

A Bank run occurs when a huge number of customers of the bank or other financial institutions withdraw their deposits simultaneously over the threats of banks been going to be insolvent.

(b)Consumer Psychology in Bank runs:

The psychology behind the Bank run is that people fear that their deposited money in the institutions will run out of money and they will lose their amount if they kept it in the institution furthermore.

A bank run is mostly triggered by the fear and this actually leads to the bank going insolvent even if it had any little chance of sustainability. It also happens because the bank doesn't keep a huge stack of cash with them because of the limit assigned. The money is used up pretty soon during a bank run which causes more panic among customers.

(c) What happened to the quantity of money in the aftermath of the Great Depression?

After the Great Depression, The Banking Act of 1935, reorganized the Fed's open market committee and improved the boards of governor's authority. By these measures, the real GNP had recovered to $209.4 billion and the money supply was $32.2 Billion, larger than 1929 figure.

(d)Why do runs on banks reduce the quantity of money?

Bank runs reduce the quantity of money because depositors demand their money back from the institutions and the Banks, even after that they hold on their cash to invest or deposit in the fear of the same even happening again. Banks who go out of cash has to sell their investments to meet the need of shortage of cash. This kind of situation reduces cash flow and hence result in the reduced quantity of money.

(e) According to John Maynard Keynes, what should the government do if private spending is insufficient to maintain full employment?

Keynes advocated for increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the depression.

Keynes approach to full employment was simple, to make people spend which would then become income for the workers. Therefore, he wanted the government to inject money in the economy to which will result in an added business activity and will create even more spending and the cycle continues.

(f) What does Friedman believe to be a fundamental weakness in the leadership system of the Federal Reserve (during the discussion with Von Hoffman about Keynes and Strong)?

Friedman along with Anna shwartz stated that fed pursued an erroneously restrictive monetary policy. he opposed the Keynesian policy and later went to the extent of calling it a naive theory.

(g)Why does Friedman believe that the US government has taken such an active role in the economy in the post-World War II era?

Milton Friedman in spite of being a critic of the fed reserve during the great depression emphasized on the policy post world war 2 era.

he said in an interview

“when I was at the Treasury, I was essentially a Keynesian, as I believed that the way to control inflation was by controlling government spending. I paid very little attention to money”