Article in business
Abstract
The economic depression that was experienced globally affected many financial markets and institutions. In attempting to mitigate the effects of the economic depression, different players used different approaches citing different reasons. This paper will look at a particular theorist in economics and his contributions to some of the approaches used by different countries to deals with the issue of economic depression. In doing so, the paper will analyze the contribution of Keynes while striking relevance to the global economic recession. The dispute between Keynes and what he called orthodoxy was based on the reservations he expressed on the General theory. The multiplier effect refers to the expansion or increase in a country’s supply of money as a result of the bank’s ability to lend. There are different schools of thought when dealing with economic depression. Different theories are backed by unique justifications and theoretical approaches. While I would recommend consideration of evidence before adopting any of the approaches, it is ones responsibility to consider the prevailing conditions as a guide to the approach to adopt.
Introduction
The economic depression that was experienced globally affected many financial markets and institutions. In attempting to mitigate the effects of the economic depression, different players used different approaches citing different reasons. This paper will look at a particular theorist in economics and his contributions to some of the approaches used by different countries to deals with the issue of economic depression. In doing so, the paper will analyze the contribution of Keynes while striking relevance to the global economic recession.
The dispute between Keynes and what he called orthodoxy was based on the reservations he expressed on the General theory Most proponents of the theory of value and production are chiefly concerned with how a given volume of employed resources are distributed to the different uses. They are also concerned with the conditions that determine the relative rewards and value of the products given the employment of a certain quantity of resources (Brady, 2006).
Though it has mostly been treated descriptively, the theory of the determinants of the actual employment of the resources available in terms of size of the resources, the natural wealth and accumulated capital equipments has not been examined. In the dispute with orthodoxy, Keynes contends that a theory of demand for output as a whole, the effective demand theory, a theory that considers the prevailing conditions in order to determine the effect the conditions will have on the entire output.
In economics, effective demand refers to the demand for a certain product or service that occurs when the buyer is constrained in another market. The demand for goods or services is determined by spillovers from constraints from another market. The Theory of effective Demand states that in a market economy and by extension a monetary economy, where money is the medium of exchange, store of value and the unit of account, there is a single, solitary and autonomous decision in every transaction that involves buying and selling; that is spending. Consequently, all the spending from the transactions adds up to income by the same measure. By aggregation, the total money spend at any given period of time is always equal and determines the total income. The dispute is very relevant to the current policy debate because it poses significant questions that have to to be answered before companies can be bailed out of the recession by the public sector. The theory helps to establish the effect the prevailing conditions will have on the demand of the outputs from the bail outs. The dispute puts to perspective the constraints in the monetary market and the effect this might have on the stimulus packages extended to companies experiencing the financial meltdown (Mankiw, 2009).
Relevance of the Multiplier
The multiplier effect refers to the expansion or increase in a country’s supply of money as a result of the bank’s ability to lend. The multiplier effect has very serious policy implications. Firstly, exogenous increases in money spent especially from an increase in government outlays, causes an increase in the total spending by a manifold of the aforesaid increase. Therefore, a government can stimulate new production by offering outlays is the people or institutions given the money spend it on consumption goods and save any surpluses (Krugman & Wells, 2009).
This move would also stimulate new production if the money given can facilitate the employment and subsequent remuneration of people by businesses as it will lead to an increase in consumer spending. At each step, the amount of consumer spending is smaller than the previous step. Consequently, the multiplier effect levels off, allowing for the attainment of an equilibrium. Moving away from a ‘closed economy’, this is moderated by taxation. This is where there is a reduction in the size of the multiplier effect and induced consumer sending with increase in imports and tax payments.
This effect is very relevant especially when determining the amount of outlay the government is going to afford the affected companies. According to Keynes economics, monetary policies are less ineffective in times like the great depression as the interest rates, the partial determinants of the investments to be made in the bail outs, because they seek to regulate the economy through the supply of money. The fiscal policy on the other hand can stimulate an economy hinders similar conditions (Rauchway, 2007).
Problems in applying the Keynesian stimulus to ease the strain of the recession
Keynes recommends the application of the fiscal policy during times of recession in order to expand the economy. However, a number of problems might be experienced when applying the Keynesian stimulus to ease the strain of the recession. These problems include the following; firstly, the application of the stimulus package might result to an rise in imports and a decline of exports.
This is because of marginal appreciation of the local currency over foreign currencies. With the marginal appreciation in the local currency, the cost of goods to foreigners increases when compared to before the stimulus packages. Secondly, there is a prolonged lag time in between when the stimulus package is applied on the receding economy to the time when effects are noticed on the economy. The stimulus packages also cause inflationary effects on the economy
Theoretically, the application of the fiscal policy does not result to inflationary effects especially when the money used would have been otherwise idle. The use of the stimulus to increase labor demand while the labor supply is still fixed will result to wage inflation and consequently price equation.
Problems in seeking to deal with government debt by austerity in the midst of recession
Fiscal austerity refers to measures taken by the government to reduce deficits by reducing spending. The reduction in spending is achieved through reducing the benefits and the amount services a fine. Through the implementation of austerity policies, the government attempt to reduce on deficit spending (Dillard, 2005).
According to Keynes, budget deficits are extremely important when an economy is experiencing a recession. During such a time, everyone tries to cut down on their spending. The reduction in spending by everyone traps the economy in a paradox of thrift. The result of this is a fall in the gross domestic product leading to deterioration of the recession. The alternative when the private sector is unwilling to spend in the government spending more. This is because spending boosts the employment rates and gross domestic product.
This is because there would be increased demand for labor decreased supply. The result would be decreased rates of employment. Consequently, there would be a decrease in the gross domestic product thereby worsening the depression. Keynes would recommend increased government spending to levels that increase employment. He would argue that austerity measures do not stimulate growth of an economy. More precisely, austerity measures attempt to stabilize the economy, something that is not favorable for an economy undergoing a depression (Carbaugh,. 2011).
Evidence that there that policies of either austerity or stimulus are working
There is overwhelming evidence from the two sides of the split as to which policies are working. For instance, during the recent economic depression, Britain and the United States of America took very different and antagonistic approaches to dealing with the issue. Britain adopted the policies of austerity with massive cuts in its spending. Based on the recommendations of Keynes, the United States of America adopted the stimulus packages to bail out their companies and financial markets. The following is a comparative graph of the gross domestic products of the two countries after their approaches (Mankiw, 2011).
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The comparative graph shows the performance of the approaches used to mitigate the effects of economic depression with gross domestic product as the main parameter or indicator. This evidence collaborates the assertions made in this paper to the effect that increased spending during the period economic depression. It backs the observation that stimulus packages are more practical when dealing with the economic depression. (Schier, 2011).
Conclusion
There are different schools of thought when dealing with economic depression. Different theories are backed by unique justifications and theoretical approaches. While I would recommend consideration of evidence before adopting any of the approaches, it is ones responsibility to consider the prevailing conditions as a guide to the approach to adopt.
References
Brady, M. E. (2006). Applied mathematics of j.m. keynes theory of effective demand in the general theory: . [S.l.], Xlibris Corp.
Carbaugh, R. J. (2011). Contemporary economics: an applications approach. Armonk, N.Y., M.E. Sharpe.
Dillard, D. D. (2005). The economics of John Maynard Keynes: the theory of a monetary economy. [Whitefish, Mont.], Kesinger Publishing.
Krugman, P. R., & Wells, R. (2009). Economics. New York, Worth Publishers.
Mankiw, N. G. (2009). Principles of macroeconomics. Mason, OH, South-Western Cengage Learning.
Mankiw, N. G. (2011). Principles of economics. Mason, Ohio, Thomson South-Western.
Rauchway, E. (2007). The Great Depression and New Deal. Oxford, Oxford University Press.
Schier, S. E. (2011). Transforming America: Barack Obama in the White House. Lanham, Md, Rowman & Littlefield.
