13.3 Long and Variable Lags Flashcards
What lays at the root of the debate between Monetarists and Keynesians?
Different interpretations of the causes of the Great Depression lay at the root of the debate between Monetarists and Keynesians.
What do most people believe began the Great Depression?
In most people’s minds, the Great Depression began with the stock-market crash of October 1929.
In the US, Canada and Europe, what was the magnitude of the decline in economic activity over the four years proceeding the market crash of the Great Depression?
From 1929 to 1933:
- Real output fell by roughly 25 percent,
- One-quarter of the labour force became unemployed
- The price level fell by more than 25 percent.
- Businesses failed on a massive scale.
What did the stock market crash of 1929 do to Cash demand?
The stock market crash of 1929, along with other factors associated with a moderate downswing in business activity during the late 1920s, caused U.S. firms and households to want to hold more cash and fewer demand deposits in banks. The banking system, however, could not meet this increased demand for cash without help from the Federal Reserve System (the U.S. central bank).
Did the federal Reserve help during the 1929 stock market crash?
However, the Federal Reserve refused to extend the necessary help, and successive waves of bank failures followed as a direct result. During each wave, hundreds of banks failed, ruining many depositors, reducing the flow of credit, and worsening an already severe recession.
How many banks were forced to suspend operations (1929)
In the second half of 1931, almost 2000 U.S. banks were forced to suspend operations.
One consequence of these failures was a sharp drop in the money supply; by 1933, M2 was 33 percent lower than it had been in 1929.
What do Monetarists believe was the cause of The Great Depression?
To them, the fall in the money supply was clearly the major cause of the fall in output and employment that occurred during the Great Depression.
Monetarists see the Great Depression as perhaps the single best piece of evidence of the strength of monetary forces and the single best lesson of the importance of monetary policy.
In their view, the increased demand for cash that led to the massive monetary contraction could have been prevented had the Federal Reserve quickly increased the level of cash reserves in the commercial banking system.
In this case, the rise in cash reserves would have accomodated the higher cash demand, so that the money supply could be maintained.
What do Keynesians believe was the fundamental cause of The Great Depression?
Keynesians argued that the fundamental cause of the Great Depression was a reduction in autonomous expenditure. They cite a large decline in housing construction, a decline in automobile purchases, and a reduction in consumption driven largely by pessimism caused by the stock-market crash. Although Keynesians accept the argument that the Federal Reserve’s behaviour was perverse and exacerbated an already bad situation, they do not attribute a pivotal role to the Federal Reserve or to the money supply. Instead, they see the fall in the money supply as a result of the decline in economic activity, through a reduced demand for loans and thus reduced bank lending, rather than as its primary cause.
What was the difference in consiquences of the Great Depression between The U.S. and Canada?
Canada had broadly the same magnitude of economic collapse as did the United States during the Great Depression, but had no bank failures.
How do Keyesians look at Canada’s experience through the Great depression to support their views?
Keynesians look to Canada’s experience to support their view that money was not central to the cause of the economic collapse in the United States.
They point out that since Canada did not escape the Great Depression but did escape the banking crisis and the associated collapse in the money supply, money was unlikely to have been the central cause of the U.S. economic collapse.
What do monetarists argue for in reguards to Canada’s experience with The Great Depression?
Monetarists accept the point that Canada did not have a massive reduction in the money supply, but they argue that the economic contraction in the United States (which was caused by the collapse in the money supply) spilled over into Canada, largely through a dramatic reduction in demand for Canadian goods. This spillover implies a large decline in export expenditure for Canada, and thus a decline in Canadian national income. Thus, Monetarists essentially argue that money (and inappropriate monetary policy) in the United States was an important contributor to the economic decline in Canada.
What debate is a at its centre the role of lags?
The debate between Monetarists and Keynesians was about more than just the effectiveness of monetary policy.
The debate sometimes also focused on the question of whether active use of monetary policy in an attempt to stabilize output and the price level was likely to be successful or whether it would instead lead to increased economic instability.
This debate is as important today as it was then, and at its centre is the role of lags.
What is a negative side effect of lags?
Experience has shown that lags in the operation of policy can sometimes cause stabilization policy to be destabilizing.
For two reasons, a change in monetary policy does not quickly affect the economy…
- Changes in Expenditure Take Time
- The Multiplier Process Takes Time
What are the aspected of changes in expenditure that take time when implementing monetary policy?
It takes more time before households and firms adjust their spending and borrowing plans in response to the change in interest rates. Consumers may respond relatively quickly and alter their plans for purchasing durable goods like cars and appliances. But it takes longer for firms to modify their investment plans and then put them into effect.
It may take a year or more before the full increase in investment expenditure occurs in response to a fall in interest rates.
- Subsequent effect on net exports takes more time while purchasers of internationally traded goods and services switch to lower-cost suppliers.
