Keynesian Response to Economic Slowdown

 After 1929 , US witnessed lot of slump in the economic activity, resulting in many bankruptcies and layoffs. According to classical economy , market plays God. What it means is, whenever there is a fall in demand , price will fall and because of price fall,  demand needs to pickup. So every product that's getting created , will be sold at some price. For example, say suddenly people buy only Android phones. Apple needs to cuts its prices down. At some price, people needs to start buying iPhones again . Similarly if someone is unemployed in a recession , he is part of labour supply. If he cuts his salary expectation he will become employed at some point of time and start producing goods/services.

 During the depression, people waited for prices to find a bottom and economic activity to pick up. Unemployment peaked at 25% and didn't come down significantly until spending on second war started.

 Spending decision of persons/Govt, will have multiplier impact in overall economic activity. You might have read this story during school days which drives this point. Keynes argued that, when the individuals and corporates panic and don't spend much, started to save all together at the same time, spending and hence the overall demand comes down. It will have multiplier effect in the negative direction .Saving may be good when one person tries to pay off loan. But for a nation, when all do that at the same time its quite bad for economy, he argued.

 At that situation Govt needs to take loan and spend/invest on important things, like infrastructure activities. This will create employment , put money in the pockets of people to spend. This spending is referred to as economic stimulus. Instead of waiting for market to find its own bottom in a recession, he said ,'In the long run we are all dead'. So Govt needs to act fast. Like a car, when it stalls, being pushed by people to resume working on its own, when market has problem Govt needs to push it with extra spending is the Keynesian response to slowdown.

 

 US spent 787 Billion dollars to fight the slump in 2008 and ran a fiscal deficit of 10%. In US, it was particularly interesting, as the Fed Rate was cut to 0.25 percent. Indian , Chinese Govts all provided stimulus during that period to fight the slowdown. In Europe, austerity gained prominence over spending and it’s pointed out by economists like Krugman for its slower recovery.

 

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