ECON 1A Midterm Review #5

Keynesians: $500 billion target gap in a recession, government increase its expenditures, MPC = 0.8

$500B = G * (1/(1-0.8)); G = $100B

Keynes' argument on what business leaders used to make their investment decisions

According to Keynes, they followed herding and extrapolating

Federal Reserve's crimes of omission in the spring of 1931 as called by Friedman and Schwartz

Banks started to fail after European banks started faltering, putting pressure on U.S. associated banks

Classical economists vs Keynes on laissez-faire policy

Classical economists argued that the laissez-faire was a good policy, but Keynes claimed that it was a terrible policy and that the government should be intervening

Classical economists on a decrease in consumer spending and interest rates

Decrease in consumer spending would increase consumer savings, reducing real interest rates and causing an increase in investment

Roosevelt's Third New Deal

Deficit spending, pump priming: upset the economy by increasing government expenditures, thereby increasing private expenditures

Friedman's argument regarding leaving the economy alone

Friedman argued that leaving the economy alone would leave it to operate at or near full employment

Cause of German hyperinflation

German hyperinflation was caused by an increase in the money supply

Crowding out and its effect on real interest rates

Government expenditures increase because of bonds sold to private buyers, so essentially borrowed money and more bonds on the market which increases real interest rates

President Roosevelt and "pump priming"

Government spending would push private spending

Friedman's position on classical economic theory

He supported the classical economic theory, and attempted to bring it back after the Keynes theory had ruled

Classical economists' warning against financing fiscal policies

Higher taxes could meant reduced productivity because of reduced incentive to work for wages, aka it may not actually contribute to growing the economy if the taxes were going elsewhere

Federal Reserve's crimes of commission in the summer/fall of 1931 as called by Friedman and Schwartz

In an attempt to convince the public that the U.S. was remaining on gold standard, the Fed raised interest rates by contracting the money supply, the biggest reduction in U.S. history

Type of fiscal policy financing that produces inflation

Increasing the money supply (aka monetized debt)

Keynesian monetary policy's target

Influencing investment expenditures by the way of interest rates

3% real interest rates, 6% expected inflation rate, +4% real GDP; what is the nominal interest rate?

Ir = In - INF; 3% = In - 6%, In = 9%; the nominal interest rate is 9%

No money illusion, money supply increase, effects on real wages

It will not change real wages

Consequence of the Fed's crime of commission on the U.S. money supply

It worsened the U.S. economy, contributing to the the Great Depression

No money illusion, money supply increase, effects on nominal interest rates

It would raise nominal interest rates

Economists on the pro-side and the other side of recessions turning into permanent depression

John Maynard Keynes vs Jean Batiste Say

First explicit Keynesian policy in the U.S.

Kennedy-Johnson Tax Cut of 1964

Keynes on money illusion and how it affects most people

Keynes believed that money illusion was prevalent and that people never did get rid of it usually

Keynes on the policies a socialist government should pursue

Keynes wanted a socialist economic policy, aka he wanted a panel of "experts" to make the decisions for the economy instead of investors and the like to rule the economy

Keynes and classical economists' interest in the future

Keynes was more interested in the short run, while classical economists were more interested in the long run

Fine-tuning

Keynesians believed in the ability of the government to fine tune, to erect policies in an attempt to smooth and eradicate the business cycle

Discretionary monetary policies according to monetarists

Monetary policies should operate by rule, not by discretion, as variable lags could make a recession worse

Classical economists about money illusion amongst the general public

Money illusion is widespread, but the public learns quickly and it does not last

Keynes and wages' flexibility on cushioning a recession

No, he didn't, he preferred wages to be rigid

A recession would not turn into a permanent depression based on Say's law

People keep working in order to buy things, and therefore a recession will eventually pass

Reason that the Bank of the United States' Dec 1930 failure that impacted the public confidence so badly

People thought it was the actual bank of the U.S. that was failing

Classical economists constantly reminding everyone that the business cycle is a true cycle

People would realize that any recession or depression eventually recovers

Roosevelt's "pump priming" vs. Keynes' policy

Pump priming was the same thing as the Keynes multiplier, essentially increasing government spending to boost the economy

Expansionary fiscal policies permanently increase the level of real GDP or employment

Real GDP: no; employment: temporary, via monetized debt

Say's law as a one-liner

Supply creates its own demand

Three basic ways an expansionary fiscal policy might be financed

Taxes, an increase in money supply (aka monetized debt), and true borrowing

Classical economists on the best policy for the government to pursue

The best economic policy was laissez-faire, and therefore good government should be small government

Keynes' argument on government policies during a recession

The government should cut taxes, look to multipliers

Keynesian economists about increases in money supply and nominal rates, real interest rate

They believed that an increase in money supply would reduce interest rates, and they were unconcerned about the real interest rate

Federal Reserve's crimes of omission in the last quarter of 1930 as called by Friedman and Schwartz

They failed to protect the Bank of the United States, a private bank in NY which caused panic because people thought that the actual bank of the U.S. had failed

J. M. Keynes and President Roosevelt's meeting in 1934

They met terribly because Roosevelt thought that Keynes was a giant snob and Keynes thought that Roosevelt was an intellectual midget

Classical economists on why some business leaders would invest even during the worst depression

They would realize that there is a recovery at the end of the depression, even turning a profit, especially if they invest

Type of fiscal policy financing that produces "crowding out"

True borrowing produces crowding out

Crowding out

When an increase in government expenditures means a decrease in private expenditures

Action by a central bank that produces monetized debt

When the Treasury Department sells bonds to the Federal Reserve, which it pays for by printing new money

Flexible wages' effects on the economy

Yes, as it could cushion the decline in profits during a recession and therefore also lessen the blow of decreased output and employment