2.6.2. Demand-Side Policies in the Great Depression and the Global Financial Crisis of 2008

This study note for Edexcel economics looks at Demand-Side Policies in the Great Depression and the Global Financial Crisis of 2008

Demand-side policies involve the use of government spending and tax policies to influence the level of aggregate demand in the economy. During economic downturns, these policies aim to boost demand to counteract the effects of reduced private sector spending.

Great Depression (1929-1939)

Context:

• The Great Depression was a severe worldwide economic depression that took place during the 1930s.
• The U.S. experienced a drastic fall in GDP and industrial production, leading to massive unemployment and deflation.

Policy Responses:

United States:

• New Deal (1933-1939): Implemented by President Franklin D. Roosevelt, this series of programs and projects aimed to restore economic stability.
  • Examples:
    • Public Works Administration (PWA): Created jobs through large-scale public works projects.
    • Social Security Act (1935): Introduced unemployment benefits and pensions.
  • Keynesian Influence: Policies were influenced by John Maynard Keynes, who advocated for increased government spending to boost demand.

United Kingdom:

• Initially followed a policy of austerity and balanced budgets.
• Abandonment of the Gold Standard (1931): Allowed for more flexible monetary policy.
• Public Works Programs: Some increase in public spending, but not as extensive as the New Deal.

Global Financial Crisis (2008)

Context:

• Triggered by the collapse of the housing market in the U.S., leading to a banking crisis and severe global economic downturn.

Policy Responses:

United States:

• American Recovery and Reinvestment Act (2009): A $787 billion stimulus package aimed at creating jobs and spurring economic activity.
  • Examples:
    • Tax cuts and benefits for families and businesses.
    • Funding for infrastructure, education, and health.
  • Keynesian Influence: Emphasis on government spending to stimulate demand.

United Kingdom:

• Bank Rescue Packages (2008): Nationalization and bailout of banks to stabilize the financial system.
  • Examples:
    • Government purchase of shares in banks.
    • Guarantees on bank debts.
• Fiscal Stimulus (2009): Measures included VAT reduction and increased government spending on public services and infrastructure.
  • Keynesian Influence: Similar approach to the U.S. with increased government intervention.

Different Interpretations

Classical Economists:

• Emphasize self-correcting nature of markets and argue against excessive government intervention.
• Believe that markets will naturally adjust to downturns through wage and price flexibility.

Keynesian Economists:

• Advocate for active government intervention to manage economic cycles.
• Emphasize the importance of boosting aggregate demand during recessions through fiscal and monetary policy.

Monetarist Economists:

• Focus on controlling the money supply to manage economic stability.
• Criticize Keynesian policies for leading to inflation and inefficiency.

Key Economists

John Maynard Keynes:

• Advocated for increased government spending during economic downturns to boost aggregate demand.
• His ideas significantly influenced policies during both the Great Depression and the Global Financial Crisis.

Milton Friedman:

• Monetarist who emphasized the importance of controlling the money supply.
• Critical of extensive fiscal intervention, favoring monetary policy as the primary tool for managing the economy.

Christina Romer:

• An economic historian who contributed significantly to the understanding of the Great Depression.
• Advised President Obama during the Global Financial Crisis, advocating for substantial fiscal stimulus.

Carmen Reinhart:

• Notable for her work on financial crises, including the Global Financial Crisis.
• Emphasized the importance of understanding the interplay between public debt and economic recovery.

Joan Robinson:

• Worked on Keynesian economics and development economics.
• Advocated for addressing inequality and structural issues within economies.

Essay-Style Questions

1. Compare and contrast the demand-side policy responses of the United States during the Great Depression and the Global Financial Crisis of 2008.
2. Evaluate the effectiveness of Keynesian economic policies in addressing severe economic downturns, with reference to the Great Depression and the Global Financial Crisis.
3. Discuss the criticisms of demand-side policies from the perspectives of classical and monetarist economists, using examples from the Great Depression and the Global Financial Crisis.
4. Analyze the role of government intervention in stabilizing economies during major financial crises, considering both the benefits and potential drawbacks.

Glossary

• Aggregate Demand: The total demand for goods and services within an economy.
• Fiscal Policy: Government adjustments to spending and taxation to influence the economy.
• Monetary Policy: Central bank actions involving the control of the money supply and interest rates.
• New Deal: A series of programs and reforms introduced during the Great Depression to stimulate economic recovery.
• Stimulus Package: Government initiatives aimed at boosting economic activity through increased public spending and tax cuts.