The Great Depression led to a shift in economic views, with Keynesian economics advocating for government intervention to balance the free market. The US Federal Reserve’s monetary policy and the Smoot-Hawley Tariff Act were also significant factors in the depression.
The Great Depression is a phenomenon that changed the world and the views of many nations on how to handle economic situations. While classical economic theory, like the Austrian School, espouses limited government intervention in the free-market system, proponents of Keynesian economic theory believe in correctly calculated government economic policies. These policies exist because free markets are unable to provide full employment and lack self-balancing mechanisms. Keynesian theory was dominant in the decade leading up to the Great Depression, which of course led to the worst economic recession in American history.
Keynesian economics is thought to be somewhat anti-entrepreneurial in nature, requiring that governments be able to exercise great authority. Policies are often debated, as the real cause of the Great Depression is not a single incident but rather a series of missteps through misguided government policy. For example, the blame for the Great Depression lies with the US Federal Reserve. This institution is responsible for setting the economic market’s monetary policy, mainly in the realm of money supply. Keynesian economics attempts to balance the supply and demand for money by using a central bank to set an interest rate that represents the cost of borrowing. During the 1920s, America was still using the gold standard. The Federal Reserve raised the discount rate to keep gold from leaving America after World War I. This had an immediate deflationary effect on the markets and started limiting economic activity and artificially lowering prices in the economic market.
Once the Great Depression was evident and in full force, Keynesian economic theory called for government to intervene through programs and other investments guided by federal policies. Tax rates also increased during this period, reducing individual incomes. This was the result of the New Deal, which created Social Security taxes – a Keynesian economic idea designed to provide retirement for the elderly. Monetary policy has also led to a significant decline in lending, which has prevented banks from providing funds for individuals and businesses to engage in economic activity.
Another significant factor in the Great Depression was the Smoot-Hawley Tariff Act. Classical economic theory holds that free trade equals a well-managed economy; Keynesian economics applied the government balancing act to regulate market and trade with foreign nations. Smoot-Hawley was a protectionist measure to ensure America was able to produce and sell manufactured goods within its borders. This attempted to prevent cheap goods from entering the market, which would have reduced business investment and thus reduced employee wages. Engaging in protectionist economics was also thought to help avoid the Great Depression, as fewer imports meant more domestic employment. These factors are just some of the significant links between Keynesian economics and the Great Depression.
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