Ashish Reddy
SID: 25574135
Econ 105 – History of Economic Thought
Final Paper
12/13/16
Government Intervention
The Great Recession in 2008 was predicted by numerous economists and even though their theories wouldn’t have prevented the recession from happening, their theories should have helped us be more prepared in what to do next and how to implement their theories. The Great Recession saw the biggest dip in our economy since the Great Depression of the 1930s leading to an economic crisis that most weren’t prepared to deal with. The 3 economists whose theories revolved around government intervention were John Keynes, Alfred Marshall, and Giovani Arrighi. Arrighi predicated the world’s shifts every couple centuries and knew that the US was due for a power shift. Marshall focused on the fact that government intervention was needed for a “so called” economic freedom. But it was Keynes, especially, that was known for his economic resurgence during the 2008 crises. Keynesian economics made a comeback during this time and changed the way we view economics in everyday life today.
After the Great Recession occurred, the Federal Reserve decided to lower the real interest rates to almost near zero. The US housing market crashed and the economy took a huge hit and because of this, the fed wanted to take action to prevent what happened during the Great Depression. They wanted to encourage more borrowing and spending and in result of that, wanted the GDP to increase and they did this by lowering the borrowing cost to near zero. Bringing the borrowing to near zero in theory should encourage people to spend more money which in turn, should stimulate the economy.
This mostly had to do with the Fed raising the interest rates as less borrowing and less spending means the aggregate demand curve will be decreasing and shifting to the left. The aggregate demand curve shifting left causes both the inflation rate and the output to decrease. Another effect of raising the interest rate would decrease the price of foreign currency and raise the dollar while decreasing their net exports. All the combined changes from the investment curve, net exports, and aggregate demand will set off the multiplier effect which means that the Fed’s actions will slow the growth but will not and should not trigger a recession.
Now where is the economy headed? It is nearly impossible to say with Trump as our next president. However, Arrighi has long been predicting the American downfall, even before Trump’s presidency. Giovanni Arrighi was a Marxist that focuses on how the economy is predictable. He focuses on how the national economy and capitalism hasn’t been national in over five centuries. Arrighi talks about how the world’s economy follows a pattern or almost like a cycle. From the Genoese, to the Dutch, to the UK, and to the US, it has all followed a pattern. His pattern prediction started in the 15th century and goes all the way to present time. The Genoese were in power from the 15th to the 17th century. The Dutch were in power from the 16th to the 18th century. The British were in power from the 19th century to the 20th century and the US has been in power ever since. However, Arrighi knows that the next power shift is over due and has been predicting, who’s next? The world follows a pattern as investors invest in a global stage and economy is transportable. If things go bad in one country, you simply invest in another country. You just move your assets from one bank to another. For example, if the economy goes south in the United States, people will move their funds and invest in a country like China. They will just transfer their wealth to wherever the economy is doing well. The thing is that investors are not bound by the boundaries that we already made. This can be seen from the 2008 recession. Arrighi has predicted that the US reign is coming to an end and the Great Recession might have just been the turning point that he was awaiting.
In his writing, he was able to reflect on all the past crisis and reflected on the worlds power shifts. He talked about how long periods of discontinuous change have been far more typical as of late. “Our thesis is that capitalist history is indeed in the midst of a decisive turning point, but that the situation is not as unprecedented as it may appear at first sight Long periods of crisis, restructuring and reorganizing in short, of discontinuous change, have been far more typical of the history of the capitalist world-economy” (Arrighi). We can see that he clearly states that the world is changing and the capitalist world is overdue for a power shift.
In his paper, Arrighi also brings up an additional interesting point with the theory of the MCM’ diagram. At first glance, this diagram is very confusing but with time, the diagram truly explains how the power shifts occur and can be used when looking at the Great Recession. The MC stands for the capital accumulation phase while the CM’ stands for the financial rebirth and expansion phase. “Marx’s general formula of capital (MCM’) can therefore be interpreted as depicting not just the logic of individual capitalist investments, but also a recurrent pattern of historical capitalism as world systems. The central aspect of this pattern is the alternation of epochs of material expansion (MC phase of capital accumulation) with phases of financial rebirth and expansions (CM’ phases)” (Arrighi). He basically talks about how this is a systemic cycle of accumulation is what the alternating MC and CM phases show. The implication of the MCM diagram for investing patterns is that investors invest in fixed capital are not at the end of the process but as a means toward more “M.” Otherwise, the capital would just revert back to a more flexible money form.
Arrighi applies the MCM’ to regimes and capital accumulation. When investments flat line, investors look elsewhere. Basically, you start the MC phase for successor hegemon until the CM phase begins where this investment flat lines. The start of the CM phase is the start of the MC phase for the next hegemon. To summarize, its consecutive systemic cycles of accumulation overlap, and although they become progressively shorter in duration, they all last longer than a century.
While Arrighi is unique in his own way, he is in some aspects very similar to other economists. Marshall, Keynes, and Arrighi are not that different. They all have the same groundwork in their theories. Marshall and Keynes say that there are no boundaries and capital will flow where there are the highest returns. Capital does not follow negatively or downhill because it would rather just go internationally. This is very similar to Arrighi‘s thinking in that investors will just invest where the wealth is.
Alfred Marshall was a British economist that is well known for transforming the thinking of economics. His theory was based off how the price of a good cannot be the only determinant when producing the good but you must also take into account who actually buys the good. There must be more than just production that goes into the price making. His theory is what we know as the law of supply and demand and this is where our modern supply and demand graph comes from. This goes into how the price of a good is determined by how hard it is for society to supply the good and how useful and how much demand there is for the good for society. For the first time, it takes into account both supply and demand. Taking a look at his book The Principles of Economics, he mentions numerous times that the price and output of a good are determined by both supply and demand. (“Alfred Marshall”) Marshall is credited for many of the elements that make up modern economics and his theory was used when the Great Recession occurred. His theory of supply and demand brought in government intervention and he wanted to speed up the economy by encouraging more spending and decreasing the cost of borrowing. This could all be derived from the original supply and demand graph. While Marshall introduced this model we use everyday, it was actually Keynes that further developed the theories and is the one that made the biggest impact into our economy today.
John Maynard Keynes was an English economist who is know for his theories that changed macroeconomics to what we know of today. Keynes was different than all the other economists because he was one of the first ones to think about the demand side of economics and thought about how demand actually drives the economy, not only supply. He knew that the demand for goods would be what would lead to more jobs, more spending, and would drive the economy positively. “…Equipment and technique, real wages and the volume of output (and hence of employment) and uniquely correlated, so that, in general, an increase in employment can only occur to the accomplishment of a decline in the rate of real wages” (Keynes 15).
Keynes’s biggest piece of work was “The General Theory of Employment, Interest and Money.” His book introduced Keynesian economics and for the first time, challenged the neo-classical thinking and classical economics. His work made points that without the government, the market would establish full employment equilibrium. The General Theory also argued, as mentioned above, that demand, not supply is what is driving the overall level of economic activity. “The postulate that there is a tendency for the real wage to come to equality with the marginal disutility of labor clearly presumes that labor itself is in a position to decide the real wage for which it works, though not the quantity of employment forthcoming at this wage” (Keynes 10). This goes to show that labor does not set the real wages but rather the employment level. “But there is no reason in general for expecting it to be equal to full employment. The effective demand associate with full employment is a special case, only realized when the propensity to consume and the inducement to invest stand in a particular relationship to one another” (Keynes 31).
One of Keynes biggest point was that it is wrong to assume that in the long run, there will be full employment. He also wanted to make it clear that how much employment is not and should not be a determinant of the price of labor. We should just move our attention to the actual spending of money, or the aggregate demand, which was exactly what was proposed in the aftermath of the Great Recession. “…Leaving the real wage and the level of unemployment practically the same as before, any small gain or loss to labor being at the expense or profit of other elements of marginal cost which have been left unaltered…A fall in real wages due to a rise in prices, with money-wages unaltered, does not, as a rule, cause the supply of available labor on offer at the current wage to fall below the amount actually employed prior to the rise of prices. To suppose that it does is to suppose that all those who are now unemployed though willing to work at the current wage will withdraw the offer of their labor in the event of even a small rise in the cost of living.” (Keynes 11-12)
The great depression was the trailblazer with which the Keynesian Revolution started. “For Government borrowing of one kind or another is nature’s remedy, so to speak, for preventing business losses from being, in so severe a slump as to present one, so great as to bring production altogether to a standstill” (Keynes 144; Essays in Persuasion).
While Keynesian economics was the primary response during the Great Depression up till the 1970s, his theory was abandoned after that. By 2009, economists realized the need for fiscal stimulus. However, 2010 rolled around and while the recession was pretty much over, unemployment was still very high all around. The wake of the financial crisis was known as the Keynesian resurgence. Fiscal stimulus packages were launched around the world from 2008 to 2009. Keynes made sure to put a lot of importance on avoiding large trade deficits or surpluses. It was to make sure there was no global trade imbalances.
In 2009, congress passed their “stimulus bill” as I mentioned above but Congress failed to actually enact a stimulus. There are some main opposition to Keynesian economics though. Classical theorists believe that the markets self correct themselves. These theorists believed that an increase in unemployment is not permanent and would eventually correct itself. This is where Keynes came in and made arguments against the classical economists. He suggested that wages are indeed not flexible and are sticky as this would eliminate unemployment. The second thing he suggested was that even if wages decreases, it could cause deflation and this deflation will reduce the amount of business spending on investments, lowering the aggregate demand, and lead to lower demand for labor. He knew that cutting wages would not end a depression but further make the situation worse.
Since the 1970s, Keynesian economy was out and the monetarist economy was the new focus. However, even in the Great Depression, many people blamed monetary factors for the reason the banks collapsed which ended up causing the depression. We all believe that Presidents FDR New Deal was the reason we got out of the Great Depression but that is a common misconception. It was actually his policies put in place to stabilize the banks and get rid of the bank standard that got the economy going back in the right direction. (Kling) When you further look into though, some believe that the Keynesian policy has failed us. His stimulus plan that economists believed would work just did the complete opposite. However, even this proposition is argued by most economists because his plan has never fully been put into action.
When looking back at the 2008 financial crisis, it might have just come down to our economy and our policy makers just simply not being ready for the crisis. Keynes, Marshall, and Arrighi all had proven theories that could have been used when the Great Recession hit. Arrighi knew the world was due for a power shift and predicted that the US was on its way down. Marshall knew that the economy needed government intervention when the economy collapsed but we failed in that aspect. Keynes brought his theory of macroeconomics and economists believe that Keynesian economics could have been used better in the aftermath of the Great Recession. I don’t necessarily agree with all of Keynesian economics but I believe that economists should have viewed both Keynesian and Classical economics theories better when trying to resolve the economic downfall. I think economists learned from this situation and will be better prepared to deal with the next big recession or depression.
Works Cited
“Alfred Marshall.”: The Concise Encyclopedia of Economics. N.p., n.d. Web.
Arrighi, Giovanni. The Long Twentieth Century: Money, Power, and the Origins of Our times. London: Verso, 1994. Print.
Golem. “Why Are We Bailing out the Banks? Part Two. Theory, Ideology and Failure. – Golem XIV – Thoughts.” Golem XIV – Thoughts. N.p., 2012. Web. 17 Nov. 2016.
Granville, Kevin. “Why December Is Looking Likelier for the Fed to Raise Interest Rates.” The New York Times. December 7, 2015. Accessed December 8, 2016.
“Fed Decision: What Happens When Interest Rates Rise?” Fed Decision: What Happens When Interest Rates Rise? Accessed December 7, 2016.
Keynes, John Maynard. Essays in Persuasion. New York: Norton, 1963. Print.Keynes, John
Keynes, John Maynard. The General Theory of Employment, Interest and Money. New York: Harcourt, Brace, 1936. Print.
Kling, Arnold. “Would Keynes Have Supported the Stimulus Bill?” The American, 23 Feb. 2016. Web. 8 Dec. 2016.
Marshall, Alfred. Principles of Economics. London: Macmillan for the Royal Economic Society, 1961. Print.
“Monetary Policy Basics.” Monetary Policy Basics. Accessed December 8, 2016.
“What’s Behind the Fed’s Interest Rate Decision?” Whats Behind the Feds Interest Rate Decision Comments. September 21, 2015. Accessed December 10, 2016.