Keynes on Govt Intervention & US Macroeconomics

John Maynard Keynes, born 1883 in Cambridge, was a prominent economist and is known as the father of modern macroeconomics, Keynes was inspired by the Great Depression of the 1930’s in America to delve into the consequences of classical laissez-faire economics, Laissez-faire (roughly translated from French meaning “leave it alone”) was the leading economic theory at the time that essentially theorized that markets, when left alone and with no government intervention, were self-regulating. During the Great Depression, however, this theory did not prove effective as after the economic crash the economy did not manage to restore itself and the recession lasted for a decade.

Keynes saw the flaws within this classical economic theory and believed that laissez-faire capitalism was inherently unstable and created a volatile economy.

In 1936 Keynes published The General Theory of Employment, Interest, and Money, detailing what he believed were the flaws of capitalism, and presenting his theory that government intervention was necessary to stimulate growth in an economy and bring it out of a recession.

During the Great Depression, in 1934, President Franklin D Roosevelt met with Keynes who urged Roosevelt to stimulate the economy through public works spending. Roosevelt, however, dismissed many of Keynes ideas and it was not until 1938 that some of Roosevelt’s economic advisors were able to convince him that some fiscal stimulus would be beneficial to the economy. The Roosevelt administration did turn to public work spending, which did increase growth, however the spending was not large enough to pull the American economy out of recession.

Get quality help now

Doctor Jennifer

Verified

Proficient in: Bank

5 (893)

“ Thank you so much for accepting my assignment the night before it was due. I look forward to working with you moving forward ”

+84 relevant experts are online

Hire writer

It was not until World War II, when government spending increased significantly, that Keynes was proved right as the economy not only began to recover, but boomed.

It was after this point that many finally began to embrace Keynes’ theories and disregard classical economic theory. The prosperity that came after WWII lasted for almost four decades until the late 1970’s. Though while the 1980’s loomed so did an era of deregulation and the reign of finincialization that once again brought the American economy to its knees in a manner than sharply mirrored the financial collapse of the 1930’s, In 1933 the Glass-Steagall Act was enacted This piece of legislation set up provisions separating commercial and investment banking. As early as the 1960’s, banks began lobbying for the repeal of this act and over the next few years banks continued chipping away at it. In 1986, the Federal Reserve “reinterpreted“ the Glass-Steagall Act and allowed commercial banks to use up to five percent of gross revenues in investment banking.

In 1987, Alan Greenspan, an outspoken supporter of deregulation, was appointed Chairman of the Federal Reserve and further “reinterpreted“ the Glass-Steagal Act over the next ten years, allowing banks to use more and more of their revenues in investment banking operations until the Glass-Steagal Act was declared “no longer appropriate” by President Bill Clinton in 1993. One years later, in 2000, the Commodity Futures Modernization Act fully deregulated derivatives, essentially allowing banks free reign to gamble. Further, after the collapse of the dot»com bubble and the September 11 terrorist attack, Greenspan, sensing that the economy might be in trouble, set interest rates at only 1 percent, While this initially discouraged investors from investing, it gave great incentive [0 banks to borrow more than ever before. This era of deregulation was highly encouraging to the financial sector, which grew enormously in both size and influence in a process known as financialization.

During this time there were several stock market crashes after which the banks were bailed out, contributing to the banks own inflated sense of self-importance and further incentivising their risk taking With these reverse incentives and the ability to borrow money with only 1 percent interest, banks turned their attention to the housing market. With their borrowed money, banks bought large bundles of mortgages (known as Collateral Debt Obligations, or CDO’s) and sold them at higher prices to investors and other bankers, Initially these mortgages were relatively safe, but as banks became more invested in trading CDO‘s and found that many of those who could qualify for a mortgage already had one, they turned to those who would not be desirable home-owners. The banks felt safe increasing the risk of Lhe CDO‘s, and lenders no longer required down-payments or proof of income from those buying homes, leading to a large expansion of the housing market.

These mortgages to undesirable home-owners, known as subprime, however, were rated as being safe investments in order to increase their desirability The banks did not care that these mortgages were bad, as long as they could sell them on to the next person and collect their profit. While this system worked to further expand the financial sector and make everyone who played along wealthy, it could only go on for so long. Between 1973 and 2005 debt within the financial sector grew from 9,7 to 31.5 percent of GDP as banks borrowed extremely large amounts of money believing that they would be able to pay it back in the future, after they had succesfully sold their CDO’s along to the next investor. This was common practice at every bank in America and even spread across the world. Everyone was digging themselves into more and more debt as they continued to pass along CDO’s made up of subprime mortgages, in what can only be described as a ridiculous form of the game ‘hot potato.’

Furthermore, the financial sector was not the only sector going deeper into debt. Total debt between 1973 to 2005 rose from 140 to 328.6 percent of GDP. During the same period wages for the average worker stagnated. Today the average male worker makes less than he did at the end of the 1970’s. However, despite the fact that wages began to stagnate in the late 70’s, the middle class was still spending. Robert Reich, in his film Inequality forAll, explains that the middle class employed three coping mechanisms in order to maintain their standard of living. The first was that women began to work. When this way of life was no longer enough to maintain a certain standard of living, workers began to work more hours, however that was not even enough to combat the wage divide that was continuing to increase.

Finally, the middle class turned to borrowing, and between households and financial institutions a huge debt bubble was created Meanwhile, the banks game of hot potato with CDO’s was coming to an end as more and more households were defaulting on their loans and no banks were able to sell their risk off to the next person. In 2008 the bubble burst and the American economy collapsed; millions ofAmericans lost their homes and their jobs as the economy went into recession. As the 2008 financial crisis greatly resembled the Great Depression of the 1930’s, it would be easy to imagine what Keynes would have to say, as his criticisms of capitalism would once again be proved right. History has been cursed to repeat itself once more as the American government refuses to listen to the voice of reason warning against deregulation and financialization Banks are being bailed out and sent on their way to do it all over again.