Keynesian Theory says that the problem was lack of aggregate demand. Keynes passionately argued that governments should intervene in the economy to stimulate demand through inspiring consumer confidence by increasing the government spending. As he said, when the times become tough, people are starting to hoard money and not spend it so the natural circular of the money in the economy falters. That is why the government should encourage the consumers to spend their money again and this could be done only if the government increased its spending and created some jobs.
The Austrian School Theory on the other side thinks that the main cause of the Great Depression was the creation of the Federal Reserve and the loss of confidence in the banking system. Federal Reserve caused that the government monopolized the money supply and credit and money. They believe that the increased money supply in that period caused that the prices have risen and therefore the consumer spending dropped. There has also been an expansion of credit in 1920s which means that goods or services are obtained without immediate payment, usually by agreeing to pay interest. First it was good but after a while the banks were not able to pay the money back, so that is why many banks closed down. Moreover, after the stock market crash in 1929, there was a panic and people withdrew their money from the banks which caused that even more banks went out of business.
The Monetarist Theory is of an opinion that the actions taken by the central bank system (the FED) created and perpetuated the depression. The FED raised the interest rates in 1928 which discouraged business borrowing and spending. This resulted in the decline of the production and therefore the total output dropped significantly. Between 1929 and 1932, the Federal Reserve allowed the money supply to fall by a third. In particular, Monetarists such as Friedman criticize the decisions of the FED not to save banks going bankrupt. As the banks closed down, the amount of money circulating in the economy decreased and this also caused that the aggregate demand for goods and services decreased, too.
The economy started to recover when Franklin Roosevelt became a president on March 4, 1933 and immediately instituted The New Deal. The New Deal was that the federal government stepped in and created jobs. The ambitious New Deal program put 8,500,000 jobless to work, mostly on projects that required manual labor. Basically, The New Deal was that the government spending was increased and there were more jobs available. As the unemployment dropped, people had more money so the consumer spending and confidence have risen along with the aggregate demand. Moreover, a rise in aggregate demand caused that the production increased and the circular flow of money in economy came back to normal.
by
kacuzzka (student)
