The Return of Depression Economics Essay Example for Free

The Return of Depression Economics Essay Classical economists like Smith and Ricardo often argued that economic prosperity can be best achieved if the market is left alone. They argued that the market alone is the most efficient mechanism of determining supply and demand, wages and labor supply. The market â€Å"being the invisible hand† removes sluggishness in the economy. At the beginning of the 20th century, these assumptions were attacked by neo-classical economists led by John Maynard Keynes. Keynes argued that because wages are essentially fixed in the short-run, it is possible for an economy to experience sluggishness (Keynes, 1936). This â€Å"sluggishness† causes temporary recessions, that if â€Å"untreated† may lead to depressions. The only means to treat temporary recessions is government intervention. Keynes (1936) argued that it is desirable for the government to either increase or decrease spending in order to boost the economy. This increase or decrease in spending may be facilitated by increasing or decreasing interest rates (on the expenditure side of the economy). Now, the assumptions of both classical and neo-classical economists are being attacked. Paul Krugman (a Nobel prize winner), in his book â€Å"The Return of Depression Economics,† put his main arguments against mainstream economics (Krugman, 2008). Here are some of his main points: 1) It is very possible for recession to occur even if an economy is in good shape. To illustrate this, he used the story of babysitting groups in Washington D. C. Here, couples agreed to babysit for each other. A special currency was used. Those who want to babysit would get the currency while those who do not want to babysit will give the currency. However, because the economy is in â€Å"good shape†, nobody wanted to babysit. Couples preferred going to social gatherings than babysitting. This creates a shortage of babysitters, which in effect caused the economy to experience recession. This is same case with government control of money supply. Supposing the government increases money supply in order to boost the economy, the real effect may in fact a real decline in overall production. The â€Å"good shape† of the economy may well be an enough reason for people to work less (which in the long run translates into lower economic output); 2) During economic prosperity, people usually invest their â€Å"money† to risky forms of investments. Supposing there are two sources of investments: trust funds and bank securities. Trust funds offer more returns and of course, higher risks. Bank securities are more conservative in nature (low returns and risks). During economic prosperity, trust funds usually earn more, and thus people invest in it. However, when one trust fund fails, people will usually withdraw their investment out of the system. This creates panic (confidence decreases) and the economy experiences recession; 3) And, panic can destroy wealth more easily than confidence can create it. Krugman noted that it took almost 100 years for the United States to accumulate wealth and only 5 years to destroy it (The Great Depression). In essence, a financial panic has a higher probability of occurring than a miraculous boom (due to soaring financial confidence). As Krugman noted, as more and more economies are being integrated into the world economy, the chances of experiencing recession in times of economic prosperity increases (Krugman, 2008). In short, economic prosperity may not be a bailiwick for economic certainty. References Keynes, John Maynard. 1936. General Theory of Employment, Interest and Money. London: London Publishing Company. Krugman, Paul. 2008. The Return of Depression Economics and the Crisis of 2008. New York: Penguin Books.