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Principles of Economics- Mankiw (5th) 700

Principles of Economics- Mankiw (5th) 700 - 724 PA R T T W...

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724 PART TWELVE SHORT-RUN ECONOMIC FLUCTUATIONS percent. At the same time, the price level fell by 22 percent over these four years. Many other countries experienced similar declines in output and prices during this period. Economic historians continue to debate the causes of the Great Depression, but most explanations center on a large decline in aggregate demand. What caused aggregate demand to contract? Here is where the disagreement arises. Many economists place primary blame on the decline in the money supply: From 1929 to 1933, the money supply fell by 28 percent. As you may recall from our discussion of the monetary system in Chapter 27, this decline in the money supply was due to problems in the banking system. As households withdrew their money from financially shaky banks and bankers became more cau- tious and started holding greater reserves, the process of money creation under fractional-reserve banking went into reverse. The Fed, meanwhile, failed to off- set this fall in the money multiplier with expansionary open-market operations.
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