20100908+notes - Lecture 3: September 8, 2010 Downturns and...

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Lecture 3: September 8, 2010 Downturns and Financial Markets Keynesians and Monetarists J. Bradford DeLong: Econ 1: Fall 2010 Version 0.8 This is the lecture on the relationship between economic downturns and ±nancial markets. The problem in economic downturns is that a lot of people who could work productively at wages that would make them and their employers happy are not. Yet when you talk to economists about how to cure such downturns they almost always come up with some theory or policy affecting ±nance. Why? R ECAPITULATION Our Framework for Depression Economics Last time we saw how recessions and depressions could come to be—how you can have collapses in the circular ²ow of economic activity and of total economy-wide spending like this one we are in now. We started with a puzzle. Jean-Baptiste Say set forth the circular ²ow principle in 1803—the idea that because everybody's spending is somebody else's income there can be no depressions, no recessions, no “general gluts” but only sectoral shifts and readjustments. Nobody makes except to use themselves or to sell. Nobody sells unless to buy. Therefore supply creates its own demand: why have to worry about sectoral maladjustment in which their to too much demand for one commodity and too little for another, but we don’t have to worry about excess supply, de±cient aggregate demand in general. That’s what Say said in 1803. Malthus pointed out that that sounded good in theory but did not seem to work in practice. And by 1829 Say and John Stuart Mill agreed with Malthus. We started with this circular ²ow principles, with “Say’s Law,” and we broke it. We broke it by pointing out that the normal process of adjustment, by which workers smoothly move from industries and occupations where there is excess supply to industries and occupations where there is excess demand, simply does not work when the excess supply is of goods and services and the excess demand is for money—or some other kind of ±nancial asset. Then people working in industries where there is excess supply lose their jobs. But there is no countervailing source of extra hiring in the economy to give them someplace to go.
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And last time we saw how these recessions and depressions could come to be big. Workers who lose their jobs are in households that thus lose their incomes, and they cut back on their spending. This second round of falling spending on currently-produced goods and services ampliFes the shortage of aggregate demand for goods and services, and multiplies the effect of whatever the initial problem was. Then there is a third round, a fourth, and a Ffth, until the economy settles down in some high-unemployment depressed state. What is the level of production at that depressed state? We presented a way to calculate it: our
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This note was uploaded on 10/04/2011 for the course ECON 1 taught by Professor Martholney during the Fall '08 term at Berkeley.

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20100908+notes - Lecture 3: September 8, 2010 Downturns and...

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