APPENDIX A A Closer Look at Aggregate Expenditure and the Multiplier
Photographer Dorothea Lange documented the dire circumstances of the Depression.
Stocks tanked. A typical investment in the stock market worth $100 just a few years prior quickly fell to be worth only $13. Bankruptcies soared and more than a third of all banks failed, erasing families’ savings. The economy shrank by nearly 30%, and roughly one in four people who wanted to work couldn’t find jobs. The Great Depression began in 1929 and launched a dark decade in U.S. history. It didn’t just reshape the American economy, it reshaped society. Poverty and malnourishment rose. Evictions led to widespread homelessness. The birth rate fell and the suicide rate spiked.
This extraordinary episode also changed economics forever. It exposed the mistakes of an earlier generation of economic thinkers who had argued that the economy would quickly repair itself. This period saw the introduction of the term macroeconomics, and it led to the development of a new approach to understanding broad economic trends. John Maynard Keynes and colleagues such as Joan Robinson created a macroeconomic framework that explains the painful reality that recessions and depressions can be common, costly, and persistent.
This chapter outlines the framework they built. We’ll start by analyzing the central role that spending decisions play in determining economic outcomes. Then we’ll explore how it’s possible for the economy to get stuck in a bad equilibrium in which joblessness and misery can persist. Finally, we’ll investigate the possibility that changes in spending can have a multiplied effect on the broader economy.
Together, these insights suggest that a determined government can halt an economic slump by boosting spending. This prescription was tested as the government scrambled to counter the Great Depression. President Roosevelt’s New Deal boosted government spending and appeared—at least for a while—to halt the economic decline. As Hitler rose to power in Europe, nervous investors sent their funds to the United States, which lowered interest rates and stimulated greater spending. The U.S. government’s heavy investment in the war effort also helped to boost spending. Ultimately economic growth resumed, the Depression ended, and this new field of macroeconomics had proved its worth. The insights we’ll explore in this chapter have since been built into the foundations of modern macroeconomics.