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How the Economy Responds to Governmental Attempts to Overcome Slumps and Depressions

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HOW THE ECONOMY RESPONDS TO GOVERNMENTAL ATTEMPTS TO OVERCOME SLUMPS

1. INTRODUCTION

National economies are continuously undergoing change and are never completely stable. A good indication of the degree of this activity is the paper-value of the total share-holdings that continuously expand or contract in size and is called a bulls or a bears market. But in certain circumstances this fluctuation does not remain small and one particular part of the macroeconomics system has prices that steadily increase. This unstable behaviour cannot last for ever and eventually these prices stop rising and then suddenly collapse. From this catastrophe the shock spreads across the whole system as a depression develops. At the stage being considered here, this failure has recently occurred and an economic slump is in progress. The total value of share-holdings has decreased dramatically and the stock-market trade has significantly shrunk. Reductions in the demand for produce have led to much unemployment and the increased withdrawals of savings have resulted in some bank failures.

In the great slump of 1929, it was first believed that the best governmental policy is to do nothing, because the robust nature of the market economy causes it to quickly right itself. But even after some changes were introduced this recovery took almost 10 years. Today most economists believe that the adverse effects of slumps should be eased by taking suitable measures. However, the choice of which changes to introduce, for creating a beneficial effect on the national economy as a whole, is not so obvious as when in 1936 John Maynard Keynes [1] first began to prescribe them. Experience and deeper analysis of these and other proposals has found that all but two are ineffective, and one of these at best, is remedial for a limited time. The situation is more complex and a change that favours a specific part of the social structure does not necessarily improve all of it. The following analysis shows why Keynes's proposals are mostly unsatisfactory and determines which action produces better results.

2. DESCRIPTION OF THE SLUMP AND ITS INFLUENCE

The origin of these slumps is due to speculation within the building industry and the dynamics of the supply and prices of building-land. With every other kind of traded item, the ability to use similar but different products avoids the dictatorial influence of a perfect monopoly. (This freedom is expressed in the natural self-regulation of prices, by supply always equalling demand according to Say's Law. Neither over-production nor under-production results; competition always ensures that the goods are traded close to their optimum price.) However, as Mark Twain proclaimed "Buy land, they're not making it anymore", and the number of building-sites is severely limited. Consequently the land-owning cartel is absolute-there is no alternate suitable path that demand for this resource can take.

The ensuing steady rise in the prices of housing reaches a level where the landlords, banks and builders decrease their participation and eventually stop investing or speculating in land-values. Builders no longer manage to sell their houses before they are completed and the land prices in the real-estate business cease growing sufficiently fast as to attract any speculators. Few investors or banks are now funding house-building, although it is not the cost of their construction which has dramatically changed but that of the land. At this stage in the business-cycle the system is ready to collapse and it takes but a small external shock to cause this. It inevitably comes from a different economic source, which has an independent effect on the community.

Recently and as an example, a sharp rise in oil prices causes the speculative value of out-of-town housing to fall, due to the greater cost of motoring to the densely-populated centres of industry, commerce, learning and recreation. No longer is it desirable to reside where the more expensive travelling adds to the house-keeping bills. The reduced demand for this kind of real-estate lowers its price (and its rent), but existing mortgage payments remain unchanged and cease to be compatible. With the awareness of the speculative loss, a significant number of foreclosures follow and bank insolvencies result, the houses being sold off cheaply. As credit becomes harder to obtain, the recession of the associated economic activity spreads outside of this sector of the community unemployment grows and many more families are unable to pay their regular fees for the rental or mortgage of their more modest homes.

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The news of bank loses from the foreclosures warns the savers, and many of them decide to transfer their money into non-interest paying current accounts or to withdraw it. The use of these sums by the banks is now inhibited, causing a "credit-squeeze" having high interest rates. With less money being spent, the productive sectors of the macro-economy reduce their prices so as to encourage the purchase of more consumer goods. But this does not overcome the problems of high interest rates on loans nor return the monetary commerce to its former level. Consequently the system enters into a depressed state, with substantially less macro-economic activity.

These experiences and the places or kinds of individuals that feel them are described below. The logical arrangement of this dissertation is complicated by the combinations of the various parties involved, together with the different ways that they are affected. The hardships caused by the slump simultaneously influence the macro-economy in four basically different ways.

2.1 Decreased Demand for Goods and Less Employment in Industry

The curtailed programme of house-building, the diminished credit and the reduced purchasing by would-be householders and other consumers, result in less economic activity and smaller demands for many kinds of goods items. The unit cost of their manufacture rises, whilst the available sums for their acquisition shrink and lower outputs are the result. After trying to stimulate the demand by reducing prices, the managers in industry and commerce are reluctant to retain labour with little or nothing to do. So they shorten the length of the working-day, temporally lay-off some of their workers and eventually have to dismiss them. Many manufacturing concerns fail to provide dividends on their shares which fall in value, whilst some companies cannot even manage to stay in business. The level of unemployment grows. Petty crime increases, due to the rising levels of poverty and boredom.

2.2 Smaller Pensions

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With pension funds, the process of saving and withdrawing is a continuous one. Some of the out-flowing money comes from contributions by younger subscribers, but much of the funding is taken from the dividends on prior investments made at the stock-exchange. After these have slumped there is less money available for paying regular pensions, even though some of the losses are spread by insurance. The managers of the funds want to avoid disproportionately high withdrawals and the result is that smaller sums are paid out. Consequently the pensioners have less income to meet their needs and they buy smaller quantities of consumer goods and services.

2.3 Bank Insolvency

The multiple-credit structure of the finance-system is now under heavy stress. With slump conditions prevailing, some of the investors and speculators are defaulting in the return of their credit, due to their inability to sell the land and buildings even for the sums at which they were purchased many years before. In parallel with this, due to the reduced level of production and wages, savings are being withdrawn at greater rates, because the reduced average rate of consumption is still more than the reduced average rate of earnings. These effects add to the credit squeeze.

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