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Chapter 17: Q1. (page 612)

In their famous book A Monetary History of the United States, the economists Milton Friedman and Anna Schwartz argued that the Federal Reserve was responsible for the Great Depression because it failed to pursue a sufficiently expansionary monetary policy. Why would a classical economist have thought that action by the Federal Reserve would not have made a difference in the length or depth of the Great Depression?

Short Answer

Expert verified

According to a classical economist, the Federal Reserve’s action of expansionary monetary policy would have remained ineffective in terms of output.

Step by step solution

01

Step 1. Belief of the classical economist regarding the action which the Federal Reserve could have taken

Prior to the occurrence of the Great Depression during the 1930s, when the deflationary pressures were operating, the Federal Reserve did not implement the expansionary monetary policy.

According to a classical economist, the action of expansionary monetary policy would not have revived the economy for which there would not be any difference in the Great Depression’s length and depth.

In the short-run, the action could have rejuvenated the economy but would have remained unsustainable as in the long-run, due to attainment of full employment level, the output will not increase, but the price will increase.

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Most popular questions from this chapter

Question: Why did the Great Recession lead to the decline of the Great Moderation consensus? What is the current state of consensus among most economists?

In late 2008, as it became clear that the United States was experiencing a recession, the Fed reduced its target for the federal funds rate to near zero, as part of a larger aggressively expansionary monetary policy stance (including what the Fed called quantitative easing). Most observers agreed that the Fed’s aggressive monetary expansion helped reduce the length and severity of the Great Recession.

a. What would rational expectations theorists say about this conclusion?

b. What would real business cycle theorists say?

In a press release during the Great Recession, the National Federation of Independent Business, which calculates the Small Business Optimism Index, stated "The Small Business Optimism Index rose just 0.1 points in January… . Historically, optimism remains at recession levels. While small business owners appeared less pessimistic about the outlook for business conditions and real sales growth, that optimism did not materialize in hiring or increased inventories plans." Would this statement seem familiar to a Keynesian economist? Which conclusion would a Keynesian economist draw for the need for public policy?

What are the limits of macroeconomic policy activism?

Why did the Great Recession lead to the decline of the Great Moderation consensus? What is the current state of consensus among most economists?
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