All Terrain Thinking

A Compendium of things I think are Important

Economics: It's not just whats' in your wallet

Answers for the Day
1930s: The Challenger

1. What is Roosevelt referring to in his inaugural speech when he says:  "I shall... wage war against the emergency as great as the power that should be given to me if we were in fact invaded by a foreign foe." How is the New Deal related to the emergency.

The emergency is the Great Depression and the collapse of the American economy that bottomed out with approximately 25 percent of the labor force unemployed at a time where there were no unemployment benefits.  If a foreign power invaded the country and bombed the factories, then this would have created the type of unemployment that Roosevelt saw in the country during the early 1930s.  The New Deal was the set of programs that Roosevelt began to get the economy moving again.  Just as we would mobilize our country in the early 1940s to deal with foreign aggression, in the early 1930s it was time to mobilize the country to deal with the domestic crisis.   Part of the program was to increase government spending on domestic projects - a small scale version of a wartime economy. 

2. What is a Hooverville and what is the relationship between it and Keynes' statement: "In the long run we are all dead?"

The collapse of the economy put many people out of work and they were forced out of the apartments and homes that they had in America's cities.   Some of these set up "home" in shanty towns on the outskirts of towns - places that you see today on the outskirts of many Latin American cities.  many of these displaced also started moving west where there was more open space - the people Steinbeck wrote about in the Grapes of Wrath.  Keynes' view was that the economy may in the long run correct the problems, but that the Hoovervilles were proof that the long run was too long - that the suffering and death that would accompany the adjustment was too large to accept. 

3.  What is the relationship between the concepts of the multiplier and crowding out and the Visible and Invisible Hands?

The Classical economists believed that government intervention in the economy would crowd out the private sector, that there would be no net increase in the size of the economy that would result from an expansion in government activity.   The Invisible Hand would work fine and there was no need for the Visible hand of government.  Keynesians, meanwhile, believed that the economy could get stuck in a very bad place - a depression - and that the government may be needed to "jump-start" the economy.  The jumps start would work because of the multiplier - an increase in government spending would create further increases in the private sector as unemployed workers returned to work and bought more "stuff."   The multiplier provided a basis for believing in the power of the Visible Hand.

4. Most states are actively involved in attracting firms to create jobs through the multiplier effect.  In the late 1990s Rhode Island was successful in convincing Fidelity, a large, successful financial company, to locate one of their facilities in the state.  How would the multiplier differ if the firm located its plant in Texas.  Would the multiplier be bigger in Texas or Rhode island? 

Here the discussion focuses on the marginal propensity to spend - how much of the additional income generated in the first round of an expansion will end up as secondary demand. As a lead in to the discussion you should return to the concept of withdrawals from the system and show how the size of the multiplier depends upon the nature of the leakages. There are two primary adjustments. The first would be taxes. If there is a tax system where the level of taxes is dependent upon the level, then some of the increased income will be 'drained' off as a leakage in the form of taxes. The second would be imports. If some of the additional income went to support spending on goods and services produced outside of the area, then this would be a leakage from the system and reduce the multiplier. Once this is understood, then the discussion of the multipliers in Rhode Island and Texas should be easy. In Rhode Island, a small state with much of its population living near a border, the leakages through imports are likely to be larger than in Texas and thus the multiplier should be smaller.

5. What would you do if you were an advisor to the President and the economy took a nose-dive with unemployment running at 25 percent of the labor force, investment spending down over fifty percent, and people moving away from the cities to try to make a go of it by moving back to the farms. Would you attempt to balance the government budget?

Sound familiar? Another Great Depression? If you believe Keynes, the answer is to be found in demand. The economy is withering because there is no demand for the output of the workers. Too correct the problem you would simply increase the level of spending - either by coaxing the private sector to spend more with tax incentives, or more directly by increases in government spending.

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