Classical Economic Crises Before the Great Depression

Trade-off & Conflict Analysis of growth suggests a short-term trade-off between consumption and investment Analysis of growth suggests a short-term trade-off between consumption and investment The larger the surplus to be invested, the smaller the immediate consumption The larger the surplus to be invested, the smaller the immediate consumption Consumption = mostly consumption of workers Consumption = mostly consumption of workers Surplus = profits of capitalists Surplus = profits of capitalists Thus conflict between workers & capitalists, labor and business Thus conflict between workers & capitalists, labor and business

Wage as Cost Business used to view wages as pure cost. Business used to view wages as pure cost.  the more they paid workers  the less surplus available as profits Profit maximization    hold wages down Profit maximization    hold wages down  minimum wage laws  use of force & violence, both private & public With wages at or near subsistance all wealth accumulated by capitalists With wages at or near subsistance all wealth accumulated by capitalists Thus "class struggle" Thus "class struggle"

Crisis as Solution Along with laws and force,business could go on strike, i.e., refuse to invest Along with laws and force,business could go on strike, i.e., refuse to invest For example in period of rapid growth, high profits and high investment, labor markets get tight, workers get higher wages, rate of profit fills and busines cuts back on investment For example in period of rapid growth, high profits and high investment, labor markets get tight, workers get higher wages, rate of profit fills and busines cuts back on investment Thus a downturn as economic activity diminishes Thus a downturn as economic activity diminishes

Classical Business Cycle Classical Business Cycle time Output I  Q  W     I  Q  W  U  p  I 

Classical Economics No "crisis" only adjustment No "crisis" only adjustment Adjustment through markets Adjustment through markets Debate Malthus vs Ricardo Debate Malthus vs Ricardo Two key markets Two key markets  labor market  financial markets Use Supply & Demand for each Use Supply & Demand for each

Labor Market supply of labor demand for labor quantity wage

Says' Law Supply creates its own demand Supply creates its own demand True for barter True for barter Non true for money economy Non true for money economy  money can be hoarded  savings of individuals  retained earnings of corporations Financial institutions channel savings/profits into investment Financial institutions channel savings/profits into investment

Financial Market supply of loanable funds demand for loanable funds quantity interest

Quantity Theory Quantity Theory of Money argued for stable relationship between money supply & prices Quantity Theory of Money argued for stable relationship between money supply & prices Money Supply = M =  p i q i /V, where  p i q i = sum of all goods q at prices p, and V = velocity of money, where p = f(M) in short run

Gold Standard International dimension of classical economics International dimension of classical economics All currencies values in fixed ratio to gold, e.g. $35/ounce. All currencies values in fixed ratio to gold, e.g. $35/ounce. All domestic money supply tied to gold, I.e, any change in amount of gold would change amount of money internally. All domestic money supply tied to gold, I.e, any change in amount of gold would change amount of money internally. International Acounts settled through gold transfers International Acounts settled through gold transfers

Adjustment Trade Deficit = more imports than exports Trade Deficit = more imports than exports Trade Surplus = more exports than imports Trade Surplus = more exports than imports Net imports  gold export Net imports  gold export Net exports  gold import Net exports  gold import Export of gold would reduce money supply Export of gold would reduce money supply Import of gold would increase money supply Import of gold would increase money supply So…. A trade deficit would be cured by So…. A trade deficit would be cured by   demand for imports caused by econ slowdown   demand for imports caused by drop in relative prices   exports caused by drop in relative prices

Int'l Circulation of Crisis -I Acrisis in one country would circulate to others in the gold standard Acrisis in one country would circulate to others in the gold standard Contraction in economy  drop in demand for imports  drop in other countries exports  drop in other countries levels of production Contraction in economy  drop in demand for imports  drop in other countries exports  drop in other countries levels of production Reduction in local markets  increased protectionism, e.g., limits on imports to protect local industry  further reductions in trade and foreign output Reduction in local markets  increased protectionism, e.g., limits on imports to protect local industry  further reductions in trade and foreign output

Int'l circulation of Crisis - II Economic crises, e.g. financial collapse  gold flight  further deflation due to link of domestic money level to gold and further reduction in economic activity Economic crises, e.g. financial collapse  gold flight  further deflation due to link of domestic money level to gold and further reduction in economic activity Such deflation SHOULD result in lower prices and increasingly competitive exports whose growth would spur recovery. Such deflation SHOULD result in lower prices and increasingly competitive exports whose growth would spur recovery. So crisis should be corrected via shift from trade deficit to trade surplus, influx of gold, expanded money supply, reduced interest rates, etc. So crisis should be corrected via shift from trade deficit to trade surplus, influx of gold, expanded money supply, reduced interest rates, etc.

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