This is a very uncertain and difficult period for the global economy and there are some similar periods in history, the most significant period is the Great Depression of the 1920s and 1930s (1929-1933). One thing to be mentioned is that the Wall Street Crash in the USA was fuse for the Great Depression of the world. In October 1929, much stock was sold and the price of stock plummeted. From mid-October until mid-November, the value of securities on the stock depreciated of 50% and the stock market crash. (Leonard, 1944) Across the ocean, UK was similarly affected by the great depression. Therefore, many businesses were bankrupt soon eventuated in mass unemployment. People could not raise a family so they did not want invest money in business. As a result, the Consumer Price Index and Gross Domestic Product (GDP) reduced from 1929 to 1933. In addition, the levels of production declined due to many businesses were bankrupt. (Leonard, 1944)
After the Great Depression, a British economist Keynes who proposed that inefficiency of overall consumption demand is the reason of unemployment. Keynes felt that the Classical economists did not conform to the reality and needed to be “corrected”. (Patil, N.D)Therefore, The General Theory of Employment, Interest and Money was published and it supported the theory of Keynes that unemployment could be set at rest by government. He also contended governments can stimulate economic activity by rising public spending and lower taxation. In this paper, Classical and Keynesian theory will be contrast and analyze first and the Keynesian 45ï¿½line model diagrams will be explained combining with recently economic crisis in detail. In the end, a large number of researches of fiscal policies by British government will be analyzed combining with the economic situation in UK.
Classical economists by Adam Smith which proposes the “invisible hand” theory which consider that free markets can adjust themselves and do not need any intervention. (Marshall, 1988) It believes that there is an invisible hand can move markets to equilibrium without any intervention. (Patil, 2010) Therefore, Adam Smith’s theory advocated that government should not interfere in the economy, even in the Great Depression. Nevertheless, Keynes argued that government has to adjust by fiscal policies in order to boost the economy and reduce unemployment (Keynes, 1936).
In addition, the Classical economists deny the fact that unemployment must exist since classical economists believe the self correcting system of an economy. It considers that unemployment can be considered as an interim disequilibrium since it is a balance caused by redundant labor. (Patil, 2010) While in Keynes’s theory, it held essentially that insufficient demand causes unemployment and government must take measures to insure a sufficient demand in order to reduce unemployment. (Sloman, 2007, P254)
In Keynes’s theory, Keynes used a 45ï¿½line model to discuss the economy’s equilibrium level which is the relation between consumption and consumers’ disposable income. (Sloman, 2007, P254) In this model, it refers to individual consumptions on domestic products(C), private investment (I), government expenditure on domestic products and services (G) and net export (NX) which constitutes Aggregate Demand (AD). The formula of Aggregate Demand is AD = C + I + G + NX. In one sense, Aggregate Demand can impact the balance of economy. (Sloman, 2007, P256)
In September 2007, the global economic crisis started to show its effects. Around the world stock markets have collapsed, and the real estate crashed. In the meantime, governments had to rescue their financial systems. (ablemesh.co.uk, 2007) The reason is bank lend money to people who may not afford their mortgages. However, they were still happy to lend because all the money is from governments. These lenders could regulate interest rates and make money on sub-prime loans.
If the borrowers reimbursement, banks could sell the house in order to get the loan back. Unfortunately, lots of people which had a bad credit histories got the loan but could not repay the loan. Because of this, a profusion of property on the market therefore the prices of property plummet. (Shah, 2009) Anyway, the credit well dried and the housing market declined. With the Keynesian 45 line model diagrams in next page (Diagram 1), it will explain the economic situation clearly and find the best measures which can help promote economic increasing.
Diagram 1: Keynesian line model diagram In diagram 1, the vertical axis is Cd (consumptions on domestic products); W (withdrawals), J (injections) and the horizontal axis is Y (income). In the diagram, Line 1 represents national income; line2 represents aggregate expenditure and line 3 represents consumptions on domestic products. (Sloman, 2007, P255) From Keynesian 45 line model diagram, there is a distance between point h and point g which means national income exceeded aggregate expenditure and the distance can be called deflationary gap.
It illustrates that people would purchase fewer but the products are still produced. Firms will find the stocks could not be sold. Therefore the business had to decrease the level of production and dismiss employees. In this way, national income and expenditure would both decrease. There would be a movement down and the gap between Y and E becomes smaller until to point Z, Y= Z. (Sloman, 2007, P256) With the purpose of putting the economy to the equilibrium position, there are some measures combine the diagram below.