According to John Maynard Keynes, what is the most effective tool for reviving an economy during a depression?
Show answer & explanation
Correct answer: C
Explanation
Answer: Expanding government expenditure.
Explanation:John Maynard Keynes, the father of modern macroeconomics, revolutionized economic thought during the Great Depression of the 1930s. His theory (Keynesian Economics) suggests that:
Aggregate Demand is Key: During a depression, the primary problem is a lack of demand. Consumers aren't spending, and businesses aren't investing because they don't see future profits.
The "Liquidity Trap": Keynes argued that simply lowering interest rates (monetary policy) might not work because people and banks prefer to hold onto cash rather than spend or lend it.
Government Intervention: He proposed that the government should step in as the "spender of last resort." By increasing government expenditure on public works (roads, bridges, etc.), the government creates jobs.
The Multiplier Effect: When the government spends money, it becomes income for workers and businesses. They, in turn, spend that income, creating more demand and further income for others, leading to an overall increase in national income greater than the initial injection.
Additional Points for Exam
Fiscal Policy vs. Monetary Policy: Keynes prioritized Fiscal Policy (government spending and taxation) over Monetary Policy during deep recessions.
Deficit Financing: Keynes believed it was acceptable for a government to run a budget deficit (spend more than it earns) during a depression to jumpstart growth.
Potential Exam Questions & Answers
Q: What did Keynes mean by the "Paradox of Thrift"?
Answer: It is the idea that if everyone tries to save more money during a recession, aggregate demand will fall, leading to lower total savings in the economy because economic growth slows down. Saving is good for an individual but can be bad for the economy as a whole during a slump.
Q: According to Keynesian theory, what is the role of the government during a period of high inflation?
Answer: The opposite of a depression—the government should reduce expenditure or increase taxes to cool down demand (Contractionary Fiscal Policy).