Question

Consult exhibit 2 then, answers the following questions: 1/ Using the IS-LM model, how does the spending hypothesis explain the great depression 2 2/ When relying on the IS-LM model, economists often reach the conclusion that the "Money hypothesis" is not so relevant to explain the great depression. Explain why. Exhibit 2: TABLE 11-2 What Happened During the Great Depression? Consumption Unemployment Rate (1) Real GNP 23 1930 2036 1835 1695 144.2 141.5 1396 130.4 126.1 1931 1932 1933 1934 1935 169.5 125 5 1936 1932 1937 203.2 192.9 1402 1939 209.4 146.2 1960 227.2 155.7 t rautistics of the Colow e 1970, and Washington, DC: US Department of Commerce, Bureau of Census, 1975) (1) The unemployment rate is 19 (2) Real GNP, consumption mement, and government purchases are series 3.43.152 and 166, and are measured in alios of 1958 dollars (9) The interest rate is the prime Commercial S 545 52.5 Nominal Money Supply Price Level Inflation Real Money Interest Rate (3) (4) (5) (6) Balances (7) 1929 26,6 50.6 52.6 1930 52.3 1931 1932 1933 50.7 1934 51.8 1935 60.8 1936 62.9 1937 1938 69.5 1939 79.1 1940 90.3 Paper 4-6 months, series 15. ( he money applies 414. Current plus de rand depots, measured billions of dollars. (5) The price level is the NP deco (1958 - 100%.sores El. (6) The inflation rate is the percentage change in the price levels (Real money salances, calculard by dividing the money supply by the price level and text 69.5

Answer 1

1. According to the spending hypothesis, great depression occurred due to a decrease in spending. This will lead to a contractionary shift of the IS curve. This may be attributed to the following factors.

• When the stock market crashed in 1929, it paved the way for a future which was not certain. This made the people to save more for the future by cutting down the current consumption.
• Due to the overbuilding of 1920s the residential investment decreased during the time period. The reduced rate of immigration also decreased the residential investment.
• Many banks faced closure during the early 1930s due to inadequate bank regulations and this lead to a decrease in the availability of money for the public which inturn reduced the spending.
• The contractionary fiscal policy adopted by the government for balancing the budget was another reason for reduced spending by the people. They was least concerned about keeping the unemployment level at the natural level

2. Inorder to explain the situation of great depression, the monetary hypothesis is less significant due to the following reasons

• According to the hypothesis, the great depression can be explained by a contractionary shift in the LM curve. And this can happen if the real money balance decrease. But during the time period of 1929_1931 , the real money balance increased due to a decrease in the price level. Still the unemployment rate was increased during this period.
• It could not explain why the interest rate decreased continuously during the period 1929-1933. For a contractionary shift of the LM curve the interest rate should be higher. But the interest rate came down to 1.7 from 5.9 during this period.