No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Seventeen: A Short History of Macroeconomics 432 of the world. Since English goods and services were overvalued due to the strength of the pound, their consumers could buy cheaper imports while their export industries were uncompetitive. This led to significant gold outflows from Great Britain during the latter 1920s. Much of those gold outflows ended up in the U.S., and contributed to the U.S.’s roaring 20s “boom period. ” 7 Meanwhile France chose to undervalue its currency resulting in gold inflows, going from holding 7% of the world’s gold reserves in 1926 to 27% by 1932; even the U.S. saw gold outflows as a result of these deflationary French policies. These monetary flows were ultimately unsustainable, leading to a bust in the U.S. and the rest of the world, followed by monetary “beggar thy neighbor” devaluation policies and restricted trade. President Hoover matched Great Britain’s bad policies by telling American businesses that wages would not be allowed to adjust; this problem wouldn’t be fixed on the back of the “working man.” U.S. unemployment subsequently rose to almost 25% by 1933, and was greater than 14% throughout the 1930s (including those on work relief jobs). Friedrich Hayek was reported to have predicted the Great Depression, and he expanded Von Mises skeletal business cycle theory into a robust explanatory theory of how the Great Depression happened. Yet the essence of that theory (outlined above) was that the problem is found in the capital and labor misallocation during the original boom; the bust is the necessary corrective action. Hayek didn’t really have much positive policy advice; all he could say to do was stop messing things up. During a financial crisis a proposed action plan of “don’t do anything” is never well received by politicians who are elected precisely to do something. This provided an opening for a new way to think about depression. THE KEYNESIAN REVOLUTION This short and obviously incomplete introduction to the Great Depressio n 8 is to help the reader understand why microeconomic explanations of “let the price system restore equilibrium” were not satisfying. Economists such as John Maynard Keynes could justifiably ask how long we should have to wait for such corrective action to occur. Given that Great Britain had already been in a Depression for almost a decade when Keynes’ General Theory was published, we can almost forgive Keynes’ dismissal of long run concerns over his policy proposals when he argued that “in the long run, we are all dead.” Keynes attempted to answer the puzzle of why markets were not clearing. Why didn’t wage cuts restore equilibrium in the labor market? Keynes surely had to know that significant pro-labor laws as well as cultural mores diminished wage rate flexibility. As he noted in the General Theory in his description of the classical theory, you might have unemployment “due to the refusal or inability of a unit of labour, as a result of legislation or social practices or of a combination of collective bargaining or of slow response to change or of mere human obstinacy. ” 9 Yet, he argued “It is not very plausible to assert