Market Failures And Business Cycles Part 2
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Market Failures and Business Cycles: Part 2
Market Failures and Business Cycles (Part 2)
Summary:
In this continuation from Part 1, we explore the dynamics where Savings and Investment grow faster than Consumption, which can lead to economic issues. Before the Great Depression, there was a lack of understanding of Keynesian principles of aggregate demand, leading to policies that favored Investment over Consumption, exacerbating economic troubles.
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Article Body
Savings and Investment Outpacing Consumption
An imbalance where Savings and Investment exceed Consumption can be more detrimental than the reverse. Historically, before the Great Depression, policymakers didn't fully grasp the significance of aggregate demand, as explained by Keynes. This oversight led to policies favoring heavy Investments, neglecting the need to stimulate demand. Consequently, income distribution became skewed, reducing household purchasing power. The Great Depression was partly caused by this rapid growth in Investment and Savings compared to Consumption.
In such scenarios, production capacities increase beyond what households can consume, making further Investments unattractive. As Savings accumulate without being invested, the economy stalls, with money hoarded and income circulation disrupted. This lack of demand causes a vicious cycle of reduced production and increased unemployment. Eventually, either a new Investment opportunity emerges, or outdated capacities become obsolete, resetting the economic cycle.
Understanding Stagflations
Stagflation can arise during cycles led by Consumption growth. After a period of growth, a decline in Savings triggers a need for economic correction?"cutting Consumption and boosting Savings. The extent of this correction influences future economic booms. If Savings accumulate sufficiently during downturns, long-lasting booms can follow. Conversely, insufficient corrections, often due to government intervention through expansionary policies like interest rate cuts, can prematurely trigger recessions.
Government actions to stimulate demand often cause the economy to expand before adequate Savings are restored, leading to immediate downturns. This results in a cycle of expansion and contraction, potentially increasing unemployment. High Investment demand against low Savings also spikes interest rates, leading to cost-push inflation. When producers find Investment unprofitable, they hoard profits, stagnating the economy despite money circulation continuing due to inflationary pressures.
The Role of Speculation
During times of economic stagnation, capitalists may shift their spending from production to speculation in real estate and shares. This speculative bubble exacerbates inflation, reducing workers' purchasing power as housing costs rise. Workers demand higher wages, which, contrary to some economists' views, can somewhat curb speculative excesses by redirecting capital.
Prolonged Booms of the 80s and 90s
The long booms of the 1980s and 90s were driven by Investments in IT infrastructure rather than production capacity expansion. Unlike pre-1930s cycles, IT investments didn’t result in surplus manufacturing capabilities, thus avoiding depressions caused by overcapacity. Workers' bargaining power was weakened due to technological advancements, preventing wage-led inflations and allowing Savings to fuel further Investment without triggering recessions.
Conclusion
Over the past two centuries, business cycles have been shaped by various dynamics between Consumption, Savings, and Investment. Notably, household Savings impact the economy differently than Capitalist Savings?"primarily affecting firm margins rather than economic stability. Understanding these interactions helps us grasp the complexities of market failures and business cycles.
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Note: This discussion focused more on Capitalist Savings, as household Savings have a different economic impact.
© 2005 Thotakura R. US Registration: TXU 1-256-191
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