MACROECONOMICS I

MODULE 2
Classical Macroeconomics

MANSOOR P
Assistant Professor
Department of Economics
Amal College of Advanced Studies, Nilambur
 Classical Economics
• The term ‘classical’ was coined by Karl Marx.
• Means contribution of Adam Smith, David Ricardo, J S Mill, J B Say, Thomas
Malthus, etc.- 18th and 19th Century economists.
Major Classical Postulates
• Full employment without inflation.
• Perfect competition in product and labour market.
• Closed laissez faire- self regulating economy.
• Say’s Law of Market.
• Perfect wage-price flexibility.
• Quantity Theory of Money.
• Quantity of money is constant.
Assumptions of Classical Macroeconomics
1. There is freedom of entry and exit. No monopoly elements are present in
the market to prevent newcomers from entering the market or stopping
the present ones from quitting the market.
2. Prices and wages are flexible in both upward and downward directions
according to the demand and supply forces.
3. No single seller or buyer of a product has sufficient market power to
influence the industry price, nor does any supplier or purchaser of labor
services have sufficient market power to influence the market wage rate.
4. Thus all economic agents are price-takers and not price-setters.
5. The markets are competitive and disequilibrium can only exist for a short
period of time.
6. The prices and wages are flexible. If product market were experiencing
excess demand in some industry, with quantity demanded greater than
quantity supplied, prices would rise until quantity demanded once again
equaled quantity supplied. The rise in price returns the market to
equilibrium.
7. Wages and prices are flexible and hence if there were an excess supply of
workers, wages would decline until equilibrium in the labor market were
restored.
8. There is full employment in the economy.
9. All economic decision-makers are assumed to be operating by having all
the information they needed to make the best decisions.
 Say’s Law of Market
• Jean Baptiste Say (1767-1832)- French economist.
• Say was a major proponent of Adam Smith’s self-directing economic system of
competition, natural liberty, and limited government.
• J.B. Say was the original supply-sider and documented that production is the source
(reason) of consumption and placed supply over demand in the hierarchy of
economics.
• A person’s ability to demand goods and services from others proceeds from the
income produced by his own acts of production. His level of production determines his
ability to demand.
• A person sells his labor services or assets for money which he then uses to demand
products.
• Say's law is based upon the fact that every production of goods also creates incomes
equal to the value of goods produced and these incomes are spent on purchasing
these goods.
• Production of goods itself creates its own purchasing power.
• Therefore, Say's law is expressed as “Supply creates its own demand”.
• The supply of goods produced creates demand for it equal to its own value with the
result that the problem of general overproduction does not arise.
• So general gluts cannot exist.
Saving-Investment Equality
• There is a serious omission in Say’s Law. If the recipients of income in this simple
model save a portion of their income, consumption expenditure will fall short of total
output and supply would no longer create its own demand. Consequently there
would be unsold goods, falling prices, reduction of production, unemployment and
falling incomes.
• However, the classical economists ruled out this possibility because they believed
that whatever is saved by households will be invested by firms. That is, investment
would occur to fill any consumption gap caused by savings leakage. Thus, Say’s Law
will hold and the level of national income and employment will remain unaffected.
Saving-Investment Equality in the Money Market
• Rate of interest was determined by the demand for and supply of capital. The
demand for capital is investment and its supply is saving.
• The equilibrium rate of interest is determined by the saving-investment equality.
• Any imbalance between saving and investment would be corrected by the rate of
interest.
• If saving exceeds investment, the rate of interest will fall. This will stimulate
investment and the process will continue until the equality is restored.
• Savings is beneficial and it is used in the production of capital goods or in
additional production. When production exceeds consumption, the difference is
savings, which goes toward the production of investment goods, which are the
basis for future growth.
• There will be no deficiency in aggregate demand as long as savings are reinvested
in productive uses.
Assumptions of the Say's Law of Market
(i) Pure competition exists. No single buyer or seller of commodity or an input can
affect its price.
(ii) Wages and prices are flexible. The wages and prices of goods are free to move to
whatever level the supply and demand dictates.
(iii) Self interest. People are motivated by self interest. The businessmen want to
maximize their profits and the households want to maximize their economic well
being.
(iv) No government interference. There is no necessity on the part of the
government to intervene in the business matters.
Say’s Law in a Barter Economy
• According to say, supply creates its own demand. This is explained as according
to say, whatever is produced in the barter economy is sold out.
• Hence nothing remains unsold and there is no possibility of over production and
there is no possibility of general unemployment.
Criticisms of Say’s Law of Market
1. Supply does not Create its Demand: Say’s law assumes that production
creates market for goods. Therefore, supply creates its own demand. But
this proposition is not applicable to modern economics where demand
does not increase as much as production increases. It is also not possible
to consume only those goods which are produced within the economy.
2. Self-Adjustment not Possible: According to Say’s Law, full employment is
maintained by an automatic and self adjustment mechanism in the long
run. But Keynes had no patience to wait for the long period for he
believed that “In the long run we are all dead.” It is not the automatic
adjustment process which removes unemployment. But unemployment
can be removed by increase in the rate of investment.
3. Money is not Neutral: Say’s Law of market is based on a barter system and
ignores the role of money in the system. Say believes that money does
not affect the economic activities of the market. Conversely, Keynes has
given due importance to money. He regards money as a medium of
exchange. Money is held for income and business motives. Individuals
hold money for unforeseen contingencies while businessmen keep cash in
reserve for future activities.
4. Over Production is Possible: Say’s Law is based on the proposition that
supply creates its own demand and there cannot be general over
production. But Keynes does not agree with this proposition. According to
him, all income accruing to factors of production is not spent but some
fraction out of it is saved which is not automatically invested. Therefore,
saving and investment are always not equal and it becomes the problem
of overproduction and unemployment.
5. Underemployment Situation: Keynes regards full employment as a special
case for the reason that there is underemployment in capitalist
economies. This is since the capitalist economies do not function
according to Say’s Law and supply always exceeds its demand. For
example millions of workers are prepared to work at the current wage
rate and even below it, but they do not find work.
6. State Intervention: Say’s Law is based on the existence of laissez faire
policy. But Keynes has highlighted the need for state intervention in the
case of general overproduction and mass unemployment. Laissez faire, in
fact led to the Great Depression, had the capitalist system been automatic
and self adjusting. This would not have occurred. Keynes therefore
advocated state intervention for adjusting supply and demand within the
economy through fiscal and monetary measures.
 WAGE-PRICE FLEXIBILITY & FULLEMPLOYMENT
•The classical economists generally assumed full-employment.
•The cornerstone of classical automatic full employment was their deep faith in the
downward flexibility of money wages and prices.
•According to them, unemployment is caused by wages being too high. Hence, the
remedy for unemployment lies is lowering the wage rates.
•In a free market economy, the free working of the market forces of demand and
supply for labour determines market wage rate which avoids the possibility of
unemployment.
•If there is unemployment, the market wage rate would fall till the supply of labour
is equal to the demand for labour and full employment is restored.
•There is always full employment in the economy and in case of unemployment, a
general cut in money wages will result in full employment in the economy
• The idea that a general cut in money wages will lead the economy to full employment
was mainly suggested by A.C.Pigou.
• When money wages are reduced, the cost of production will be lowered. This would
lower the prices of products. When prices fall, demand increases and sales will
increase and increased sales will increase employment resulting in full employment.
• If there is an increase in the savings of the people, the expenditure of the people
declines; it will then affect the prices of products. As a result of fall in aggregate
expenditure or demand, the prices of products would decline and at reduced prices
their quantity demanded will increase and as a result all the quantity produced of
goods will be sold out at lower prices.
• In spite of the decline in aggregate expenditure caused by the increase in savings, the
real output, income and employment will not fall.
• According to the classical logic, increased saving will bring down the prices of products
and not the amount of production and employment.
• But when price falls, in order to make business profitable, producers will have to
reduce price of factors of production like labour. With a fall in wages of labour, all
workers will get employed.
KEYNES’S CRITICISM OF THE CLASSICAL VIEW
• Keynes did not accept the classical view that reduction in money wages led
to full employment.
• He emphasized that unemployment could be removed by raising the
effective demand.
• According to Keynes, a cut in money wages applied to the economy as a
whole reduces employment rather than increasing it.
• According to Keynes, when money wages are reduced in the economy,
they will reduce money incomes of the workers who will reduce their
demand for products.
• Total expenditure will fall and lead to a decline in effective demand and
employment.
CLASSICAL THEORY OF EMPLOYMENT AND OUTPUT DETERMINATION
• Classical economists maintain that the economy is always capable of achieving the
natural level of real GDP or output, which is the level of real GDP that is obtained
when the economy's resources are fully employed.
• Any disequilibrium to fall below or to exceed the natural level of real GDP, self-
adjustment mechanisms exist within the market system that work to bring the
economy back to the natural level of real GDP.
• The classical doctrine—that the economy is always at or near the natural level of
real GDP—is based on two firmly held beliefs: Say's Law and the belief that prices,
wages, and interest rates are flexible.
• Classical full employment equilibrium is perfectly compatible with the existence of
frictional and voluntary unemployment, but does not admit the possibility of
involuntary unemployment.
• The increase in production during short period becomes essentially a function of
increased inputs of factor services like labour (N), capital (K) and land (L), ie,
Q=f(N,K,L).
• In the classical model the equilibrium levels of income and employment were
supposed to be determined largely in the labour market.
• At lower wage rate more workers will be employed. That is why the demand curve
for labour is downward sloping. The supply curve of labour is upward sloping
because the higher the wage rate, the greater the supply of labour.
• Total output Qo is produced with the employment of Lo units of labour. According
to classical economists this equilibrium level of employment is the ‘full
employment’ level.
• So the existence of unemployed workers was a logical impossibility.
• The classical economists believed that aggregate demand would always be
sufficient to absorb the full capacity output Qo.
• In other words, they denied the possibility of under spending or overproduction.
• In money market- According to them the rate of interest was determined by the
demand for and supply of capital. The demand for capital is investment and its
supply is saving. The equilibrium rate of interest is determined by the saving-
investment equality. Any imbalance between saving and investment would be
corrected by the rate of interest. If saving exceeds investment, the rate of interest
will fall.
Keyne’s Criticism of Classical Theory
• According to Keynes saving is a function of national income and is not
affect by changes in the rate of interest. Thus, saving-investment equality
through adjustment in interest rate is ruled out. So Say’s Law will no longer
hold.
• The labour market is far from perfect because of the existence of trade
unions and government intervention in imposing minimum wages laws.
Thus, wages are unlikely to be flexible. Wages are more inflexible
downward than upward. So a fall in demand (when S exceeds I) will lead to
a fall in production as well as a fall in employment.
• Keynes also argued that even if wages and prices were flexible a free
enterprise economy would not always be able to achieve automatic full
employment.
Classical Theory of Price Level Determination
• Price level is determined by the intersection of demand for and supply of goods
and services.

• In the diagram price level is determined at OP corresponding to Oq level of

quantity demanded and supplied.
• If there is excess supply or excess demand, the mechanism of invisible hand
works in the economy to bring economy to equilibrium.
QUANTITY THEORY OF MONEY (Transaction Approach)
• Fisher’s Equation of Exchange- Irving Fisher- ‘The Purchasing Power of Money’ (1911).
• “Other things remaining unchanged, as the quantity of money in circulation increases,
the price level also increases in direct proportion and the value of money decreases
and vice versa”.
• Direct and proportionate relation between quantity of money (M) and price level ( P).
• Inverse proportionate relation between Supply of Money and Value of Money.
• If the quantity of money in circulation is doubled other things being equal the general
price level will be doubled and the value of money is halved.
• In Fisher’s Cash Transactions Version of Money, the general price level in a country, like
the prices of commodities, is determined by the supply of and demand for money.
• MV=PT
• M is the total supply of money, V is the velocity of circulation of money, P is the
general price level, T is the total volume of transactions in physical goods.
• Fisher assumed that;
(1) at full employment total physical transactions T in an economy will be a
constant.
(2) the velocity of circulation remain constant in the short run because it largely
depends on the spending habits of the people.
(3) Money is only a medium of exchange and it is not hoarded.
Criticisms of the Transaction Approach
(1) Unrealistic assumptions: The theory is based on unrealistic assumptions. In this
theory P is considered as a passive factor. T is independent. M1, V, V1, are
constant in the short run. All these assumptions are covered under “Other things
remaining the same.” In actual working of the economy, these do not remai
constant; hence, the theory is unrealized and misleading.
(2) Various Variables in the transaction are not independent. The various variables
in transaction equation are not independent as assumed in the theory The fact is
that they very much influence each other For example when money supply (M)
increases the velocity f money (V) also goes up Take an other case. Fisher assumes
(P) is a passive factor and has no effect on trade (T). In actual practice, when price
level P) rises, it increases profits and promotes trade (T).
(3) Assumption of full employment is wrong. J. M. Keynes has raised en objection
that the assumption of full employment is a rare phenomenon in the economy
and the theory is not real.
(4) Rate of interest ignored. In the quantity theory of Fishers, the influence of the
rate of interest on the money supply and the level of prices have been completely
ignored. The fact is that an increase or decrease in money supply has an
important bearing on the rate: of interest. An increase in money supply leads to a
decline in the rate of interest and vice versa.
(5) Fails to explain trade cycles. The theory fails to explain the trade cycles. It does
not tell as to why during depression, the increase in money supply has little
impact on the price level, Similarly, in boom period the reduction in money supply
or tight money policy may not bring down the price level. G. Crowther is right in
saying, “The quantity theory is at best an imperfect guide to the cause of the
business cycle”.
(6) Ignores other factors of price level. There are many determinants other than M,
V, and T which have important implication on the price level. These factors such
as income, expenditure, saving, investment, population consumption etc have
been ignored from the purview of the theory.
QUANTITY THEORY OF MONEY (Cash Balance Approach)
• Cambridge Equation- developed during 1920s.
• Associated with Cambridge Economists like Alfred Marshall, A C Pigou, D H
Robertson and J M Keynes.
• The Quantity Theory of Money seeks to explain the factors that determine the
general price level in a country.
• The theory states that the price level is directly determined by the supply of
money.
• Certain fraction of money is kept in the form of money or currency.
• The quantity theory of money is based directly on the changes brought about by
an increase in the money supply.
• The quantity theory of money states that the value of money is based on the
amount of money in the economy.
• Thus, according to the quantity theory of money, when the supply of money
increases the, the value of money falls and the price level increases.
• Marshall’s Equation
Based on the fact that total demand for money is a function of annual income and size of
assets.
M=KPO
P=M/KO
M= Money Supply
P= Price
K= Proportion of income that people tend to hold in cash
O= Output
• Pigou’s Equation
P= KR/M
P= Purchasing power
R= Total real income
K= Proportion of real income people hold in the form of cash
M= Number of units in legal tender (quantity of money)
• Keyne’s Equation
N=P(k+rk’)
N= amount of cash in circulation
P= Price of a consumption unit
k= amount of consumption unit people decide to hold in the form of cash
k’= amount of consumption unit people hold in the form of bank deposits
• Robertson’s Equation
M=KTP
P=M/KT
P= Price level
M= Supply of money
T= Amount of goods and services
K= Fraction of T over which people want to hold commodity in the form of cash
balance.
Criticisms of Cash Balance Approach
(1) Use of Purchasing Power for consumption goods. The Cambridg economists give undue importance the
purchasing power of money in term of consumption goods. The theory ignores speculative motive of
demand for money.
(2) Role of rate of interest ignored. The cash balance theory excludes the role of rate of interest in
explaining the changes in the price Level which is very important in influencing the demand for money.
(3) Unitary elasticity of demand. The Cambridge equation assumes that the elasticity demand for money is
unity. This is not realistic in the dynamic society of today.
(4) Real income not the sole determinant of K. According to the Cambridge equation, real income only
determines the value of K i.e., the cash held by people. The fact is that other factors as price level;
banking and business habits of the people, political conditions in the country can influence the value
of K.
(5) Simple Truism. The Cambridge equation, like the Fisherian equation establishes proportionate
relationship between the quantity of money and the price level. M = KPY. The theory does not explain
as to how and why this relationship between the two is established.
(6) K and T assumed constant. The Cambridge economist like Irving Fisher also assumes that K and T
remain constant. This is possible in a static situation but not in dynamic conditions.
(7) No explanation of business cycles. The Cambridge equations do not provide any explanation for the
business cycles.
Comparison between Transactions and Cash Balance Approaches
Similarities
1. Same conclusion about M and P: The basic conclusion in both the approaches is the same that the
value of money or the price level is a function of the quantity of money.
2. Similar Equations: The two approaches use almost similar equations.
3. Both approaches consider that money serves as a medium of exchange in the economic system.
Dissimilarities
1. Functions of Money: The Fisherian approach lays emphasis on the medium of exchange function
of money while the Cambridge approach emphasises the store of value function of money.
2. Flow and Stock: In Fisher’s approach money is a flow concept while in the Cambridge approach it
is a stock concept.
3. V and k Different: In Fisher’s equation V refers to the rate of spending and in Cambridge equation
k refers to the cash balances which people wish to hold.
4. Nature of Price level: In Fisher’s equation, P refers to the average price level of all goods and
services. But in the Cambridge equation P refers to the prices of final or consumer goods.
5. Nature of T: In Fisher’s equation, T refers to the total amount of goods and services exchanged for
money, whereas in the Cambridge equation T refers to the final or consumer goods exchanged
for money.
Superiority of Cash Balance Approach over Transactions Approach
1. The Transaction approach emphasizes the medium of exchange function of money only. On the other
hand, the Cash Balance approach stresses equally the store of value function of money. Therefore, this
approach is consistent with the broader definition of money which includes demand deposits.
2. In its explanation of the determinants of V, the Transaction approach stresses the mechanical aspects of
the payments process. In contrast, the Cash Balance approach is more realistic as it is behavioral in
nature which is built around the demand function for money.
3. As to the analytical technique, the Cash Balance approach fits in easily with the general demand-supply
analysis as applied to the money market. This feature is not available in the Transaction approach.
4. The Cash Balance approach is wider and more comprehensive as it takes into account the income level
as an important determinant of the price level. The Transaction approach neglected income level as
the determinant of the price level.
5. According to the Transaction approach, the change in P is caused by change in M only. In the Cash
Balance approach P may change even without a change in M if k undergoes a change. Thus k,
according to the Cash Balance approach is a more important determinant of P than M as stressed by
the Transaction approach.
6. Moreover, the symbol k in the Cash Balance approach proves to be a better tool for explaining trade
cycles than V in Fisher’s equation.
NEUTRALITY OF MONEY
• Neutrality of money is an important idea in classical economics and is related to the
classical dichotomy.
• If money is neutral, an increase in the quantity of money will merely raise the level of
money prices without changing the relative prices and the interest rate.
• It implies that the central bank does not affect the real economy (e.g., the number of
jobs, the size of real GDP, the amount of real investment) by printing money. Instead,
any increase in the supply of money would be offset by an equal rise in prices and
wages.
• Classical economists believed in the neutrality of money.
• Neutrality of money means that money is neutral in its effect on the economy.
• Changes in the aggregate money supply affect only the nominal variables and do not
affect real variables.
• Therefore, an increase in the money supply would increase all prices and wages
proportionately, but have no effect on real economic output (GDP), unemployment
levels, or real prices.
• The neutrality of money is based on the idea that changing the money supply will not
change the aggregate supply and demand of goods, technology or services. The only
impact of a change in the money supply is on the general price level.
Money Illusion
• The term “Money Illusion” was first used by the American economist, Irving
Fisher.
• He used it to refer the failure to realize that the value of a unit of currency is liable
to vary in value terms of what it will buy.
• In economics, money illusion refers to the tendency of people to think of currency
in nominal, rather than real, terms.
• The numerical/face value (nominal value) of money is mistaken for its purchasing
power (real value).
• Money illusion- people have an illusory picture of their wealth and income based
on nominal (dollar) terms, rather than in real terms.
• Real prices and income take into account the level of inflation in an economy.
• Consumer’s perception of the value of money is nfluenced by the nominal value
of the currency.
THE PIGOU EFFECT
• The Pigou effect is also known as the real balance effect.
• The Pigou effect also identified as the wealth effect was advocated by A.C Pigou.
• The term Pigou effect refers to the stimulation of output and employment caused
by increasing consumption due to a rise in real balances of wealth, particularly
during deflation.
• The Pigou effect was propounded by A.C. Pigou in 1943 to counter Keynes’
argument that wage-price deflation cannot lead to automatic full employment.
• Pigou effect is an economics term that describes what happens in the economy,
particularly with the aggregate consumption, if prices fall.
• It is an effect that deals with economic wealth. Wealth was defined by Arthur
Cecil Pigou as the sum of the money supply and government bonds divided by the
price level.
• Thus, Pigou effect is a term in economics referring to the relationship between
consumption, wealth, employment and output during periods of deflation.
• When there is deflation of prices, employment (and thus output) will be increased
due to an increase in wealth (and thus consumption).
• With the inflation of prices, employment and output will be decreased, due to a
decrease in consumption.
• Wage-price deflation will generate automatic full employment via an increase in
the level of consumption.
• When money wages are cut, prices fall and the value of money rises. The rise in
the value of money means a rise in the real value of assets such as stocks, shares,
bank deposits, government securities, bonds, etc.
Criticisms of Pigou Effect
1. The Pigou effect assumes that the depressing effect of a reduction in the price
level is offset by its stimulating effect on creditors. A price decline will have
different reactions on debtors and creditors. Pigou overlooked the possibility of
microeconomic distributional effects.
2. The Pigou effect considers only the effects of a change in real balances on
consumption or saving of the household sector. It neglects the influence of
real balances on firms.
3. Pigou’s analysis assumes a definite knowledge about the effect of saving or
consumption of an increase in the real balances which is not always true.
4. The Pigou effect is difficult to weigh quantitatively. It also neglects the role of
price expectations.
Real Balance Effect
• Major supporters- A C Pigou and Patinkin.
• Real balance means the real purchasing power of cash holdings of the people.
• Whenever there is a change in the price level, the real balance of the people are
affected which in turn affect the demand for and supply of goods and services.
• Demand for and supply of goods are affected only by relative prices and not by
absolute prices.
• If money price increases, it will not have any effect on demand and supply of
goods.
Classical Dichotomy
• The classical dichotomy is the division between the real side of the economy and the
monetary side.
• According to the classical dichotomy, changes in monetary variables do not affect real
values as output, employment, and the real interest rate.
• Money is therefore neutral in the sense that it cannot affect these real variables.
• Classical dichotomy refers to the idea that real and nominal variables can be analyzed
separately.
• The notion that changes to the variables that affect monetary values will not impact
real values such as interest rates, employment, industrial output is known as classical
dichotomy.
• An economy exhibits the classical dichotomy if real variables such as output,
unemployment, and real interest rates can be completely analyzed without
considering what is happening to nominal variables.
• GDP and other real variables can be determined without knowing the level of the
nominal money supply or the rate of inflation.
Full employment
• Classical concept- economy will have full employment always.
• Full employment- all people who are willing to work at prevailing wage rate will
be able to find out a job.
• Unemployment in the economy will be for a very short period.
• In the long run, there will be full employment in the economy.
• There will be voluntary and frictional unemployment in the economy.
• Voluntary Unemployment- people are not ready to work at prevailing wage rate
or they are interested in working at all.
• Frictional Unemployment- a temporary unemployment situation when workers
leave a job and searching for a better one.
Great Depression
• worldwide economic downturn that began in 1929 and lasted until about 1939.
• It was the longest and most severe depression ever experienced by the
industrialized Western world, sparking fundamental changes in economic
institutions, macroeconomic policy, and economic theory.
• Although it originated in the United States, the Great Depression caused drastic
declines in output, severe unemployment, and acute deflation in almost every
country of the world.
• The timing and severity of the Great Depression varied substantially across
countries. The Depression was particularly long and severe in the United States
and Europe; it was milder in Japan and much of Latin America.
• Between the peak and the trough of the downturn, industrial production in the
United States declined 47 percent and real gross domestic product (GDP) fell 30
percent. The wholesale price index declined 33 percent.
• Perhaps not surprisingly, the worst depression ever experienced by the world
economy stemmed from a multitude of causes.
• Declines in consumer demand, financial panics, and misguided government
policies caused economic output to fall in the United States, while the gold
standard, which linked nearly all the countries of the world in a network of
fixed currency exchange rates, played a key role in transmitting the American
downturn to other countries.
• The recovery from the Great Depression was spurred largely by the abandonment
of the gold standard and the ensuing monetary expansion.
• The economic impact of the Great Depression was enormous, including both
extreme human suffering and profound changes in economic policy.
• The Great Depression began in the United States as an ordinary recession in the
summer of 1929.
• The downturn became markedly worse, however, in late 1929 and continued until
early 1933.
Causes
• Decline in spending (sometimes referred to as aggregate demand), which led to a
decline in production as manufacturers and merchandisers noticed an unintended
rise in inventories.
• Monumental decline in aggregate demand.
• Stock market crash in 1929.
• Banking panic and monetary contraction - The United States experienced
widespread banking panics in the fall of 1930, the spring of 1931, the fall of 1931,
and the fall of 1932.
• As in the United States, banking panics and other financial market disruptions
further depressed output and prices in a number of countries.
• Reduction in foreign lending may have led to further credit contractions and
declines in output in borrower countries.