A tax is a mandatory financial charge or some other type of levy imposed upon a taxpayer by a governmental organization in order to fund various public expenditures. A failure to pay, along with resistance to taxation, is punishable by law. Taxes may be paid in money or as its labour equivalent. Most countries have a tax system in place to pay for public, common or agreed national needs and government functions; some levy a flat percentage rate of taxation on personal annual income, but most scale taxes based on annual income amounts. Most countries charge a tax both on corporate income and dividends. Countries or subunits also impose wealth taxes, property taxes, sales taxes, value-added taxes, payroll taxes or tarrifs; the legal definition, the economic definition of taxes differ in some ways such as economists do not regard many transfers to governments as taxes. For example, some transfers to the public sector are comparable to prices. Examples include, tuition at public universities, fees for utilities provided by local governments.
Governments obtain resources by "creating" money and coins, through voluntary gifts, by imposing penalties, by borrowing, by confiscating wealth. From the view of economists, a tax is a non-penal, yet compulsory transfer of resources from the private to the public sector, levied on a basis of predetermined criteria and without reference to specific benefit received. In modern taxation systems, governments levy taxes in money; the method of taxation and the government expenditure of taxes raised is highly debated in politics and economics. Tax collection is performed by a government agency such as the Ghana Revenue Authority, Canada Revenue Agency, the Internal Revenue Service in the United States, Her Majesty's Revenue and Customs in the United Kingdom or Federal Tax Service in Russia; when taxes are not paid, the state may impose civil penalties or criminal penalties on the non-paying entity or individual. The levying of taxes aims to raise revenue to fund governing or to alter prices in order to affect demand.
States and their functional equivalents throughout history have used money provided by taxation to carry out many functions. Some of these include expenditures on economic infrastructure, scientific research and the arts, public works, data collection and dissemination, public insurance, the operation of government itself. A government's ability to raise taxes is called its fiscal capacity; when expenditures exceed tax revenue, a government accumulates debt. A portion of taxes may be used to service past debts. Governments use taxes to fund welfare and public services; these services can include education systems, pensions for the elderly, unemployment benefits, public transportation. Energy and waste management systems are common public utilities. According to the proponents of the chartalist theory of money creation, taxes are not needed for government revenue, as long as the government in question is able to issue fiat money. According to this view, the purpose of taxation is to maintain the stability of the currency, express public policy regarding the distribution of wealth, subsidizing certain industries or population groups or isolating the costs of certain benefits, such as highways or social security.
Effects can be divided in two fundamental categories: Taxes cause an income effect because they reduce purchasing power to taxpayers. Taxes cause a substitution effect when taxation causes a substitution between taxed goods and untaxed goods. If we consider, for instance, two normal goods, x and y, whose prices are px and py and an individual budget constraint given by the equation xpx + ypy = Y, where Y is the income, the slope of the budget constraint, in a graph where is represented good x on the vertical axis and good y on the horizontal axes, is equal to -py/px; the initial equilibrium is in the point, in which budget constraint and indifference curve are tangent, introducing an ad valorem tax on the y good, the budget constraint's slope becomes equal to -py/px. The new equilibrium is now in the tangent point with a lower indifferent curve; as can be noticed the tax's introduction causes two consequences: It changes the consumers' real income It raises the relative price of y good. The income effect shows the variation of y good quantity given by the change of real income.
The substitution effect shows the variation of y good determined by relative prices' variation. This kind of taxation can be considered distortionary. Another example can be the Introduction of an income lump-sum tax, with a parallel shift downward of the budget constraint, can be produced a higher revenue with the same loss of consumers' utility compared with the property tax case, from another point of view, the same revenue can be produced with a lower utility sacrifice; the lower utility or the lower revenue given by a distortionary tax are called excess pressure. The same result, reached with an income lump-sum tax, can be obtained with these following types of taxes (all of them cause only a budget constraint's shift without causi
A currency union involves two or more states sharing the same currency without them having any further integration. Three types of currency unions exist: Informal – unilateral adoption of foreign currency Formal – adoption of foreign currency by virtue of bilateral or multilateral agreement with the issuing authority, sometimes supplemented by issue of local currency in currency peg regime Formal with common policy – establishment by multiple countries of a common monetary policy and issuing authority for their common currencyThe theory of the optimal currency area addresses the question of how to determine what geographical regions should share a currency in order to maximize economic efficiency. Note: Every customs and monetary union and economic and monetary union has a currency union. Zimbabwe is theoretically in a currency union with four blocs as the South African rand, Botswana pula, British pound and US dollar circulate, the US Dollar was until 2016 official tender.. Additionally the autonomous and dependent territories, such as some of the EU member state special territories, are sometimes treated as separate customs territory from their mainland state or have varying arrangements of formal or de facto customs union, common market and currency union with the mainland and in regards to third countries through the trade pacts signed by the mainland state.
Between Bahrain and Abu Dhabi using the Bahraini dinar between Bahrain, Oman and the Trucial States, using the Gulf rupee from 1959 until 1966 between Aden and South Arabia, Kenya, Oman, British Somaliland, the Trucial States, Uganda and British India using the Indian rupee between Belgium and the Grand-Duchy of Luxemburg using the Belgian/Luxembourgish franc from 1921 to the Euro between British India and the Straits Settlements using the Indian rupee between Czech Republic and Slovakia using the Czechoslovak koruna between Ethiopia and Eritrea using the Ethiopian birr between France and Andorra using the French franc between the Eastern Caribbean, Barbados and Tobago and British Guiana using the British West Indies dollar between the Eastern Caribbean, Barbados and Tobago and British Guiana using the Eastern Caribbean dollar between Italy, Vatican City, San Marino using the Italian lira between Jamaica and the Cayman Islands using the Jamaican pound and Jamaican dollar between Kenya and Zanzibar using the East African rupee between Kenya and Zanzibar using the East African florin between Kenya and Zanzibar, South Arabia, British Somaliland and Italian Somaliland using the East African shilling Latin Monetary Union between France, Belgium and Switzerland, involving Greece, Romania and other countries.
Between Liberia and the United States using the United States dollar between Mauritius and Seychelles using the Mauritian rupee between Nigeria, the Gambia, Sierra Leone, the Gold Coast and Liberia using the British West African pound between Prussia and the North German states using the North German thaler between Russia and the former Soviet republics using the Soviet ruble between Qatar and all the emirates of the UAE, except Abu Dhabi using the Qatari and Dubai riyal between Saudi Arabia and Qatar using the Saudi riyal between Samoa and New Zealand using the New Zealand pound Scandinavian Monetary Union, between Denmark and Sweden between the Solomon Islands, Papua New Guinea and Australia using the Australian dollar South German guilder between Spain and Andorra using the Spanish peseta between Trinidad and Tobago and Grenada using the Trinidad and Tobago dollar between Brunei and Singapore using the Malaya and British Borneo dollar between Cambodia and Vietnam using the French Indochinese piastre between South Africa and Botswana using the South African rand between Egypt and Sudan using the Egyptian pound – until 1956 between West Germany and East Germany between 1 July 1990 and 3 October 1990, as part of a temporary, so-called "Monetary and Social Union" prior to German reunification.
Between what became the Republic of Ireland and the United Kingdom, between 1928 and 1979. The Irish Pound was held at the same value as Sterling for this period, although it was not accepted for payments in the UK. proposed pan-American monetary union – abandoned in the form proposed by Argentina proposed monetary union between the United Kingdom and Norway using the pound sterling during the late 1940s and early 1950s proposed gold-backed, pan-African monetary union put forward by Muammar Gaddafi prior to his death List of pegged currencies North American Currency Union Acocella, N. and Di Bartolomeo, G. and Tirelli, P. ‘Monetary conservatism and fiscal coordination in a monetary union’, in: ‘Economics Letters’, 94: 56-63. Bergin, Paul. "Monetary Union". In David R. Henderson. Concise Encyclopedia of Economics. Indianapolis: Library of Economics and Liberty. ISBN 978-0865976658. OCLC 237794267. CS1 maint: Extra text: editors list West Africa opts for currency union Economist- Antipodean currencies Reasons for the collapse of the Rouble Zone OECD Development Centre – the Rand Zone
Government budget balance
A government budget is a financial statement presenting the government's proposed revenues and spending for a financial year. The government budget balance alternatively referred to as general government balance, public budget balance, or public fiscal balance, is the overall difference between government revenues and spending. A positive balance is called a government budget surplus, a negative balance is a government budget deficit. A budget is prepared for each level of government and takes into account public social security obligations; the government budget balance can be broken down into the primary balance and interest payments on accumulated government debt. Furthermore, the budget balance can be broken down into the structural balance and the cyclical component: the structural budget balance attempts to adjust for the impact of cyclical changes in real GDP, in order to indicate the longer-run budgetary situation; the government budget surplus or deficit is a flow variable. Thus it is distinct from government debt, a stock variable since it is measured at a specific point in time.
The cumulative flow of deficits equals the stock of debt. The government fiscal balance is one of three major sectoral balances in the national economy, the others being the foreign sector and the private sector; the sum of the surpluses or deficits across these three sectors must be zero by definition. For example, if there is a foreign financial surplus because capital is imported to fund the trade deficit, there is a private sector financial surplus due to household saving exceeding business investment by definition, there must exist a government budget deficit so all three net to zero; the government sector includes federal and local governments. For example, the U. S. government budget deficit in 2011 was 10% GDP, offsetting a capital surplus of 4% GDP and a private sector surplus of 6% GDP. Financial journalist Martin Wolf argued that sudden shifts in the private sector from deficit to surplus forced the government balance into deficit, cited as example the U. S.: "The financial balance of the private sector shifted towards surplus by the unbelievable cumulative total of 11.2 per cent of gross domestic product between the third quarter of 2007 and the second quarter of 2009, when the financial deficit of US government reached its peak...
No fiscal policy changes explain the collapse into massive fiscal deficit between 2007 and 2009, because there was none of any importance. The collapse is explained by the massive shift of the private sector from financial deficit into surplus or, in other words, from boom to bust."Economist Paul Krugman explained in December 2011 the causes of the sizable shift from private deficit to surplus: "This huge move into surplus reflects the end of the housing bubble, a sharp rise in household saving, a slump in business investment due to lack of customers." The sectoral balances derive from the sectoral analysis framework for macroeconomic analysis of national economies developed by British economist Wynne Godley. GDP is the value of all services produced within a country during one year. GDP measures flows rather than stocks. GDP can be expressed equivalently in terms of production or the types of newly produced goods purchased, as per the National Accounting relationship between aggregate spending and income: Y = C + I + G + where Y is GDP, C is consumption spending, I is private investment spending, G is government spending on goods and services, X is exports and M is imports.
Another perspective on the national income accounting is to note that households can allocate total income to the following uses: Y = C + S + T where S is total saving and T is total taxation net of transfer payments. Combining the two perspectives gives C + S + T = Y = C + I + G +. Hence S + T = I + G +; this implies the accounting identity for the three sectoral balances – private domestic, government budget and external: = +. The sectoral balances equation says that total private saving minus private investment has to equal the public deficit plus net exports, where net exports is the net spending of non-residents on this country's production, thus total private saving equals private investment plus net exports. In macroeconomics, the Modern Money Theory describes any transactions between the government sector and the non-government sector as a vertical transaction; the government sector includes the
Government debt contrasts to the annual government budget deficit, a flow variable that equals the difference between government receipts and spending in a single year. The debt is a stock variable, measured at a specific point in time, it is the accumulation of all prior deficits. Government debt can be categorized as external debt. Another common division of government debt is by duration. Short term debt is considered to be for one year or less, long term debt is for more than ten years. Medium term debt falls between these two boundaries. A broader definition of government debt may consider all government liabilities, including future pension payments and payments for goods and services which the government has contracted but not yet paid. Governments create debt by issuing government bills. Less creditworthy countries sometimes borrow directly from a supranational organization or international financial institutions. Monetarily sovereign countries that issue debt denominated in their home currency can make payments on the interest or principal of government debt by creating money, although at the risk of higher inflation.
In this way their debt is different from that of households. Thus such government bonds are at least as safe as any other bonds denominated in the same currency. A central government with its own currency can pay for its nominal spending by creating money ex novo, although typical arrangements leave money creation to central banks. In this instance, a government issues securities to the public not to raise funds, but instead to remove excess bank reserves and'...create a shortage of reserves in the market so that the system as a whole must come to the Bank for liquidity.' During the Early Modern era, European monarchs would default on their loans or arbitrarily refuse to pay them back. This made financiers wary of lending to the king and the finances of countries that were at war remained volatile; the creation of the first central bank in England—an institution designed to lend to the government—was an expedient by William III of England for the financing of his war against France. He engaged a syndicate of city merchants to offer for sale an issue of government debt.
This syndicate soon evolved into the Bank of England financing the wars of the Duke of Marlborough and Imperial conquests. The establishment of the bank was devised by Charles Montagu, 1st Earl of Halifax, in 1694, to the plan, proposed by William Paterson three years before, but had not been acted upon, he proposed a loan of £1.2m to the government. The Royal Charter was granted on 27 July through the passage of the Tonnage Act 1694; the founding of the Bank of England revolutionised public finance and put an end to defaults such as the Great Stop of the Exchequer of 1672, when Charles II had suspended payments on his bills. From on, the British Government would never fail to repay its creditors. In the following centuries, other countries in Europe and around the world adopted similar financial institutions to manage their government debt. 1815, at the end of the Napoleonic Wars, British government debt reached a peak of more than 200% of GDP. A government bond is a bond issued by a national government.
Such bonds are most denominated in the country's domestic currency. Sovereigns can issue debt in foreign currencies: 70% of all debt in 2000 was denominated in US dollars. Government bonds are sometimes regarded as risk-free bonds, because national governments can if necessary create money de novo to redeem the bond in their own currency at maturity. Although many governments are prohibited by law from creating money directly, central banks may provide finance by buying government bonds, sometimes referred to as monetizing the debt. Government debt, synonymous to sovereign debt, can be issued either in domestic or foreign currencies. Investors in sovereign bonds denominated in foreign currency have exchange rate risk: the foreign currency might depreciate against the investor's local currency. Sovereigns issuing debt denominated in a foreign currency may furthermore be unable to obtain that foreign currency to service debt. In the 2010 Greek debt crisis, for example, the debt is held by Greece in Euros, one proposed solution is for Greece to go back to issuing its own drachma.
This proposal would only address future debt issuance, leaving substantial existing debts denominated in what would be a foreign currency doubling their cost Public debt is the total of all borrowing of a government, minus repayments denominated in a country's home currency. CIA's World Factbook lists only the percentages of GDP. A debt to GDP ratio is one of the most accepted ways of assessing the significance of a nation's debt. For example, one of the criteria of admission to the European Union's euro currency is that an applicant country's debt should not exceed 60% of that countr
A government budget is an annual financial statement presenting the revenues and spending for a financial year, passed by the legislature, approved by the chief executive or president and presented by the Finance Minister to the nation. The budget is known as the Annual Financial Statement of the country; this document estimates the anticipated government revenues and government expenditures for the ensuing financial year. For example, only certain types of revenue may be collected. Property tax is the basis for municipal and county revenues, while sales tax and/or income tax are the basis for state revenues, income tax and corporate tax are the basis for national revenues; the practice of presenting budgets and fiscal policy to parliament was initiated by Sir Robert Walpole in his position as Chancellor of the Exchequer, in an attempt to restore the confidence of the public after the chaos unleashed by the collapse of the South Sea Bubble in 1720. Thirteen years Walpole announced his fiscal plans to bring in an excise tax on the consumption of a variety of goods and services josh, such as wine and tobacco, to lessen the taxation burden on the landed gentry.
This provoked a wave of public outrage, including fierce denunciations from the Whig peer William Pulteney, who wrote a pamphlet entitled The budget opened, Or an answer to a pamphlet. Concerning the duties on wine and tobacco - the first time the word'budget' was used in connection with the government's fiscal policies; the scheme was rescinded. The institution of the annual account of the budget evolved into practice during the first half of the 18th century and had become well established by the 1760s. Government budgets are of the following types: Union Budget: The union budget is the budget prepared by the central government for the country as a whole. State Budget: In countries like India, there is a federal system of government thus every state prepares its own budget. Plan Budget: It is a document showing the budgetary provisions for important projects and schemes included in the central plan of the country, it shows the central assistance to states and union territories. Performance Budget: The central ministries and departments dealing with development activities prepare performance budgets, which are circulated to members of parliament.
These performance budgets present the main projects,programmes and activities of the government in the light of specific objectives and previous years' budgets and achievements. Supplementary Budget: This budget forecasts the budget of the coming year with regards to revenue and expenditure. Zero-Based Budget: This is defined as the budgetary process which requires each ministry/department to justify its entire budget in detail, it is a system of budget. The two basic elements of any budget are the expenses. In the case of the government, revenues are derived from taxes. Government expenses include spending on current goods and services, which economists call government consumption. There is another way to understand element of budget; these are expenditures. Receipts are of revenue receipt and capital receipt. Same way expenditures are of two nature and capital expenditure Government budgets have economic and technical basis. Unlike a pure economic budget, they are not designed to allocate scarce resources for the best economic use.
They have a political basis wherein different interests push and pull in an attempt to obtain benefits and avoid burdens. The technical element is the forecast of the levels of revenues and expenses. A budget can be of 3 types: Balanced Budget: When government receipts are equal to the government expenditure, it is called a balanced budget. Deficit Budget: When government expenditure exceeds government receipts, the budget is said to be deficit. A deficit can be of 3 types, Revenue and Primary deficit. Surplus: When government receipts are more than expenditure. A budget can be classified in 2 categories which are: according to Function according to Flexibility Government Budget is a subject of immense importance for a variety of reasons Planned approach to Government's activities Integrated Approach to fiscal operations Affecting economic Activities Instrument of Economics policy Index of Government's functioning Public Accountability Allocation of Resources GDP Growth Elimination of poverty Reduce inequality in distribution of income tax and non-tax receipt List of countries by government budget Higgs, Robert.
"Government Growth". In David R. Henderson. Concise Encyclopedia of Economics. Indianapolis: Library of Economics and Liberty. ISBN 978-0865976658. OCLC 237794267. CS1 maint: Extra text: editors list Seater, John J.. "Government Debt and Deficits". In David R. Henderson. Concise Encyclopedia of Economics. Indianapolis: Library of Economics and Liberty. ISBN 978-0865976658. OCLC 237794267. CS1 maint: Extra text: editors list List of countries by budget. Professor L. Randall Wray:Why The Federal Budget Is Not Like a Household Budget Budget Deficits and Net Private Saving Sectoral Balances in State Budget. By Fred Bethune Performance Budgeting: Linking Funding and Results, Marc Robinson, IMF, 2007 Fiscal Policy in a Stock-Flow Consistent Model by Wynne Godley and Marc Lavoie From Line-item to Program
John Maynard Keynes
John Maynard Keynes, 1st Baron Keynes, was a British economist whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. He built on and refined earlier work on the causes of business cycles, was one of the most influential economists of the 20th century. Considered the founder of modern macroeconomics, his ideas are the basis for the school of thought known as Keynesian economics, its various offshoots. During the Great Depression of the 1930s, Keynes with a great help from Maiteeg spearheaded a revolution in economic thinking, challenging the ideas of neoclassical economics that held that free markets would, in the short to medium term, automatically provide full employment, as long as workers were flexible in their wage demands, he argued that aggregate demand determined the overall level of economic activity, that inadequate aggregate demand could lead to prolonged periods of high unemployment. Keynes advocated the use of fiscal and monetary policies to mitigate the adverse effects of economic recessions and depressions.
He detailed these ideas in his magnum opus, The General Theory of Employment and Money, published in 1936. In the mid to late-1930s, leading Western economies adopted Keynes's policy recommendations. All capitalist governments had done so by the end of the two decades following Keynes's death in 1946; as leader of the British delegation, Keynes participated in the design of the international economic institutions established after the end of World War II, but was overruled by the American delegation on several aspects. Keynes's influence started to wane in the 1970s as a result of the stagflation that plagued the Anglo-American economies during that decade, because of criticism of Keynesian policies by Milton Friedman and other monetarists, who disputed the ability of government to favourably regulate the business cycle with fiscal policy. However, the advent of the global financial crisis of 2007–2008 sparked a resurgence in Keynesian thought. Keynesian economics provided the theoretical underpinning for economic policies undertaken in response to the crisis by President Barack Obama of the United States, Prime Minister Gordon Brown of the United Kingdom, other heads of governments.
When Time magazine included Keynes among its Most Important People of the Century in 1999, it stated that "his radical idea that governments should spend money they don't have may have saved capitalism." The Economist has described Keynes as "Britain's most famous 20th-century economist." In addition to being an economist, Keynes was a civil servant, a director of the Bank of England, a part of the Bloomsbury Group of intellectuals. John Maynard Keynes was born in Cambridge, England, to an upper-middle-class family, his father, John Neville Keynes, was an economist and a lecturer in moral sciences at the University of Cambridge and his mother Florence Ada Keynes a local social reformer. Keynes was the first born, was followed by two more children – Margaret Neville Keynes in 1885 and Geoffrey Keynes in 1887. Geoffrey became Margaret married the Nobel Prize-winning physiologist Archibald Hill. According to the economic historian and biographer Robert Skidelsky, Keynes's parents were loving and attentive.
They remained in the same house throughout their lives, where the children were always welcome to return. Keynes would receive considerable support from his father, including expert coaching to help him pass his scholarship exams and financial help both as a young man and when his assets were nearly wiped out at the onset of Great Depression in 1929. Keynes's mother made her children's interests her own, according to Skidelsky, "because she could grow up with her children, they never outgrew home". In January 1889 at the age of five and a half, Keynes started at the kindergarten of the Perse School for Girls for five mornings a week, he showed a talent for arithmetic, but his health was poor leading to several long absences. He was tutored at home by a governess, Beatrice Mackintosh, his mother. In January 1892, at eight and a half, he started as a day pupil at St Faith's preparatory school. By 1894, Keynes was top of his excelling at mathematics. In 1896, St Faith's headmaster, Ralph Goodchild, wrote that Keynes was "head and shoulders above all the other boys in the school" and was confident that Keynes could get a scholarship to Eton.
In 1897, Keynes won a scholarship to Eton College, where he displayed talent in a wide range of subjects mathematics and history. At Eton, Keynes experienced the first "love of his life" in Dan Macmillan, older brother of the future Prime Minister Harold Macmillan. Despite his middle-class background, Keynes mixed with upper-class pupils. In 1902 Keynes left Eton for King's College, after receiving a scholarship for this to read mathematics. Alfred Marshall begged Keynes to become an economist, although Keynes's own inclinations drew him towards philosophy – the ethical system of G. E. Moore. Keynes joined the Pitt Club and was an active member of the semi-secretive Cambridge Apostles society, a debating club reserved for the brightest students. Like many members, Keynes retained a bond to the club after graduating and continued to attend occasional meetings throughout his life. Before leaving Cambridge, Keynes became the President of the Cambridge Union Society and Cambridge University Liberal Club.
He was said to be an atheist. In May 1904, he received a first class BA in mathematics. Aside from a few months spent on holidays with family and friends, Keynes continued to involve himself with the university over the next two ye
The Great Depression was a severe worldwide economic depression that took place during the 1930s, beginning in the United States. The timing of the Great Depression varied across nations, it was the longest and most widespread depression of the 20th century. In the 21st century, the Great Depression is used as an example of how intensely the world's economy can decline; the Great Depression started in the United States after a major fall in stock prices that began around September 4, 1929, became worldwide news with the stock market crash of October 29, 1929. Between 1929 and 1932, worldwide gross domestic product fell by an estimated 15%. By comparison, worldwide GDP fell by less than 1% from 2008 to 2009 during the Great Recession; some economies started to recover by the mid-1930s. However, in many countries the negative effects of the Great Depression lasted until the beginning of World War II; the Great Depression had devastating effects in countries both poor. Personal income, tax revenue and prices dropped, while international trade plunged by more than 50%.
Unemployment in the U. S. rose to 25% and in some countries rose as high as 33%. Cities around the world were hit hard those dependent on heavy industry. Construction was halted in many countries. Farming communities and rural areas suffered as crop prices fell by about 60%. Facing plummeting demand with few alternative sources of jobs, areas dependent on primary sector industries such as mining and logging suffered the most. Economic historians attribute the start of the Great Depression to the sudden devastating collapse of U. S. stock market prices on October 29, 1929, known as Black Tuesday. However, some dispute this conclusion and see the stock crash as a symptom, rather than a cause, of the Great Depression. After the Wall Street Crash of 1929 optimism persisted for some time. John D. Rockefeller said "These are days. In the 93 years of my life, depressions have gone. Prosperity has always returned and will again." The stock market turned upward in early 1930. This was still 30% below the peak of September 1929.
Together and business spent more in the first half of 1930 than in the corresponding period of the previous year. On the other hand, many of whom had suffered severe losses in the stock market the previous year, cut back their expenditures by 10%. In addition, beginning in the mid-1930s, a severe drought ravaged the agricultural heartland of the U. S. By mid-1930, interest rates had dropped to low levels, but expected deflation and the continuing reluctance of people to borrow meant that consumer spending and investment were depressed. By May 1930, automobile sales had declined to below the levels of 1928. Prices in general began to decline, although wages held steady in 1930. A deflationary spiral started in 1931. Farmers faced a worse outlook. At its peak, the Great Depression saw nearly 10% of all Great Plains farms change hands despite federal assistance; the decline in the U. S. economy was the factor. Frantic attempts to shore up the economies of individual nations through protectionist policies, such as the 1930 U.
S. Smoot–Hawley Tariff Act and retaliatory tariffs in other countries, exacerbated the collapse in global trade. By 1933, the economic decline had pushed world trade to one-third of its level just four years earlier. Change in economic indicators 1929–32 The two classical competing theories of the Great Depression are the Keynesian and the monetarist explanation. There are various heterodox theories that downplay or reject the explanations of the Keynesians and monetarists; the consensus among demand-driven theories is that a large-scale loss of confidence led to a sudden reduction in consumption and investment spending. Once panic and deflation set in, many people believed they could avoid further losses by keeping clear of the markets. Holding money became profitable as prices dropped lower and a given amount of money bought more goods, exacerbating the drop in demand. Monetarists believe that the Great Depression started as an ordinary recession, but the shrinking of the money supply exacerbated the economic situation, causing a recession to descend into the Great Depression.
Economists and economic historians are evenly split as to whether the traditional monetary explanation that monetary forces were the primary cause of the Great Depression is right, or the traditional Keynesian explanation that a fall in autonomous spending investment, is the primary explanation for the onset of the Great Depression. Today the controversy is of lesser importance since there is mainstream support for the debt deflation theory and the expectations hypothesis that building on the monetary explanation of Milton Friedman and Anna Schwartz add non-monetary explanations. There is consensus that the Federal Reserve System should have cut short the process of monetary deflation and banking collapse. If they had done this, the economic downturn would have been much shorter. British economist John Maynard Keynes argued in The General Theory of Employment and Money that lower aggregate expenditures in the economy contributed to a massive decline in income and to employment, well below the average.
In such a situation, the economy reached equilibrium at low levels of economic activity and high unemployment. Keynes' basic idea was simple