Current Economic Crisis according to Schumpeter and Keynes
A justification of the economic crisis can be precisely explained by shedding light on the perspectives of famous economists. The information gained through this method will not only be informative but will also motivate further research. The two economic theorists chosen are Joseph Schumpeter and John Maynard Keynes (Blankenburg & Palma, 2009). Their thoughts appear to be most pertinent to this crisis. Keynes presents a very keen insight into the crisis through his rationalization of market psychology and concentration on cumulative demand. On the other hand, Schumpeter's thought on improvement and business cycle offers a different informative justification.
The existing economic crisis has its origin rooted in the assumption about the real estate sector. The review of the incidents that have happened, began with the permission of quite low interest rates to financial institutions for borrowing. By a small Federal Funds Rate, financial institutions were capable of presenting credits on smaller rates of interest, which raised the demand for houses. As a result, this boosted the real estate prices (Foster & Magdoff, 2009). With the extensive securitizing, banks were currently capable of presenting mortgages that they considered almost 'free of risk' (Krugman, 2009). This was in view of the fact that they would end up selling it via securitization and gaining the transactions costs. This led banks to look for techniques for offering more credit options. The reason behind it was that they were gaining from the transaction costs instead of the interest fees. They achieved this by presenting highly uncertain 'sub-prime' mortgages to individuals who would not have been eligible for conventional mortgages.
As interest rates started to go up again, huge totals of mortgage non-payments took place. This caused not only big failures in the banks that credited the initial investments, but also in financial institutions that acquired securities financed by these mortgages (Ingham, 2003). As failures and losses went up, banks rejected requests for any additional amount for loans. This resulted in the incapacitation of the credit market. With no access to credit, every sector of the financial system would start to decline, and the financial system would move in the direction of recession (Dillard, 2005).
From the start of the existing financial crisis, no economist's name has been stated more in comparison to John Maynard Keynes. Keynes is acknowledged for bringing out the ideas that would assist in the restoration of the global financial system from the Great Depression. His ideas also aided in eternally transforming the method adopted by the governments regarding economic strategy (Dabic et al., 2011). If Keynes were writing now, his analysis of the economic crisis would be divided in three components. The first component would be the way psychology of the monetary markets created the economic crisis. The second component would be the way financial collapse manifested itself through lack of aggregate demand. The third and final component would be the extent of the economic crisis in addition to uselessness of financial strategy to be sourced by a liquidity trap (Bezemer, 2009).
As mentioned previously, when the housing real estate bubble burst, it caused losses all over the economic structure and brought the credit market to a standstill. This created a number of the actual outcomes of depression to be observed, sluggish increase in gross domestic product and rise in the rate of unemployment. According to Keynes evaluation, what had taken place was a drop within aggregate demand. Future prospects for jobs are automatically restricted by the level of aggregate demand. Aggregate demand can be originated simply from existing usage or from existing opportunity for potential usage (Bibow, 2009). With the drop of the real estate sector, customer demand reduced. This was due to the lack of demand for new housing units. In addition, that home values went down. Hence, individuals could not get a loan against the equity in their house in addition to common restrains in expenditure because of their apparent lower assets. Simultaneously, with the standstill situation of the credit markets it became more trickier for businesses to get loans for starting up and/or for spreading out their operations, causing a decline in investment. Reduced customer consumption as well as investment caused a drop in cumulative demand and dragged the financial system farther from complete employment.
According to Keynes, there is the likelihood that, after the rate of interest has dropped to a particular level; the liquidity inclination may become "nearly absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest" (Gregg, 2010). In this occurrence, the economic power would have lost efficient control on the rate of interest. At this point, he assumed a condition where interest rates were so small that any further decrease in the interest rate would be unsuccessful to fuel the financial system. This is because there is an inclination to "holding cash over lending it out" (Gregg, 2010, p. 443). This is what appeared to take place within the credit market during the existing economic crisis.
The Federal Reserve decreased interest rates to the minimum level that it could. However, it did not witness the outcomes. Keynes advice at this point would be that since financial policy cannot be successful, economic policy must be employed. The government will have to raise its expenditure to compensate the deficit in consumption as well as in investment. As a result, they will have to get the financial system back to full employment (Leijonhufvud, 2009).
Schumpeter's evaluation of the economic crisis is one that is a lot more unconventional. According to Schumpeter's opinion, the key to economic development is the capitalist. He innovates as well as drives the financial system ahead. Any existing formation and situation of doing business are constantly modifying. All conditions are being disturbed earlier than "it has had time to work itself out" (Audretsch & Link, 2012, p. 9).
Financial development, within an industrialist society, represents disorder. Schumpeter had recognized that for development to take place as contrasting to the financial system stuck at a "stationary point of equilibrium," (Audretsch & Link, p. 10) transformation is required. This is for considering the rise in production. According to him, that essential transformation was the improvement from industrialists. This point of improvement would be the time of economic growth. Therefore, as others started to implement the advancements of successful industrialists, the revenues of those innovators will drop initiating economic crisis.
In accordance with the Schumpeterian view, the economic growth which "occurred leading up to the crisis was caused by innovation" (Kurz, 2010, p. 99). The single variation is rather better than collective technical improvements. The improvements took place within the financial structure. Rather than being done by industrialists, it was done by big financial institutions. The improvement of financial securitization stimulated obvious financial development by declaring to reduce risk to different sectors. As a result, it permitted additional resources for consumption and investment to be lent. The subsequent half of his evaluation- the reason behind the economic bust - is diverse. Then what would be considered in earlier economic crisis to some extent (Skidelsky, 2010). During the existing financial crisis, the modernization of monetary securitization was approved by other businesses. However, this did not result in a reduction in prices as well as economic recession similar to Schumpeter's evaluation indicates. Instead, what occurred took place when the real estate bubble burst, it became unattainable to offer mortgages and securitize them to any further extent, at least at nowhere even near to the earlier rate. What had taken place was the improvement that had slowed the economic development was no longer there and with no fresh innovation to substitute it an economic bust happened (Whalen, 2012).
Keynes as well as Schumpeter provide quite interesting ideas regarding the economic crisis. Keynes' analysis, concentrates more on aggregate demand, is a lot more conventional one, and is the leading perspective in economic thought. On the other hand, Schumpeter's concentration on modernization, although not extensively argued, provides fine insight into the way economic booms and busts can take place. With analysis that appears almost contradictory with one another, it is possible that neither Keynes nor Schumpeter is very accurate, and a comprehensive account of the crisis should depend on the suggestions of both (Kurz, 2012).
Current Economic Crisis according to Adam Smith
During the year 2003, the World Bank estimated that there had been more than 115 systemic banking disasters during late 70s and mid of the twentieth century. All this happened earlier than the existing round of bank collapse. To have one crisis may have been a hard luck. However, to have had 117 was certainly the outcome of extreme negligence (Bortis, 2009). Nonetheless, the rate of these disasters indicates a structural concern within the international financial and banking structure.
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