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The financial crisis of 2007–2008, also known as the global financial crisis and the 2008 economic crisis, is considered to have been the worst financial crisis since the Great Depression of the 1930s by many well renowned economists. There are many factors that contributed towards the financial crisis but some of the main one was the fact that banks created huge sums of new money by making loans and they had doubled the amount of money and debt in the economy in just seven years. As a result of this, they used that money to increase prices of houses and speculate on financial markets. Eventually, all the debts became unpayable, which all in all caused the financial crisis. After the crisis, banks had refused refuse to lend any money, so by default the economy shrank.
The Neoclassical economic school of thought also referred to as “Saltwater” economics often revolves around profit maximisation. It’s an approach to economics that relates supply and demand to an individual’s rationality and his or her ability to maximise utility or profit. Neoclassical economics also increased the use of mathematical equations in the study or various aspects of the economy. Since its inception, neoclassical economics has grown to become the primary take on modern day economics.
Neoclassical or Saltwater economics believes that eventually over time, the economy will change its gross domestic products also known as GDP and the rate of unemployment will decrease. Neoclassical economics states that the economy will slowly come out of recession on its own and that any interference or intervention from the government is not required.
In the moment where the crisis first occurred politicians and economists who had been taken in by the neoclassical school of economics, immediately realised their mistake and had decided on three things in order to get out of this crisis: the first this was to drastically increase liquidity by reducing the basic interest rate of any loans by all possible means, since the crisis meant there would be a major credit crunch following the general loss of confidence in banks and consumers caused by the crisis. The second thing was to try and “save” and recapitalise the big major banks, because they are quasi-public institutions which means that they are essentially public corporations but are under private ownership control, which also means that they cannot go bankrupt and the last thing was to re-regulate the financial system, domestically and internationally.
Austrian economists believe that the Austrian school of economics is not an ideology but a way of scientific thinking, as they believe economics is a social science. Austrian economics states that free prices, private ownership of the means of production and free trade allow for the most effective allocation of scarce resources.
The Austrian perspective on managing recession or any type of financial crisis is extremely similar to the Neoclassical approach because they both believe in a free market economy, which means that they don’t want any government intervention because they believe that when the government intervene they usually create more issues and problems because they try to stimulate demand, which leads to unused and wasted resources and it also wastes time.
The Austrian perspective also believes that recessions are not the best thing for the economy, but they believe it’s beneficial for the economy to flourish as it’s a corrective process and it is needed to help stimulate the economy, therefore once the economy comes out of recession, it is more stable and will gradually balance itself out. Austrian economists blame the cause of the financial crisis on the federals monetary policies, which then resulted in a major housing bubble which means that there was a sudden rapid increase in housing price which was fuelled by demand, which then resulted later into a global financial crisis.
The Austrian economic school of thought also believe that there should have been a really bad recession after the 9/11 attacks due to the fact that trillions of dollars were wiped out in terms of wealth but the reason they didn’t was due to the fact that American economist, Alan Greenspan “came to the rescue” and brought the all the interest rates down essentially “saving” the economy from going into a recession or financial crisis at the time. But then when the 2008 economic crisis occurred, people realised that Greenspan didn’t actually save the economy, he just replaced the collapsing “dot com bubble” with a “housing bubble” which bought the world a few years of false prosperity.
Post Keynesian economics also known as called Keynesianism describes the economic theories and thoughts of John Maynard Keynes. Keynes believed that capitalism is the best economic system. In a capitalist system, people earn money from their work. Businesses employ and pay people to work. Then people can spend their money on things they want.
Keynes felt like recessions and economic crisis’ could last a long time, and he believed this for many reasons. He spread the idea of a negative multiplier effect; which is the idea that a decrease in additions into the economy has a knock-on effect and the last impact could be worse than the initial. If a firm reduces investment, people lose their jobs, and this higher rate of unemployment leads to lower spending and affects everyone in the economy. Also, if there is an initial fall in investment, businessmen may have less confidence, which could potentially lead them to they fear recession and lower profits, so they cut back on investment. Another way that they will cut back on investments is that if savings are high and consumers spending is low, firms will have a lot of unsold goods.
Keynes once famously said: “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas”
This shows that the global financial crisis of 2008 had proved him right, although it is was in a manner that he would have despised. He believed that the 2008 financial crisis and the recession in the real economy were both made possible by the political influence of incorrect economic ideas.
In conclusion I believe the economic school of thought that has most convincing argument for the causes of the financial crisis is the Post Keynesian school. This is because the Keynesian idea is to prevent recessions and any sort of economic crises at all costs because recessions involve negative economic growth, which is obviously detrimental to the economy. The most unconvincing argument out of the three schools is the I would say is from the Neoclassical School of thought as not one neoclassical economist was able to foresee or predict the economic crisis resulting in the great recession. As Professor Steve Keen has stated in his book: neoclassical economists are “wedded to the belief that capitalism is inherently stable.