Investment, Recessions, and the Depression

Keynes thought that declining investment was an important cause of the Great Depression and similar events. But there was a problem with that explanation: Investment is a relatively small component of total income, and despite its "volatility," the changes in investment were of less magnitude than the changes in income that they were supposed to explain. But the discovery of the "multiplier effect" was a solution to that problem. The "multiplier effect" explained why income fluctuated even more than investment. With a "multiplier effect," the effect could be greater than the cause.

We do know that as the Great Depression continued into 1931-2, gross investment dropped to essentially zero, making an already bad situation worse still. Whether a drop in investment was involved at the start, the crash of investment spending contributed to the severity of the great depression.

Of course, an increase in investment will also have a "multiplier effect," and perhaps lead to a boom. Historically, many booms have been led by surges of investment. In general, Keynesian economists (and indeed most others) regard changes in investment as major factors leading to economic fluctuations, both recessions and recoveries.

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