Keynesian Solution

According to Keynes the Great Depression was caused by shortfall in effective demand. If the demand is insufficient for the economy then the factories will close down and there will be surplus labor but not sufficient demand for it. One of his solution was to use monetary policy as if the level of money in the economy is increased then it will increase the demand and the supply will also respond to this so, factories will start working again which will lead to full employment. However, Keynes said that in some situations economies can be following to liquidity trap which means that when people get more money than instead of spending it and store it because so they are so deeply in the hole that they want to save money to protect their future.

So instead of spending it they just save it for precautionary demand. In such situation pumping money into the economy will not work so then he argued that we should do fiscal policy which is basically the government directly engages in making investments, public works, project, and hire people which will lead to more demand. Once the greater demand works into being then government can leave off. It is same as the working of water pump as when there is air in the pump then we have to put little water in it to work it properly. Similarly, fiscal policy is not kind of permanent thing but once the right amount of demand is created then government can leave and private sector will take over.