What is the biggest lesson from the Great Depression? In my view, it i

What is the biggest lesson from the Great Depression? In my view, it is that monetary policy and the financial sector play a crucial role in economic development. One important component of the monetary policy is the financial market, more specifically the banking sector.

Why are financial markets and the banking sector so important? Banks fulfill a very important role in the economy by matching borrowers and lenders. When we deposit $100 in a bank, the bank keeps, at most, two to three dollars in its vaults (some of this is actually kept with the central bank), the remaining $98 or so are lent to a borrower.

Most businesses require loans for their normal operations. When the banking sector does not work properly, businesses cannot get loans and they have to curtail their production and lay off workers. As they curtail production, they demand fewer products from their suppliers and therefore their suppliers have to reduce their output and fire workers. If manufacturers cannot sell their goods because the firm downstream does not need as many products as before, they cannot generate enough revenue to repay their earlier loans. Businesses go bankrupt and banks experience further problems as their balance sheet deteriorates due to non performing loans. At this point, banks want to lend even less because of the uncertainty generated from bankruptcies. As they lend less, the vicious circle continues – with producers cutting production and firing workers. On top of this, depositors start worrying about their deposits because the non-performing loans have made some banks go belly up – your bank has lent out your money to borrowers who cannot return it. Depositors start withdrawing their cash and banks have even fewer possibilities for lending as they have to hoard cash in case there is a run on the bank. If the financial sector does not work, the real economy can go into a deadly spiral and shrink by 30 per cent as during the Great Depression.

One would have thought that this fact would be obvious to all the policy makers. However all the lessons from the Great Depression seem to have been lost within three-quarters of a century. It seems, to paraphrase Marc Bard, that politics (especially of the petty and partisan variety) eats policy for lunch seven days a week.

1. What is the main purpose of the author in writing the passage?

(A) To explain how banks and other financial institutions function
(B) To discuss the lessons learnt from the Great Depression
(C) To argue that banks and manufacturing businesses are interdependent
(D) To criticise a group of people for not learning from the lessons of the Great Depression
(E) To conclude that people give preference to politics over policies


2. According to the information in the passage, which of the following can be inferred?

(A) Banks are short of cash most of the time
(B) Banks do not like to keep money with the central bank
(C) Banks do not like to keep large amounts of money in their vaults
(D) Banks usually keep some money with the central bank
(E) Banks actually fool the customers


3. In the last paragraph, the tone of the author is

(A) Adulatory
(B) Optimistic
(C) Critical
(D) Analytical
(E) Ridiculing